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* TSX falls 1.5 percent to 11,348.02
* Banking and energy issues drop steeply
* Golds advance from relative safety bid
* LIBOR rates at highest since July 2009 (Adds details)
TORONTO, May 25 (Reuters) - Toronto's main stock index dropped on Tuesday morning as worries over Europe's banking sector and North Korea's threatened military action against the South pulled financial and energy shares sharply lower.
Canadian banks, even with limited exposure to European debt, were caught up in a global selloff of bank shares as concerns mounted that the debt crisis could worsen after the Bank of Spain rescued a local lender over the weekend.
Meanwhile, funding conditions for banks have been tightening, with institutions in the United States increasingly reluctant to deal with firms with large exposure to Europe.
Three-month dollar LIBOR rates USD3MFSR= rose to their highest level since late July 2009. [MMT/]
All of the index's banks were sharply lower, led by Royal Bank of Canada (RY.TO), the country's biggest lender, down 2.1 percent at C$58.21, while No. 2 Toronto-Dominion Bank (TD.TO) fell 1.75 percent to C$70.25.
The sector, down nearly 2 percent, will be closely watched in the short term as the banks are expected to report another string of strong profits for their second quarter. Results start coming in on Wednesday. [ID:nN25118426]
At 10:05 a.m. (1405 GMT), the Toronto Stock Exchange's S&P/TSX composite index .GSPTSE was down 173.33 points, or 1.5 percent, at 11,348.02. It fell more than 2 percent shortly after the open.
Nine of the index's 10 main groups were lower, with eight showing declines of 1 percent or more.
"The selling is right across the board. I don't see too many sectors that are strong outside of a couple of gold names," said Bruce Latimer, trader at Dundee Securities.
The resource groups also saw deep declines to track a slide in the price of oil towards $67 a barrel in reaction to the possibility of military conflict between North and South Korea. Metals such as copper, platinum and palladium also tumbled.
The nervousness stemmed from increasing tensions as North Korea threatened military action if the South continued to violate the waters off its west coast. [ID:nSGE64O03B]
Safe haven demand for gold kept the price of the precious metal steady near $1,190 an ounce, and some gold-mining stocks were among the key advancers. That made the materials group the index's lone rising sector, up 0.33 percent.
Barrick Gold (ABX.TO) gained 3.6 percent to C$44.95, while Goldcorp (G.TO) rose 2.9 percent to C$44.63. Kinross (K.TO) was up 2.3 percent at C$17.99, and Yamana Gold (YRI.TO) climbed 3.5 percent to C$10.98.
On the downside, base-metals miner Teck Resources TCKb.TO was down 5.24 percent at C$31.98 and fertilizer producer Potash Corp (POT.TO) was off 1.9 percent at C$101.77.
First Quantum Minerals (FM.TO) sagged 16.5 percent to C$52.40 after the miner suffered a new legal setback to its Congo business with a court ruling to annul its rights to two copper mines in the south of the country. [ID:nLDE64L0CZ]
$1=$1.08 Canadian Reporting by Ka Yan Ng; editing by Peter Galloway