Sensor technology developments provide a basis for effective fault diagnosis in manufacturing systems. However, the limited number of sensors due to physical constraints or undue costs hinders the accurate diagnosis in the actual process. In addition, time-varying operational conditions that generate nonstationary process faults and the correlation information in the process require to consider for accurate fault diagnosis in the manufacturing systems. This article proposes a novel fault diagnosis method: clustering spatially correlated sparse Bayesian learning (CSSBL), and explicitly demonstrates its applicability in a multistation assembly system that is vulnerable to the above challenges. Specifically, the method is based on a practical assumption that it will likely have a few process faults (sparse). In addition, the hierarchical structure of CSSBL has several parameterized prior distributions to address the above challenges. As posterior distributions of process faults do not have closed form, this paper derives approximate posterior distributions through Variational Bayes inference. The proposed method's efficacy is provided through numerical and real-world case studies utilizing an actual autobody assembly system. The generalizability of the proposed method allows the technique to be applied in fault diagnosis in other domains, including communication and healthcare systems.