The FTSE 100 plunged 3.49 per cent in early trading, hitting 3,696.54 by 08:40 GMT as investors lost confidence in banking stocks.
Shares in Royal Bank of Scotland dropped 14.22 per cent to 19.9p, as the row over former chief executive Sir Fred Goodwin's pension continues to rage.
Meanwhile, HSBC, which has appeared to handle the crisis better than most banks, this morning revealed it would be raising cash through shareholders, sending shares falling by 10.99 per cent to 437.25p.
Lloyds Banking Group also continues to fall, tumbling 9.78 per cent to 52.60p.
Few stocks were trading higher on the index, with insurer Amlin rising 1.38 per cent and Tate & Lyle up 0.66 per cent.
In the US, the banking sector also led to a sharp fall in stocks, after the government confirmed it would increase its stake in Citigroup, diluting the value of its shares.
The Dow Jones index ended 1.7 per cent lower, while the S&P 500 was off 2.4 per cent.
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