HBOS predicted tough times ahead for the economy as profit fell 72 per cent to £848 million for the first half.
Underlying pre-tax profits were significantly affected by a £1.095 billion writedown following the credit crunch, the lender said.
Losses from bad debts increased by 36 per cent to £1.310 billion, from £963 million in the first half of last year, HBOS added.
The lender is "cautious" about the outlook for global financial markets and said it is adapting for a tougher economy.
Yesterday, rival Lloyds TSB shocked the market with a 70 per cent decline in profit.
Chief executive Andy Hornby said: "The first half of 2008 has seen the dislocation in financial markets evolve into a wider economic slowdown."
The decline in house prices over the first half of the year has prompted HBOS to tighten its lending criteria, and the average loan-to-value on its books is now 48 per cent.
The bank's prediction for the UK economy is somewhat gloomier than other forecasts. HBOS said the UK's GDP will continue to grow this year but there is a risk the economy will shrink in 2009, signalling a recession.
Unemployment is also set to rise, the lender predicts.
As for house prices, HBOS sees a decline in the range of between 15-20 per cent over 2008 and 2009, and expects a rise in mortgage arrears.
The group, which operates Halifax and Bank of Scotland, announced a £4 billion rights issue during the period to boost its capital.
However, its share price fell below the issue value and only eight per cent of shareholders took up the offer. It was left to the bank's underwriters to buy the rest.
The bank's tier 1 ratio, a measure of its financial strength, is now at 8.6 per cent, compared to 7.3 per cent without the rights issue.