Blue-chip shares in Britain fell by 5% on Wednesday to their lowest close in over a month.
Banks in particular were hit after Morgan Stanley said HSBC, the biggest bank in Europe, may have to raise as much as $US30 billion in capital and halve its dividend.
Barclays fell 14.4% after announcing a further 2100 job cuts in addition to 2500 job losses announced on Tuesday.
Deutsche Bank announced a loss of about 4.8 billion euros in the final quarter of 2008.
HSBC slipped 8%. Royal Bank of Scotland was down 18.4% while HBOS and Standard Chartered also slumped, losing between 10.7% - 13.5% respectively. Lloyds TSB fell 11.9%.
The FTSE 100 closed down 218.51 points at 4,180.64, falling for its sixth consecutive session. The index is down 5.8% so far this month after falling more than 31% last year.
Mining shares were also heavy losers, as metal prices fell. Rio Tinto, Xtsrata, Anglo-American, BHP Billiton, Antofagasta, Kazakhmys and Eurasian fell between 6.6% - 11.7%.
Shares on Wall Street were also down after data showed that consumers in the United States cut their spending more sharply than expected.
Retail sales fell by 2.7% in December after a revised drop of 2.1% in November.
European shares also closed lower on Wednesday for the sixth consecutive session.
The FTSEurofirst 300 index of top European shares fell 4.3% to 804.17 points.
In Frankfurt, the DAX index ended at 4,422.35 points, down 214.59 or 4.63%. In Paris, the CAC-40 index closed at 3,052 points, down 145.89 or 4.56%.
The Swiss market index closed at 5,378.81 points, down 155.52 or 2.81%.
In Japan, the Nikkei index rose 24.54 points, 0.3%, to 8,438.45 as exporters rebounded after falls the day before.
Shares in Hong Kong finish 0.3% higher. The Hang Seng Index closed 36.56 points higher at 13,704.61 after a six-day slide.
Australian shares closed 0.9% higher. The S&P/ASX 200 index rose 32.4 points to 3,687.0, ending a two-day losing run.