Investors' confidence was hit from all sides as the health of Europe's banking sector moved deeper into critical territory.
The FTSE 100 Index was 2.6% lower, closing below the 5,000-point mark for the first time since July 2010, after a shock profit warning from Germany's Deutsche Bank added to fears of a Greek debt default.
The Deutsche Bank update came as French and Belgian officials fought for the future of Belgian lender Dexia, as it buckles under the weight of its exposure to Greece's burgeoning debt pile.
EU finance ministers earlier said Greece will have to wait until November for its next eight billion euro (£6.8 billion) bailout loan after the country said it would miss its deficit-reduction targets.
Elsewhere, official figures showed a decline in US factory orders in August, with the worse-than-expected figures fuelling concerns over the health of the world's largest economy.
Deutsche Bank - one of the world's largest banks - said its third quarter earnings would be substantially lower than expected due to market turbulence and more charges on Greek government debt.
Meanwhile, the governments of France, Belgium and Luxembourg vowed to prop up Dexia bank and insure every cent of its deposits as its share price continued to slide on the Brussels Stock Exchange. The bank may be forced to spin off assets in order to shore up its balance sheet after its credit rating was put under review.
Elsewhere, investment bank Goldman Sachs hit sentiment as it forecast a "mild recession" for the eurozone area.
The banking sector dragged the London market lower as a result, with Barclays down 8%, Royal Bank of Scotland off 1% and Lloyds Banking Group dropping 2%.
A speech from US Federal Reserve chairman Ben Bernanke had no immediate impact on the US market, where Standard & Poor's 500 Index fell into official "bear market" territory, defined as a 20% fall from the highs in April.