Fears that Spain is on the verge of asking for a full-blown bailout from the EU triggered a rout on world markets.
The FTSE 100 Index fell 117.9 points, or 2.1%, to 5533.9 amid worries that a raft of Spanish regions were poised to ask for government bailout funds, increasing the likelihood that the country itself will turn to the EU for help.
The fall wiped nearly £30 billion from the value of London's leading shares index, with all 100 companies losing value and banks falling up to 4%.
Greece also returned to focus as officials from the EU, European Central Bank (ECB) and International Monetary Fund (IMF) prepared to meet with the country's government to discuss progress with its budget pledges.
If Greece is unable to deliver the spending cuts and tax reforms necessary then the so-called troika are unlikely to be forthcoming with further aid and a Greek exit from the single currency bloc will be back on the cards.
Wall Street's Dow Jones Industrial Average was 1.2% lower as the London market closed, and France's Cac40 and Germany's Dax were down about 3%.
But there was good news for holidaymakers heading to the Continent, as the pound rose to 1.28 against the euro after the single currency was hit by the latest fears over its future. But Sterling was down against the dollar at 1.55.
In London, Financial stocks came under pressure with Aviva falling nearly 7% or 19.5p to 275.2p, and Barclays dropping 4%, or 6.7p to 152.6p.
Outside the top flight, Domino's Pizza Group fell 2% despite unveiling a jump in sales and profits after the Euro 2012 football tournament and record rainfall prompted Britons to stay at home. Shares dropped 12.5p to 506.5p although the group said pre-tax profits rose 15% to £23.3 million in the 26 weeks to June 24, while like-for-like sales in the UK rose 5.7%.
There were no risers. The biggest Footsie fallers were Evraz down 16.3p at 218.1p, Aviva off 19.5p at 275.2p, Vedanta Resources down 45.5p at 835p, and Hargreaves Lansdown off 26.5p at 548p.
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