The FTSE 100 blue-chip index in London closed down 2.6 per cent, or 160.5 points, a whisker above the psychologically- important 6,000 level.
That followed a 72 point fall in the index on Tuesday. The Footsie is down 3.5 per cent on where it started 2007 following its 10 per cent rise in 2006.
HBOS, the Halifax/Bank of Scotland group that is Britain's biggest mortgage lender, closed down 5.7 per cent at 1,017p.
Royal Bank of Scotland was off 4.5 per cent at 1,955p. Other banks to register falls included Barclays, down 4.6 per cent, and Northern Rock, off 2.7 per cent.
In Tokyo, the Nikkei average lost 2.92 per cent of its value, its second-biggest percentage fall this year.
Local analysts said concern about the turmoil in the US sub-prime market was exacerbated by exporters such as Honda sliding on worries about a higher yen.
On Wall Street, the Dow reversed earlier slides, finishing up 57.12 points
, but the banks there took a hit as well.
Lehman Brothers lost a further 3.6 per cent after falling 5 per cent, like rival Morgan Stanley, on Tuesday.
Banks were also the main contributors to a 2.5 per cent fall on the broad FTSEurofirst 300 stock index, with Credit Suisse ending down 4.4 per cent and UBS 3.9 per cent lower.
Meanwhile, New Century Financial Corp., the largest independent US sub-prime mortgage lender, said its lenders plan to halt financing, pushing the company closer to bankruptcy amid dwindling cash and $8.4 billion in obligations.
Morgan Stanley is New Century's biggest lender, but Europe's Credit Suisse, UBS and Barclays have all provided credit.
Antony Broadbent, an analyst at Sanford Bernstein in London, said "a multitude of possible sources of exposure" made it difficult to quantify the exposure of banks to problem loans.
He said: "It's unlikely to be a major issue [for the UK banks] but we need more information to be completely confident."
He said the reaction of share prices was understandable given the extent of the uncertainty.
Jimmy Yates, a trader at CMC Markets, said: "The fact that Wall Street has stabilised in early trade is without doubt also adding some cheer, so as we look towards the second half of the week, the onus will now be on trying to recover some of these latest losses. Assuming there are no surprises in Asian trade [overnight], we can probably look for bid speculation to continue lending support."