The index of London's leading shares has fallen 2.4%, while US and European markets have also posted sharp declines amid continued anxiety about the state of the global economy.
The FTSE 100 closed down 124 points at 5,549 points.
Analysts said US Federal Reserve chair Janet Yellen's gloomy economic assessment on Wednesday had added to investors' worries.
In testimony to Congress, she said that financial conditions in the US had become "less supportive" of growth and warned of the "increased volatility" in global financial markets.
Rabobank European strategist Emile Cardon said the worst could still lie ahead: "The bad news in now coming from everywhere - China, Portugal, the US, the commodity sector, the banking sector. It's like several smaller crises could combine into one big crisis."
Analysis: Kamal Ahmed, economics editor
The great sell off continues. Why?
It's a mix - part economic fundamentals; part market emotion, as herding investors follow each other down a negative spiral, fearful of being left beached as the tide goes out; and part brute market forces, the major trading houses looking to make a profitable turn on share prices which they bet are not going up any time soon.
On the FTSE 100, the biggest losers were a mix of financial firms and mining stocks.
Barclays was the worst-performing bank, sliding 6.4%. Its shares have fallen by almost a third since the start of this year, leaving it worth £25bn.
That is about the same value as Royal Bank of Scotland, whose shares have fallen more than a quarter this year.
Falls in bank shares this year
- Barclays down 31%
- RBS down 25%
- Credit Suisse down 42%
- Deutsche Bank down 38%
- Soc Gen down 34%
Mining giant Rio Tinto fell 3.4% after it revealed that it had made an annual loss of £596m.
In Paris, the bank Societe Generale was particularly hard hit, falling more than 13%.
The bank's shares tumbled after it said it was scrapping its target of achieving a 10% return on equity by the end of this year.
In Frankfurt, Deutsche Bank was down 6.1%, as its share price continued to suffer from concerns about the strength of its balance sheet.
Banks are under pressure across Europe because of fears that exposure to bad loans may leave them ill-prepared to cope if the global slowdown intensifies.
US banks such as Citigroup and JP Morgan also fell on Thursday, with declines of 5.9% and 4% respectively.
On the currency markets, the pound hit a 13-month low against the euro, falling 1.17% to €1.2713.
The currency was also down 0.5% against the dollar at $1.4452.