Britain's biggest banks lost £2bn from their combined market value today as fears over Spain's creaking finances saw investors dump financial stocks.
Lloyds Banking Group lost nearly 5% of its value, while Royal Bank of Scotland shed nearly 4% and Barclays fell by more than 1%. HSBC also dipped into the red.
Traders were troubled by developments in Spain, where the Government's implied cost of borrowing is creeping higher towards unsustainable levels amid fears the struggling country will require a bailout from the European Union and its partners.
Banks also fell out of favour after equity analysts at JP Morgan Cazenove downgraded the sector amid concerns over the impact rising funding costs will have on profits.
Rupert Osbourne, futures dealer at IG Index, said: "Spain remains very much front and centre for global markets, as its borrowing costs remain near what many would consider unsustainable levels.
"If there is one thing that we have learnt from the past couple of years of European debt, it is that these problems tend not to be resolved quickly and painlessly - and it does set the stage for potentially more volatility in the weeks ahead."
The yield on Spain's 10-year government bonds hit 6.1%, moving closer to the 7% which forced Greece, Ireland and Portugal to seek financial help from the EU. The rate is at its highest level since the new conservative government took office in December.
The government has implemented a tough austerity package of spending cuts, as well as labour and financial reforms, but investors are concerned by Spain's banks, which are battling with bad loans from a collapsed property market.
The troubles in Spain were flagged by JP Morgan Cazenove as it downgraded the European banking sector from overweight to neutral.
Mislav Matejka, analyst with European equity strategy at JP Morgan Cazenove, said Spanish deposits fell by six billion euro (£4.9 bn) in February and continue to show a negative trend.
Mr Matejka said: "This is particularly worrying and shows that Spanish banks are becoming more and more vulnerable."
He said the bank started the year with a bullish stance at the start of the year, encouraged by the liquidity injection provided by the European Central Bank (ECB).
But he added: "However, most recently the costs have increased again, hurting the profitability outlook for the sector."
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