Barclays slumped 15.5 per cent in its worst daily fall since 2009, with four times the usual number of shares traded in London.
The Libor affair already is costing the bank a record $453m in fines and – more worryingly for investors – has raised the spectre of chief executive Bob Diamond being forced out.
Other banks also sold off sharply, with RBS and HSBC also under investigation.
“The honest truth is that you have absolutely no clue on what the impact from litigation will be ... and that is bad for the stock because it will create more volatility for a very long time,” said Chirantan Barua, UK banks analyst at Sanford Bernstein, adding that the possibility of Diamond’s departure was also a big negative due to a lack of good replacement.
“There is too much volatility so what I am advising clients is to lay up on the side and watch this out for the next few days.”
Sandy Chen, analyst at Cenkos, forecast “multi-year provisions that could run into the billions” for the sector.
RBS, where the public fallout could be much greater as it is owned by the government, saw its shares fall 11.5 per cent.
Banks as a whole slashed 29 points off the FTSE 100. The benchmark blue-chip index closed down 0.6 per cent, or 30.86 points, at 5,493.06.
The Libor jitters added to already negative sentiment in the financial sector as a result of its exposure to the crisis-hit Eurozone and its bonds.
Hopes of big new measures to ease the strains were low as a two-day meeting of European leaders kicked off yesterday, with Germany’s Chancellor Angela Merkel showing no sign of relenting in her refusal to back other countries’ debts.
“People are right to be cautious that you can’t fix all of the problems of the Eurozone with a two day summit so I don’t expect any magic wand solutions,” said John Haynes, head of research at Investec Wealth & Investment.
“If the euro falls apart, it’s our biggest trading partner, so we won’t be able to get out of the way of that.”
UK data offered little cheer to investors concerned about the health of the economy, with a downward revision to fourth quarter gross domestic product (GDP) and with housing prices shrinking at their fastest annual pace in almost three years in June.
The real estate sector fell 1.3 per cent. Defensive companies such as utilities and drugmakers – whose goods are needed even in tough times – outperformed.
But Reckitt Benckiser fell 2.3 per cent following a downgrade from Credit Suisse.
Longer term, investors do see value in UK stocks: a Reuters poll of more than 40 market participants showed the FTSE gaining around six per cent in coming months to end the year at 5,800.
“Institutions appear to be reserving their cash and at some point – needs must – they will have to invest it,” said Max Bascombe, institutional salesman at Merchant Securities.