More than 90 per cent of the European banks tested against stress scenarios passed, with a capital shortfall of only €2.5bn (£) – but markets rejected the results as they failed to assess how banks would respond to a sovereign debt default.
As Greece, Spain and Italy faced steep increases in their government bond yields as markets jitter over their debt levels, the test results failed to reassure fears that the banks remain exposed to huge losses.
The unease pushed the FTSE 100 down 1.6 per cent to 5,752.81 with just seven stocks closing higher.
Gainers were led by precious metals miners Fresnillo, up 2.1 per cent, and Randgold Resources, up 1.7 per cent, as they benefited from risk averse investors.
Banks took the biggest hit, with Lloyds Banking Group down 7.5 per cent by the close, as the market sold them on eurozone debt fears.
“Banks have been hit hard, especially RBS, which had the lowest tier 1 capital ratio of the UK banks tested, while Lloyds is also lower. Barclays, with the biggest exposure to Portugal and Spain is also lower trading at levels last seen in April 2009,” said CMC Markets analyst Michael Hewson.
Barclays closed seven per cent lower while RBS ended down six per cent down.
Insurance stocks also suffered, with life consolidator Resolution ending 4.4 per cent down and Old Mutual 4.3 per cent lower.
Some engineering stocks lost ground, such as IMI, which closed down 4.5 per cent and GKN, down 4.6 per cent. Cairn Energy fell 4.1 per cent.
Defensive stocks helped the FTSE, with Centrica up 0.4 per cent and Shire adding 0.5 per cent.
And satellite broadcaster BSkyB staged a rebound as growth investors piled in to replace those selling out of its takeover bid.
Its shares closed up 0.6 per cent as its shareholders discussed a boardroom coup to remove James Murdoch from its chairman’s seat.
US markets followed Europe into the red, despite bumper results from oilfield services supplier Halliburton, which saw profits soar 54 per cent in its second-quarter results.
But US banks were also sold off as the risk climate worsened. Bank of America fell four per cent to $9.61 and was the biggest percentage loser in the S&P 500 index. US-listed shares of Barclays Plc dropped eight per cent to $13.35. Both hit 52-week lows.
The US has just five days before president Barack Obama's deadline for a deal to lift the ceiling on the national debt.
Republicans and Democrats have scrambled to complete a fallback plan that would avoid a default, but the longer the debt ceiling debate remains unresolved, the bigger the risk for further declines in stocks and a spike in volatility.
The Dow Jones industrial average finished down 0.8 per cent at 12,385.50; the Standard & Poor's 500 index closed down 0.8 per cent at 1305.60; and the Nasdaq Composite index ended 0.85 per cent lower at 2,766.09.