Banks suffer as eurozone crisis triggers fresh market slump

Growth worries and concerns about a US sub-prime lawsuit add to investor fears

Banks were at the centre of another Europe-wide stock market sell-off last night as concerns about global growth and the eurozone's debt woes came back to haunt investors.

The reversal wiped £49bn off the value of London's blue chips, with the FTSE 100 sliding by 3.6 per cent to 5,102.58. The index was outdone by Germany's DAX, which fell by more than 5 per cent to its lowest level in nearly two years. The French and Spanish markets were 4.6 per cent lighter at the beginning of the week, while the main Italian index fell by 4.8 per cent.

Banks bore the brunt of the sell-off as traders fled on fears about the fallout of a US lawsuit over toxic mortgage debt. Royal Bank of Scotland, one of the 17 lenders being sued by a federal regulator over losses on subprime bonds, fell by more than 12 per cent amid speculation about potential damages. Lloyds lost 7.5 per cent of its value.

On the Continent, lenders were hit by a revival of concerns about the sovereign debt crisis, with the news that Angela Merkel's party had suffered a bruising regional election defeat over the weekend triggering worries about the German Chancellor's ability to lead Europe out of the current crisis.

A warning from the boss of Germany's biggest bank that many European lenders "would not survive" if they had to mark down their sovereign debt holdings to market levels added to the nervousness. "Prospects for the financial sector overall... are rather limited," the chief executive of Deutsche Bank, Josef Ackermann, said.

However, he rejected the call by the chief of the International Monetary Fund, Christine Lagarde, for a forced recapitalisation of European lenders. Mr Ackermann said such a move would "threaten to send the signal that politics has lost faith in the ability of existing measures to succeed".

Investors were also rattled by rumours of a possible cut to Italy's credit ratings. Although no such action was forthcoming last night, Italy's biggest banks, Unicredit and Intesa Sanpaolo, fell by about 7 per cent.

The slump came despite the European Commission President Jose Manuel Barroso insisting that "the European Union and the euro are strong and resilient". Speaking on a visit to Australia, Mr Barroso added that that while Europe would see modest growth, there would be no recession.

The comments did little to soothe sentiment, however, with investors searching for a safe haven forcing the yield on benchmark German debt to a record low of around 1.84 per cent, while gold rose back above $1,900 per ounce. At the same time, the cost of insuring against a soverign default by Italy and Spain continued to climb. Supplementing fears about Europe were worries about global growth, with last week's disappointing report on the US jobs market still hanging over dealing rooms.

Traders said the losses may have been magnified owing to the lack of support from the US, where markets were shut for a holiday. Reflecting this, volumes on the FTSE 100 were well below the levels seen during the turmoil in August.