Nearly £56 billion was wiped from the value of London's leading companies as fears over a credit crunch in global markets intensified.
The FTSE 100 Index lost 3.7% - its biggest percentage fall since March 2003 - adding to the heavy falls for the benchmark index.
Experts warned that current turmoil in global stock markets could have implications for UK consumers as lenders become more cautious.
Prime Minister Gordon Brown sought to calm the market, saying: "I think the important message to be sent is we have done everything in our power to maintain the stability of the British economy."
Uncertainty in global stock markets has been driven by fears over banks' exposure to losses in the collapsing US sub-prime mortgage market.
These concerns have spread to the wider credit markets as banks take a more cautious approach to risk amid rising interest rates.
Less than a month ago, the Footsie was trading at seven-year highs above the 6,700 barrier, but the losses saw it retreat well below the level at which it opened the year, closing at 6038.3.
Since Thursday, the US Federal Reserve, the European Central Bank and national banks in Japan, Canada, Australia and Hong Kong have all intervened with emergency funding to prop up credit markets for the first time since the 9/11 terrorist attacks in 2001.
Howard Archer, chief UK economist at Global Insight, said: "A credit crunch makes it harder and more expensive for businesses and consumers to get loans and cash.
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"There is a danger that financial market turmoil and tighter credit will hurt the mortgage and housing markets in the UK and Eurozone. This increases the risk that the UK housing market could see a sharp slowdown."
