Lloyds Banking Group warned that HBOS - the ailing bank it rescued last year - could post annual losses of around £10 billion for 2008.
The huge losses will be caused by the falling value of the group's assets and a £7 billion writedown following a "more conservative" assessment of HBOS's corporate division.
Chief executive Eric Daniels said: "HBOS's 2008 results have been adversely affected by the impact of market dislocation, which accelerated significantly in the last quarter of 2008, and the additional impairments required on the HBOS corporate lending portfolios."
Shares in Lloyds Banking Group - 43%-owned by the taxpayer - tumbled nearly 40% following the bank's warning.
The fall came despite the bank adding that Lloyds TSB will make pre-tax profits of around £1.3 billion.
The massive writedowns at HBOS throw a fresh spotlight on the handling of risk at the bank.
This week Sir James Crosby - a former HBOS chief executive - resigned as deputy chairman of the Financial Services Authority (FSA) over claims that he sacked a head of risk for warning that the bank was "going too fast". Sir James denies the allegations.
The losses include around £7 billion of writedowns at HBOS's corporate lending division, which is heavily exposed to hard-hit housing and commercial property sectors.
"These impairments primarily reflect the application of a more conservative recognition of risk and the further deterioration in the economic environment," Mr Daniels said.
The heavy losses expected at HBOS contrast with the £5.71 billion in underlying profits which the bank made for 2007. But market confidence in HBOS collapsed last autumn and the Government waived competition rules to allow the bank to be taken over by Lloyds TSB, creating a UK "super-bank".
