Lloyds Banking Group, which was formed a day earlier after the merger of rivals HBOS and Lloyds, saw its share price dive as much as 48 per cent in morning trade. The stock later pulled back to close at 44.80 pence, down 31.08 per cent.
Lloyds shares slumped nearly 34 per cent on Monday as the sector was dragged lower by fears about the solvency of major lenders despite news of another government rescue banking package worth tens of billions of pounds.
Elsewhere overnight, Barclays stock tumbled 17.16 per cent to 72.90 pence and Royal Bank of Scotland dived 11.21 per cent to 10.30 pence, while London's FTSE 100 leading shares index closed down 0.42 per cent at 4091.40 points.
"Conditions for banks remain hazardous, especially given the difficulty in raising capital from sources other than the government," said Dresdner Kleinwort analyst James Invine.
Lloyds Banking Group is 43 per cent owned by the British government after a major recapitalisation earlier this month. RBS is now about 70 per cent owned by the state.
Both HBOS and Lloyds TSB, like much of the global banking sector, have struggled to raise new funds to boost finances hit by the credit crunch.
On Monday, a second multi-billion pound bank rescue package in Britain sparked jitters after RBS forecast an annual loss of up to £28 billion ($60 billion) -- the worst ever for corporate Britain.
The news sent RBS shares plunging by almost 70 per cent on Monday.
"With RBS shares falling like a stone yesterday and Lloyds being further savaged today this period ... appears to be when markets finally decided to call the bluff of both the banks and the UK government as they searched for yet another possible nationalisation scalp," said Howard Wheeldon, senior strategist at BGC Partners.
"In the process, market behaviour sent a firm, yet very precise if somewhat unfortunate message to the government, that they neither believe the latest bailout plan will work or, perhaps more importantly, that it is affordable and that it potentially contains too much risk."
Manoj Ladwa, senior trader at ETX Capital, agreed that the government's latest bailout plan had left the market unconvinced.
"I'm getting a nasty case of deja vu. Just like the worst days of autumn last year, the banking sector is in deep, deep trouble," Ladwa said.
"Royal Bank of Scotland's shares were hammered yesterday and today it's Lloyds' turn. Life isn't much fun if you're a Barclays shareholder either.
"Essentially, the market isn't buying the government's rescue package ... and is betting that further banking nationalisations will be necessary.
"There are some aggressive research notes ... and US investors are piling out of the sector. What a 'welcome aboard' present for President Obama."
Banks savaged by crisis of confidence
First Horizon’s losses decline
Bank in UK’s biggest ever corporate loss
