The FTSE 100 fell below 4,000 for the first time in five years
The rate at which banks lend to each other has risen despite aggressive measures from governments worldwide to tackle the credit freeze.
The cost of borrowing in dollars over a three-month period rose to 4.8%. A month ago the rate stood at 2.8%
It indicates that banks are still loath to lend to each other despite interest rate cuts by major central banks and record cash injections by governments.
With banks hoarding cash, there are growing fears for the world economy.
The interbank cost of lending in dollars, sterling and euros has risen sharply since the collapse of Wall Street giant Lehman Brothers destroyed any hope that the end of the financial crisis was in sight.
Close attention is paid to the three-month London interbank offered rate, or Libor, because it is used to determine a range of business and consumer loans, including mortgages.
It is set by 16 banks in a daily survey by the British Bankers Association at about noon in London.
Three-month Sterling Libor has risen to 6.285%, while three-month euro Libor stands at 5.366% - near 14-year highs.
Concerns that Libor rates remain stubbornly high despite a range of unprecedented measures taken by policy makers around the world is playing a big part in upsetting stock markets, analysts say.
The focus is now on the meeting of finance ministers from the Group of Seven industrialised countries as traders look for some steer.
"All the rabbits are dead. It's a pretty sad picture but they have no choice but to do anything they can," said one trader in the Netherlands.