Shares in Lloyds Banking Group, the company formed after its merger with HBOS, have tumbled after it said HBOS losses would be worse than expected.
Lloyds announced that it expected HBOS to report a pre-tax loss for the whole of 2008 of £10bn, which is £1.6bn more than it predicted in November.
Shares in Lloyds - 43% owned by the government - closed down 32.5% after the surprise announcement.
The Lloyds side of the business is expected to make a profit of £1.3bn.
Lloyds Banking Group shares ended the day at 61.4 pence, having earlier fallen as low as 54.9 pence, down as much as 40%.
Commenting on the worse-than-expected HBOS losses, Chancellor Alistair Darling told BBC's Newsnight: "The problem we had last October is that we had a banking system that was about to collapse, we had to intervene, we had to do it very quickly, we didn't have months or weeks to look at it.
"What we've asked the new management to do is to go through the books so that we can deal with the assets that have gone bad, and the other problems that have emerged."
Most of the HBOS losses are blamed on a £7bn write-down at its corporate division, which is heavily exposed to the housing and commercial property sectors. In 2007, HBOS made a profit of £5.7bn.
This afternoon's horrible fall in Lloyds' share price is investors having serious doubts about whether Lloyds was right to buy HBOS
"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," Eric Daniels, its chief executive, added.
HBOS, which lent heavily to property investors and homeowners, was particularly vulnerable to the slowdown.
But he stressed that the longer term prospects were brighter.
"Whilst we recognise that the short term outlook is more challenging, Lloyds Banking Group has the largest UK financial services franchise, with excellent long-term earnings potential," he said.
Analysts voiced their shock at the update. "The market doesn't like the fact that in a period of of a month, the corporate losses (at HBOS) are twice what they had announced," said Mamoun Tazi, analyst at MF Global.
Lloyds Bank chief executive Eric Daniels speaking earlier this week about HBOS merger
Earlier this week, Mr Daniels defended the merger with HBOS to MPs on the Treasury Select Committee. Last year, Lloyds had pushed through the deal - with government support - even as certain shareholders questioned the value of the deal.
The BBC's business editor Robert Peston says the profits warning is embarrassing for Mr Daniels.
"This afternoon's horrible fall in Lloyds' share price is investors having serious doubts about whether Lloyds was right to buy HBOS.
"Daniels will hope that those investors don't start to have serious doubts about whether he is the right man to attempt to rebuild a bank that many would say has been seriously weakened by the acquisition of HBOS," our correspondent says.
The Lloyds trading update came after James Crosby, the former chief executive of HBOS, resigned as deputy chairman of the Financial Services Authority after a former employee of HBOS said his warnings that the bank was growing too fast were ignored.
This week, bosses and former bosses of key British banks were grilled by MPs about their role in the financial crisis.
The former heads of the two biggest UK casualties of the banking crisis - Royal Bank of Scotland and HBOS - apologised "profoundly and unreservedly" for their banks' failure.
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