News that Greece will fail to meet deficit reduction targets pushed the FTSE 100 down 2.8% at open, dragging it below 5,000 points.
The blue chip index opened down 145 points at 4,983, before recovering some ground to stand 1.97% down at 5027.40 at 10am.
Shares across Europe were also falling in the wake of Sunday's announcement from Greece that it will not meet deficit reduction targets.
Germany's Dax opened down 200 points, or 3.6%, to 5,301, with France's Cac 40 down 3.1% to 2,890. The Euro Stoxx 50 fell 3% to 2,115.
In the UK, Barclays was the largest faller, down 5.9% to 152.2p, with Royal Bank of Scotland falling 5.3% to 22.3p and Lloyds Banking Group down 4.4% to 33.3p. Burberry group fell by 5.8% to 1,106.
Beleaguered Greece on Sunday approved a 2012 draft budget that forecast a deficit of 8.5% for 2011, higher than the target level of 7.6%.
The budget estimated GDP growth would fall by 5.5% this year, with sources telling Reuters the economy would shrink by a further 2-2.5% next year, well below the 0.6% growth rate assumed as part of the terms of Greece's €109bn July bailout agreement.
Reports that French and Belgian officials would meet to discuss shoring up the balance sheet of Belgian bank Dexia also weighed on shares, with the euro approaching its lowest level for eight months versus the dollar at $1.334.
Other European banks were put under pressure again in early trading, Societe Generale opening down 6.9% at €18.70 and BNP Paribas falling 6.5% to €28.10. Dexia itself was down 6% at €1.36.
In Asia, the Nikkei 225 closed down 1.78% at 8,545, with Hong Kong's Hang Seng index standing down 4.5% shortly before close at 16,795.
Interest rate outlook unchaged
FCA made demands last week
'Will remain an independent business'
Despite improved risk appetite