HBOS, Britain's biggest home loan lender, lost more than two-thirds of its value in the six days from September 9 to Wednesday - its shares crashed from 308.5 pence to an all-time low of 88p.
News of the buyout talks sent HBOS shares surging higher after the heavy losses in earlier trade prompted Britain's Financial Services Authority to issue a statement saying that the group was well funded.
The British government smoothed out any competition concerns about the tie-up between Lloyds, Britain's fifth-biggest bank, and HBOS, ranked sixth, on the grounds that the merger would promote financial stability.
The FTSE 100 London stock exchange closed down 113.2 points at 4,912.4 having reached a low of 4,903.3 and a high of 5,124.4 in a volatile day of trading on Wednesday.
Barclays, another British bank, had given Wall Street a small boost on Tuesday by agreeing to buy the investment arm of Lehman Brothers, the US bank which went bankrupt on Monday, for $1.75bn and taking on its 10,000 staff.
Barclays stock rose 10 per cent on Wednesday, but major European stock indices fell tracking Wall Street's slide.
In Ireland, the Bank of Ireland became the latest bank to cut its share dividend payment, causing a sell-off in Irish banking shares.