European stocks fell on Thursday, with the banking sector reeling on heightened fears over its exposure to the eurozone debt crisis and the potential impact of more recapitalisation.
Investor sentiment was also hurt after the European Central Bank warned of downside risks to the economy, citing tensions in the euro area.
In early afternoon trade, London's benchmark FTSE 100 index fell 0.97 percent to 5,389.06 points, Frankfurt's DAX 30 dropped 1.45 percent to 5,907.61 points and in Paris the CAC 40 slid 1.23 percent to 3,189.93 points.
The euro edged down to $1.3734, compared with $1.3788 late in New York on Wednesday.
Bank shares plunged on Thursday after the French finance ministry warned that European lenders exposed to Greek debt will probably face greater losses than those already agreed to.
Ahead of a weekend meeting of G20 finance ministers in Paris, France said banks would probably be forced to write off more Greek debt than the 21 percent proposed in a July eurozone accord on a second bailout for Athens.
In their pre-G20 briefing, French officials said EU states would set up a mechanism to allow banks in difficulty to seek assistance but that the statutes of the European Financial Stability Facility would not change.
Those European institutions that do need to be recapitalised are those which either failed or just scraped through stress tests held earlier this year, said a French finance ministry official who spoke on condition of anonymity.
"This is under discussion," he said, adding that figures received Wednesday on the state of the recapitalisation process were encouraging.
Banks have been asked to increase their core capital reserves so that they will be better able to cope with any losses on their holdings of weak eurozone state bonds. French banks have large exposure to Greece.
"French banks have no liquidity or solvency problems," the French official added.
The comments came one day after European Commission president Jose Manuel Barroso called for urgent recapitalisation of lenders to help them weather the region's sovereign debt storm.
In Paris trade on Thursday, BNP Paribas tumbled 6.56 percent to 33.03 euros, Credit Agricole plunged 4.48 percent to 5.349 euros and Societe Generale plunged sank 3.93 percent to 22.245 euros.
In Frankfurt, Commerzbank stock plummeted 4.50 percent to 1.763 euros and Deutsche Bank was down 2.17 percent at 28.64 euros.
In London, Royal Bank of Scotland shares slid 0.23 percent to 25.75 pence, Lloyds Banking Group fell 1.89 percent to 35.56 pence and Barclays dropped 2.62 percent to 182.10 pence.
Barroso called Wednesday for banks to "urgently" increase their core tier-one capital ratios and warned that those refusing to comply could be forced to abandon bonuses and dividends.
However, Deutsche Bank boss Josef Ackermann argued Thursday that recapitalising Europe's banks would not solve the crisis, adding that confidence needed to be restored in the health of countries' public finances.
"It's not the capital resources of banks that are the problem but the fact that sovereign debt has lost its status as a risk-free asset," Ackermann told a business congress in Frankfurt.
European equities had rallied Wednesday as investors absorbed fresh EU proposals to battle the debt crisis, alongside news that Slovakia would soon back expansion of the EFSF despite an initial vote against it.
Slovakia's parliament prepared to reconvene Thursday for a fresh vote on a crucial eurozone rescue fund.
However, investor sentiment took another heavy blow on Thursday after the European Central Bank warned of "downside" risks to the euro area which was facing "particularly high uncertainty".
"Downside risks notably relate to the ongoing tensions in some segments of the financial markets in the euro area and at the global level, as well as to the potential for these pressures to further spill over into the euro area's real economy," the ECB said in a monthly bulletin.
"They also relate to the still high energy prices, protectionist pressures and the possibility of a disorderly correction of global imbalances."
Asian markets rose Thursday, taking a lead from Wall Street and extending a recent rally on hopes that eurozone leaders will be able to hammer out a solution to the debt crisis.
On Wall Street overnight, the minutes of the most recent Federal Reserve meeting showed some members wanted the central bank to resume large-scale asset purchases, or quantitative easing, to boost the weak economy.
The news helped send the Dow up 0.90 percent, while the Nasdaq added 0.84 percent and the S&P 500 climbed 0.98 percent.