Italian stocks plunged 7.07 percent at around 1300 GMT on Tuesday led by bank shares as bonds also came under heavy pressure amid concerns that Italy could be dragged further into the eurozone debt crisis.
Italian markets were hit hard, in line with other Europpean markets, by a surprise announcement that Greece is to hold a referendum on its eurozone debt rescue deal.
Shares in Italy's biggest bank, UniCredit, were down 11.62 percent while the country's second-biggest lender, Intesa Sanpaolo, dropped 14.41 percent. Banca Monte dei Paschi di Siena also fell 8.16 percent.
Bank shares were not the only ones suffering, with truck maker Fiat Industrial plunging 12.85 percent and insurer Fondiaria-SAI down 8.19 percent.
The spread between rates on Italian 10-year government bonds and benchmark German ones meanwhile widened to a new record of 443 basis points.
The yield on 10-year bonds also rose above six percent -- close to its highest ever level of 6.397 percent reached in August, when the government was forced to adopt emergency austerity measures and the European Central Bank intervened to prop up the bond market.
The FTSE Mib index in Milan had closed down 3.82 percent on Monday.