Lloyds Banking Group stunned the City after warning of £10 billion in annual losses at struggling HBOS.
The announcement by Lloyds - which rescued HBOS at the height of the financial turmoil last autumn - sent shockwaves through markets.
The taxpayer, which owns 43% of the bank, was left with paper losses of more than £2.5 billion at one stage as Lloyds' shares tumbled up to 40% within minutes of the announcement.
Lloyds said HBOS's assets had been hit by falling markets and announced £7 billion in writedowns at HBOS's corporate division - around £1.6 billion higher than it expected last November.
This follows a "more conservative" assessment of HBOS's corporate division, which is heavily exposed to hard-hit housing and commercial property sectors.
Lloyds chief executive Eric Daniels said: "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."
The massive losses at HBOS throws a fresh spotlight on the handling of risk at the bank.
This week Sir James Crosby - a former HBOS chief executive - resigned as deputy chairman of the Financial Services Authority (FSA) over claims he sacked a head of risk for warning the bank was "going too fast". Sir James denies the allegations.
Mr Daniels added the losses "primarily reflect the application of a more conservative recognition of risk and the further deterioration in the economic environment".
HBOS's financial pain contrasts with the £5.71 billion in underlying profits which the bank made for 2007.
