The BSE benchmark 30 share Sensex index slumped 727.95 points to 13,272.86 in early morning trade.
"Reports of weakening US financial markets and the possibility of worse to follow (for some global banks) has clearly spooked investors," said Apurva Shah, head of research with brokerage Prabhudas Lilladher.
"We could see a deeper correction," he said.
Sentiment was also impacted by blasts that rocked New Delhi on Saturday.
Indian shares have fallen nearly 31 percent this year, with overseas funds selling stock worth 7.
78 billion dollars. They were net buyers of Indian stock worth 9.
27 billion dollars at the same time last year.
Dealers said the markets have ignored an easing of oil and inflationary pressures.
"Oil is not an issue any more but it could be a positive while evaluating corporate earnings," said a dealer with brokerage ULJK Securities.
Indian companies start reporting quarterly earnings next month.
Dealers expect earnings to be impacted by higher inter