The benchmark S&P/ASX200 index fell as much as 3.5%, or 164.5 points, to 4557.7 in early trading.

''We've been waiting for this market to capitulate,'' said James McGlew, senior dealer at Argonaut Securities. ''Until the news overnight, there had been a degree of denial.''

Wall Street plunged more than 4% overnight after the US government rescued insurance behemoth American International Group for $107 billion dollars.

''We're getting to the capitulation stage,'' he said. ''People are just lining up and throwing the baby out with the bathwater.''

''I went through the 1987 crash and you need to get to a point where the fear flushes the market out.''

However, Mr McGlew said the market still had room lose another 400 points before bottoming out.

When the market eventually turns around, the weakness from the banking sector means it's not going to bounce straight back to 5000, he said.

There are, nonetheless, buying opportunities arising in companies with good, transparent balance sheets, he said.

The financial sector has been in the cross hairs of investors, with the big investment banks losing more than a fifth of their market cap.

Macquarie Bank was down as much as 21.8%, or $7.03, to $26.90 in early trading, and Babcock & Brown lost 21%, or 20 cents, to 72 cents.

ANZ Bank lost as much as 5%, or 80 cents, to $15.20, the Commonwealth Bank lost 4.8%, or $1.98, to $39.12, NAB lost 10.1%, or $2.10, to $18.60, Westpac lost 4.5%, or $1.05, to $21.96, St George lost 4%, or $1.20, to $28.95 and Suncorp Metway lost as much as 19.3%, or $1.71, to $7.15.

''It's pretty savage,'' said Lisa Jarvis of ABM Amro Morgans, ''You'd have to say there's a bit of panic with concern for potential exposures to this off-shore crisis.''

Ms Jarvis said the sell-downs mean retail and institutional brokers are trying to limit their risks. In turn, the lower prices trigger margin calls, causing people to be forced sellers, which only adds to the momentum.