JPMorgan Chase, the largest bank in the United States, said it lost $2 billion in the past six weeks in a trading portfolio designed to hedge against risks the company takes with its own money.
The news caused financial stocks to slump in London. Ian Gordon, analyst at Investec Securities, said that may be based on a fear that JPMorgan's difficulty will lead to tougher regulations on banking.
Barclays, which has a large investment banking arm, was the biggest loser, shedding 2.5 per cent at midday. Royal Bank of Scotland fell 1.6 per cent, Lloyds Banking Group 1.5 per cent and HSBC 1.3 per cent.
The British government has traditionally used "light touch" regulation of banking and trading in London, traditionally one of the world's biggest financial hubs.
But since the banking crisis which began in 2008, British authorities have been reconsidering that approach. On Wednesday, the government announced that it would be legislating new regulations in the current session of Parliament, including forcing banks to insulate their retail operations from riskier investment banking.
London accounts for 46 per cent of the over-the-counter derivatives market, 70 per cent of eurobond turnover and 19 per cent of global hedge fund assets, according to the City of London, which governs the financial district.
The Wall Street Journal reported that JPMorgan was in touch with Britain's financial regulator, the Financial Services Authority, about the trading loss, but neither the company nor the regulator would comment.
"The portfolio has proved to be riskier, more volatile and less effective as an economic hedge than we thought," CEO Jamie Dimon told reporters. "There were many errors, sloppiness and bad judgment."
The Journal and Bloomberg News reported in April that other investors were reacting to massive positions taken by a London trader identified as Bruno Michel Iksil, who worked in the Morgan's risk management arm, the Chief Investment Office.
At the time, Dimon dismissed concerns as "a complete tempest in a teapot."
According to the register of the Financial Services Authority, Iksil joined JPMorgan Chase and J.P. Morgan Europe Ltd. on Nov. 1, 2007.
Deutsche Bank, Credit Suisse, Goldman Sachs and Bank of America are among more than 240 foreign banks which have offices in London, Europe's biggest financial centre.
Swiss bank UBS last year reported losing $2 billion through unauthorized trades allegedly made by a junior employee in London.
Jordan Lambert, a trader at Spreadex in London, said the market reaction on Friday was understandable.
"When such shocks occur, it is wise to err on the side of caution and consider whether it is a possible tip of the iceberg scenario, especially when one contemplates the interconnectedness of the banking system," he said.