The FTSE 100 index closed down 62.36 points, or 1.1 percent, at 5,671.09, extending Friday's falls and retreating further from Thursday's six-month closing high.

The FTSE volatility index was also active, up over 10 percent, its biggest daily percentage rise in a month and signalling an increase in risk aversion.

Banks were the biggest blue-chip casualties, hit by concerns that extra liquidity injections from central banks had not addressed the sector's fundamental problems.

Credit Suisse reduced its recommendation on the European Banking sector to underweight as it said the direct earnings impact of the European Central Bank's (ECB) late-December splurge of cheap, long-term cash for the banks appeared to be over-estimated.

Barclays was the UK sector's biggest faller, down 4.2 percent, while Loyds Banking Group shed 4.1 percent, and Royal Bank of Scotland fell 3.5 percent.

EU leaders met in Brussels on Monday, the first summit of 2012, to sign off a permanent rescue fund for the euro zone -- Britain's biggest trading partner -- though the meeting was overshadowed by the unresolved Greek debt problems.

To avoid a chaotic default, which could have grave ramifications for sentiment and financial systems across the globe, Greece must secure a deal with its private bond holders and persuade international lenders it is serious about reforms in order to secure much-needed cash.

Fresh tensions between Greece and the euro zone's biggest economy Germany over the weekend regarding the debt bail-out terms also knocked sentiment.

This isn't the first time Greece has shown resistance to accepting certain EU bailout terms and conditions, and given their weak position they may need to concede again, otherwise risk defaulting on the debt repayments due in March, said Jordan Lambert, Trader at Spreadex.

U.S. blue chips were down 0.6 percent by London's close, also suffering on concerns over the Greek debt situation, and after further dull U.S. economic data.

U.S. consumer spending was flat in December as households took advantage of the largest rise in income in nine months to boost their savings, setting the tone for a slowdown in demand early in 2012.

COMMODITIES DIP

Weakness in commodity issues also weighed on blue chips in London, with a retreat in crude knocking the integrated oils as an expected Iranian vote to suspend crude exports to Europe was postponed, easing supply concerns.

Miners also moved lower in tandem with weaker metal prices, as softer-than-expected U.S. economic data fuelled concerns about demand levels.

Defensive stocks dominated on the short list of blue chip gainers, led by drugmakers, with AstraZeneca and GlaxoSmithKline up 0.6 percent and 0.5 percent.

AstraZeneca will post fourth-quarter results on Thursday.

Utilities were in demand, with energy generator International Power up 0.6 percent, and power distributor National Grid ahead 0.5 percent. Both firms are due to issue trading updates later this week.