Gordon Brown has demanded the banks come clean over their losses amid signs the Government is preparing a second bailout of the banking sector.

In an interview with the Financial Times, the Prime Minister said the “toxic assets” held by the banks as a result of the collapse of the sub-prime mortgage market in the United States must be dealt with.

The paper said he refused to rule out a full-scale nationalisation of the banks or a further injection of taxpayer funding in order to restore lending to business.

“One of the necessary elements for the next stage is for people to have a clear understanding that bad assets have been written off,” Mr Brown said.

“We have got to be clear that where we have got clearly bad assets, I expect them to be dealt with.”

Tackle

Mr Brown and Chancellor Alastair Darling held talks yesterday with the Governor of the Bank of England, Mervyn King, and Financial Services Authority chairman Lord Turner of Ecchinswell.

However, the meeting took place as it emerged the Government could use billions of pounds of public money to buy up “toxic” assets from banks, in the latest bid to tackle the financial crisis.

Ministers are considering creating a so-called “bad bank” in order to cleanse the books of private institutions and free them to lend again.

Mr Brown and Mr Darling were expected to discuss the idea, which has been circulating for some months, with senior bankers over the next few days.

They are also believed to be examining an alternative of “ring-fencing” such assets within banks’ balance sheets. A package could be announced as early as next week.

The move comes amid growing concern over the scale of banks’ losses from bad debts, evidenced by a further plunge in their share prices yesterday.

Mr Brown warned that unless the issue was dealt with, there was a danger of “financial isolationism” as banks retrenched into their domestic markets.

By Vicki Jones