George Osborne has warned of dire consequences if Greece leaves the eurozone without an "ambitious" plan to deal with the fallout.
The Chancellor again suggested that so-called "Grexit" might be the only way to force fundamental reform in the currency area.
But allowing the struggling country to leave before measures were in place to contain contagion would be the "worst case for everybody".
The comments, in Mr Osborne's annual speech to bankers at the Mansion House, came after interest rates on Spanish bonds hit fresh highs - sparking fears about the country's ability to service debts.
Senior German figures also played down the prospects of compromise on the key issue of closer financial integration.
Chancellor Angela Merkel cautioned world leaders against "overestimating" her nation's ability to resolve the crisis.
And her deputy finance minister Steffen Kampeter dismissed "Eurobond-lite" proposals for pooling part of members' debts.
Mr Osborne said that without greater fiscal integration "the economic and political strains of deleveraging and balance sheet repair in the eurozone periphery may prove unbearable".
The solution had to involve stronger countries agreeing to help weaker ones, more pooling of resources, and a "shared backstop" for the banking system.
"The political paradox Europe faces right now is this: some or all of these things are needed for the existing countries in the eurozone to make their currency work, but it may take Greek exit to make it happen," he said.
"That is a decision for the eurozone and the Greek people.
"One thing is for sure: if exit is the chosen route then the eurozone must have a very good plan in place to prevent contagion.
"The worst case for everyone would be exit without a sufficiently ambitious response.
"But carrying on with the current uncertainty and instability is not much better.
"A time for decisions has come."
Mr Osborne said the risks to Britain from a "disorderly collapse" of the euro were "huge".
The economic conditions were "as difficult perhaps as any our country or our continent has faced outside of war".
However, he rejected the idea that the UK should participate in banking union to help stabilise the financial system in the currency bloc.
"British taxpayers will not stand behind eurozone banks, and British voters want the British authorities to be in charge of supervising our own banks, especially in a crisis," the Chancellor said.
He insisted the Government would also continue to seek safeguards for the single market as eurozone integration became deeper.
"We want to remain full and active members of the EU single market, which has huge benefits for our economy," Mr Osborne said.
"Indeed we want to deepen and enhance the single market.
"But the rules that govern that single market must continue to be determined by all 27 members of the EU, and not just by the 17 members of the eurozone."
Shadow chancellor Ed Balls attacked Mr Osborne over his remarks about a possible Greek exit from the eurozone.
"I was at the Mansion House last night and there was a frisson around the room when our Chancellor started openly talking about whether Greece should leave the eurozone. I do not think that is a very wise or sensible thing to do," he told BBC Breakfast.
"I think Greece has got to sort out its issues - and that is a matter for Greece. What I am really worried about in the eurozone is that countries like Spain or Italy - which are huge, to which we as a country are very exposed - they have not sorted out their problems."
He added: "Unless we get a global growth plan going including in the eurozone you can't turn this round.
"I am afraid that our Government seems to be urging the wrong actions in Europe as it takes the wrong actions here in Britain too."