Wall Street banks are working on plans to separate troubled assets from the rest of their businesses in an effort to ring-fence problems and restore investors' confidence in the financial sector.

A number of US firms are looking to follow the example set by UBS (NYSE: UBS - News) , which this week put securities linked to US mortgages into a separate subsidiary with a view to eventually reducing its exposure to the troubled assets, which have been responsible for more than $30bn of losses so far.

The Wall Street banks' plans, which are yet to be finalised, would enable banks to move at least some troubled assets off their balance sheets by selling large stakes in the funds to outside investors.

Lehman Brothers (NYSE: LEH - News) , which has been forced to deny rumours about its financial health over the past few weeks, is believed to be one of the banks considering a spin-off, or sale, of some of its assets.

"We want to continue to move illiquid assets off the balance sheet," Erin Callan, chief financial officer, told CNBC this week. The bank declined to comment further.

Other banks hit by the credit crisis, including Citigroup (NYSE: C - News) , Morgan Stanley (AMEX: MWD - News) and Merrill Lynch, have said they want to take steps to shrink and de-leverage their balance sheets.

The planned creation of "bad banks" comes as US and European lenders are also discussing the creation of a common fund to buy devalued assets.

According to people familiar with the matter, banks are discussing a joint proposal to regulators to set up a fund, which would absorb US subprime assets and other troubled securities, as a way of restoring confidence in the banking system and ending the pressure to recognise mark-to-market losses.

However, bankers say the prospect of a co-ordinated solution remain remote because of the difficulties in getting banks to agree on the terms and the scope of a common fund.

Similar disagreements among banks this year led to the collapse of talks to create a "super-SIV" to buy distressed mortgage assets from banks.

Under UBS's scheme, the bad assets will remain on the bank's balance sheet because the Swiss bank will initially retain full ownership of the new fund. However, UBS is expected to sell all or part of it to outside investors, or to spin it off, according to people familiar with its plan.

Additional reporting by Aline Van Duyn in New York