Nick Clegg said the Government was "urgently" looking into Northern Ireland First Minister Peter Robinson's call for a judicial inquiry into secret letters sent to more than 180 IRA suspects.
However, the Deputy Prime Minister warned against allowing the case of Hyde Park bombing suspect John Downey to escalate into a "full-blown political crisis".
Mr Clegg told Sky News: "It is a very serious issue ... We are doing a very quick review of all the other letters in existence. We are urgently considering his view that there should be a full inquiry.
"I certainly appreciate how serious this is, how this provokes very strong emotions, dismay, outrage amongst the victims' relatives and families. We do want to make sure that we do everything to get to the bottom of exactly what did and didn't happen."
The government will conduct an audit of the letters who they went to and so on.
I don't think that they're going to rescind any of them and I don't think substantially they're in a mood to change the policy.
They're a little bit surprised that Peter Robinson didn't know about this part of the process.
They certainly think that people in the DUP did though, they're not saying that he should have known.
Clearly they have to take him at his word that he didn't.
They do think he's proably serious about resigning so they accept that there may be a political crisis.
Although I think that there is also a feeling here that perhaps having an election at this point and resigning at this point and causing an election in Northern Ireland wouldn't be the worst thing for the DUP, although they're also being very careful not to accuse him of cynicism.
I think it's very important to understand the distinctions here because it is a bit confusing. Paramilitary prisoners under the process served a maximum of two years and were out.
There were those who were suspected of crimes who are still potentially to be tried.
But there was this group in limbo who were on the run who were allowed to ask the police if they were suspected, if they weren't they were supposed to be giving those letters.
It's around then that this conspiracy is really focused.
The collapse of the 1982 Hyde Park bombing case has sparked a crisis in the judicial system according to Northern Ireland First Minister Peter Robinson
Mr Robinson said: "We're not on the brink of a crisis, we are in a crisis. This is a crisis. How could you have anything more than the setting aside of the proper judicial processes, where justice is not going to be done for at least 187 people?
"It is a crisis of confidence that the people of Northern Ireland will have on the policing and judicial processes in Northern Ireland and they are right to be angry."
Northern Ireland First Minister Peter Robinson has threatened to resign over the collapse of the case over the 1982 Hyde Park bombing and saying his administration have been deceived by Westminster.
Mr Robinson told UTV News he was "not prepared to remain as First Minister of an administration that kept us in the dark, that is being deceived by government, both past and present."
Northern Ireland First Minister Peter Robinson indicated he was prepared to resign unless there was a judicial inquiry into the collapse of the John Downey case, saying:
"I have to say quite frankly that I am not prepared to be the first minister of a government that is kept in the dark on matters that are relevant to what we are doing."
Ahead of statement in the Commons the Attorney General has said that it was 'right' John Downey was charged for the 1982 IRA Hyde Park bombing.
Before he was charged my consent was sought, as the law requires, for him to face a charge of causing an explosion. I gave that consent.
I believed then that it was right to do so and I remain of the same view today.
The allegations faced by Mr Downey were of the utmost seriousness. The bombing was an attempt by the Provisional IRA to bring their terrorist campaign to London and to attack armed forces personnel who were on ceremonial duties.
Whatever the circumstances in which the letter had been sent, and it is now clear that its assurances were wrongly given, it is right that the matter should be tested in court.
Neither I nor the CPS were prepared to accept that the letter and the circumstances in which it had been given were such as to automatically prevent Mr Downey's prosecution.
The case collapsed after it was revealed Mr Downey had received a letter in 2007 saying he would not face prosecution.
The brother of a cavalry trooper killed in the Hyde Park IRA bomb blast has criticised the Police Service of Northern Ireland for their "monumental blunder" and said he felt "devastatingly let down" by the failed prosecution.
Career soldier Lieutenant Denis Daly, then 23, died alongside three other members of his regiment the Blues and Royals, part of the Household Cavalry, when a bomb packed with wire nails and hidden in a parked car was detonated as they passed along South Carriage Drive in London on July 20 1982.
Chris Daly, a former major in the Blues and Royals, said: "The fact the judgment determines the trial will now not takes place fills the families with immense anger, frustration and disappointment.
"I think everyone is eager to get to the bottom of what went wrong."
On July 20, 1982, a car bomb left in South Carriage Drive killed the soldiers as they rode through Hyde Park in central London to the changing of the guard.
The explosion killed Roy Bright, Dennis Daly, Simon Tipper and Jeffrey Young and injured other members of the Royal Household Cavalry. Seven horses were also killed as the soldiers travelled from their barracks to Buckingham Palace.
The investigation into the bombing led police to Downey, through fingerprints on parking tickets and a description given by witnesses of two men carrying out reconnaissance in the area before the attack.
An arrest warrant was issued, but it was decided not to seek Downey's extradition from the Irish Republic in 1989, in part due to the lack of strong evidence against him, the court was told.
Then in 2007, Downey received assurance he was not at risk of prosecution as part of a scheme run by the Northern Ireland police.
Despite regularly travelling to the UK and Northern Ireland since then, in May last year he was arrested at Gatwick Airport en route to Greece and charged. He "strenuously" denied the murder of four British soldiers and causing an explosion.
Sinn Féin MP Francie Molloy has welcomed the decision to allow Hyde Park bombing suspect John Downey to walk free.
The former Chief Constable of Northern Ireland Sir Hugh Orde has "apologised unreservedly" to the families of the Hyde Park bombing victims after they were told suspect John Downey would not face prosecution.
He said in a statement: “It is a matter of great personal regret that a crucial oversight was made by a senior officer which resulted in erroneous information being sent to Mr Downey by the Northern Ireland Office and thus prejudicing the current indictment.
“As chief constable, I worked at the head of a team of very hardworking officers. While no organisation is immune from errors, it has become apparent recently that a very serious error was made in dealing with Mr Downey’s case, which is a matter I regret very deeply...
"...My mind is first and foremost with the families affected by the actions of those who perpetrated the bomb in Hyde Park in 1982, whose dignity in their grief has always been impressive. If a force under my command has failed them, as it seems it did, then I apologise to them unreservedly.”