The officer - identified only as A - thought that if the extreme nationalist seized power in the former Yugoslavia during the early 1990s he would launch a campaign of genocide as bad as Hitler's.
He proposed a hit on the warlord - who was not named in court but is thought to be the notorious leader Arkan - to the head of the Secret Intelligence Service in the Balkans at the time and was told to submit the plan in writing.
It is thought to be the first time an active MI6 agent has taken the stand in a court hearing.
To protect his identity the court was cleared of everyone except the jury, lawyers and clerks, with his testimony relayed by audiolink to an annexe at the Royal Courts of Justice in London.
The agent told the inquest: "I was worried about the possibility of this man taking power in Serbia and I thought we ought to think about having a contingency plan to assassinate this guy. My vague options were to use our special agents or our special forces."
Serbian dissidents opposed to the warlord were also a possibility, he said.
The agent said he felt MI6 rules which forbade assassinations needed to be reviewed to deal with the new threat. He said when he suggested the proposal to the commanding officer he appeared to be a mixture of "puzzled", "non-committal" and "curious".