Universities could have to bid for public money according to their own missions and strengths, with block grants replaced by individual contracts between institutions and the funding council.
The idea has been mooted by Paul Marshall, chief executive of the 1994 Group of smaller research-intensive universities. It came as the Government hinted that a larger chunk of higher education funding could be "contestable" in future.
Mr Marshall said that the matched-funding scheme for donations run by the Higher Education Funding Council for England could be applied to other areas of university finance.
Under the scheme, institutions bid for cash from Hefce to match gifts from donors in one of three tiers, each with different caps on the available cash. They decide which tier to bid for based on how much they think they will be able to raise.
Mr Marshall said a similar system could be applied more widely. "For example, universities could bid for research cash based on how they think they are going to be rated by the research excellence framework, or for widening-participation funds based on the predicted intake of students from poorer backgrounds."
This would not only link financial rewards to the strengths of individual universities, but would also make them think more clearly about those strengths.
"This approach could help universities develop future plans, strategic direction and brands. It may also have the added benefit of providing greater clarity to students and the users of research about each university's strengths," he said.
The draft Higher Education Framework, which is being reviewed by Lord Mandelson, the First Secretary, is believed to commit to more diversity in the sector, as well as noting ministers' approval of institutions' responses to the matched-funding scheme.
In his speech to the Universities UK Annual Members' Conference on 10 September, David Lammy, the Higher Education Minister, hinted that universities may have to bid for more funding in future.
If Mr Marshall's ideas were adopted, universities could be funded via individual contracts rather than block grants. This would move the sector closer to a regulated market model.
"In developing a vision for the future, it is essential that the strength gained from diversity and competition be identified, respected, valued and enhanced," Mr Marshall said.
"A regulated market, with a diverse range of institutions competing within an agreed framework, is the best way to drive up excellence."
The proposals follow a consultation in Australia, where the Government is considering mission-based "compacts" to allocate funds. The compacts will define an institution's mission and describe how it would fulfil it while contributing to federal policy objectives.
Meanwhile, in a speech at the London School of Economics on Monday, Lord Mandelson announced a review of all higher education funding agencies, including Hefce, to cut "overlapping bureaucracy".
Hefce is already the subject of its own efficiency review, chaired by Dame Sandra Burslem, former vice-chancellor of Manchester Metropolitan University. However, a Hefce spokesman said it would be happy to participate in any wider review.