Universities will be left to sink or swim after funding chiefs decided not to bail out institutions that recruit too few students for longer than a year.
The funding council was rumoured to be spending £80 million a year to support unfilled places at universities that regularly under-recruited. Such institutions got more money per student than those that did attract students. Some had received the extra money for up to a decade.
Funding chiefs had been lobbied to take the money and put it towards the bill for the improved research results. But, as today's funding allocations reveal, they decided instead to double the premium given for recruiting students from under-represented neighbourhoods to 10 per cent.
Sir Howard Newby, chief executive of the Higher Education Funding Council for England, said: "In future, institutions will have to face up more quickly to the consequences of their failure to recruit. That will mean we can put more money into the general pot, and we can allocate student numbers to those institutions that are successfully recruiting.
"We reserve the right to take the money back for students (the universities) fail to recruit. If they didn't recover in the following year, we would claw back the total. We will support them only if they can produce a robust recovery plan that tells us how they will climb out of the hole they have got in."
Sir Howard acknowledged that the cost of recruiting and retaining such students was far higher - probably 20 to 25 per cent. The funding council will spend £47.4 million on the postcode premium next year.
Meeting the full cost would require an extra £70 million.
A freer market could be bad news for some new universities. An analysis of student demand for higher education published last year found that new universities had failed to fill all their student places over seven years from 1994. In this period, more than 22,000 places went unfilled in new universities. But new universities are the best placed to benefit from the doubling of the postcode premium.
Funding at three universities - Lincoln, Luton and South Bank - will fall next year in cash terms. Twenty-three other institutions - including the University of Oxford - will suffer real-terms cuts because of under-recruitment and the decision not to fully fund the results of the research assessment exercise.
The funding council also plans to re-examine how it allocates extra student numbers. A regional aspect is likely to be introduced - for example, to promote higher education in Cornwall, Cumbria and Thanet. This could foster more strategic alliances and mergers.
Today's funding allocations show that funding per student will rise by 1 per cent in real terms next year. There is money for 23,000 more student places, and overall teaching funds will rise by 4.9 per cent. Research funding will increase by 5.9 per cent. But the extra research funding is insufficient to fully reward the improvement in the RAE results.
Sir Howard said the RAE would be reviewed early this summer, after the science review being undertaken by the Treasury and the Office of Science and Technology has reported.
He said: "There will be an RAE, but we need to have another look at it. First, the RAE is used to discriminate across a seven-point scale, but we fund only four of them. There is a ceiling effect - many departments have nowhere to go, and this has incentive effects. We also need to look at the RAE and the ways in which we can reward excellence in areas other than research.
"With the needs of society, students and the economy becoming increasingly diverse, higher education institutions need to be supported in achieving excellence in different ways as well as research. We are discussing how this might be achieved with the universities and colleges and other partners as part of our strategic planning."
Commenting on the allocations, Roderick Floud, president of Universities UK, said: "A significant number of universities are now facing a real-terms percentage cut. And the difficulties are exacerbated by the failure to fund the substantial improvements (that were) achieved in the recent RAE."
Tom Wilson, head of universities at lecturers' union Natfhe, said: "We are deeply disappointed and very angry. It's a kick in the teeth for new universities that have achieved excellent research for no extra money. Frankly, there is no chance of achieving the 50 per cent (participation) target unless there is more money coming through the spending review."
Sally Hunt, assistant secretary general of the Association of University Teachers, said: "The Treasury must now use the comprehensive spending review to provide the increases in research funding that our universities deserve and our economy needs."