Pay and pension costs, rising levels of borrowing and tougher competition for overseas students are among the key financial risks confronting English universities.

While the sector is generally in good financial health, the dangers it faces were identified in a report based on a review by the Higher Education Funding Council for England.

The assessment is based on higher education institutions' own financial forecasts for the period up to and including 2010-11, submitted to Hefce as part of the first year of the "single conversation".

The "single conversation" is a new system of audit that aims to reduce the burden of regulation by relying on institutions to submit their own accountability returns each year.

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In the area of pay and pension costs, a paper produced for the Hefce board has raised doubts about the accuracy of the sector's own forecasts.

It notes that English higher education institutions are predicting annual increases in staff costs of less than 5.5 per cent over the next four years, despite the fact that over the past six years these costs have risen by an average of 8 per cent annually.

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While acknowledging that the immediate past is not always a good indicator of the future, the paper says that if the 8 per cent annual increase continues, the sector would be left facing staff costs ?1.2 billion higher than expected in 2010-11. This would wipe out the surpluses that have been forecast for the preceding two years.

Addressing the rising levels of borrowing in the sector, Hefce said that interest and capital payments would remain affordable for institutions only as long as their income projections were met and other major costs were kept at expected levels.

The funding council said: "Increased competition may see income growth, particularly in non-publicly funded areas, become more difficult to maintain."

One area where institutions may be vulnerable is in the recruitment of international students.

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Hefce said that while total student numbers are forecast to increase by an average of 2.3 per cent each year, numbers of overseas students are expected to rise by 5.1 per cent.

The funding council warned that any downturn in the UK's share of the market will be keenly felt.

john.gill@tsleducation.com.