Funding for pockets of research excellence in teaching-focused universities should not be preserved at the expense of internationally prestigious institutions, the head of the University of Manchester has said.

In an interview with Times Higher Education, Dame Nancy Rothwell said that she did "not have a problem" with the Higher Education Funding Council for England's policy of rewarding excellence wherever it is found, "but not if that results in some outstanding institutions such as Imperial College London or the London School of Economics losing money".

Her comments came before a key speech by Vince Cable last week, in which the business secretary talked of the need to "ration" research funding by focusing on excellence and ending public support for "mediocre" research.

After the 2008 research assessment exercise, the research elements of Imperial and the LSE's block grants fell by 5 and 13 per cent respectively in 2009-10. This came as a direct result of Hefce's decision to reward "islands of excellence".

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Dame Nancy warned that reductions of this size endangered Britain's standing in the international knowledge economy.

If the coming cuts in higher education spending were so severe that Hefce was forced to choose between protecting funding for top institutions and islands of excellence, the latter should lose out, she said.

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"We have to ask ourselves whether we want to be mediocre across the board or compete with the best in the world."

Dame Nancy was appointed president and vice-chancellor of the University of Manchester in July.

She agreed that in the current financial climate, now was a "challenging time" to move into the vice-chancellor's chair, but she was happy to do so because she "cares about universities".

Dame Nancy revealed that she waived her right to several benefits in kind and took a lower salary than she was offered, preferring to be paid no more than 20 times the salary of the university's lowest-paid employee.

But universities should not shy away from paying high salaries to attract top international talent, she added, arguing that a good vice-chancellor could transform an institution.

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She cited her predecessor, the late Alan Gilbert, who took up the reins after Victoria University of Manchester's merger in 2004 with the University of Manchester Institute of Science and Technology.

He spearheaded a push to recruit "outstanding" staff, boost commercial partnerships and attract more international students.

Despite the financial squeeze, Dame Nancy said she had no plans to close departments.

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However, she admitted there were areas in which Manchester's research was not as strong as she would like. "We have to ask why that is and whether it is something we should stop doing."

She believes current student numbers are unsustainable, but was non-committal on whether an increase in fees would be the answer to financial problems.

Dame Nancy admitted that the coming cuts meant that there was a danger the sector would "disintegrate into different parts".

The friction is exacerbated by the current "unification", whereby "we are all squabbling over the same money", she said.

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The solution, she suggested, could be for a greater diversity of university missions, with some institutions focusing on providing two-year degrees, for example.

paul.jump@tsleducation.com