The Government must take urgent action to mitigate the increasing possibility of a “disorderly exit” by one or more universities from the higher education sector, a report has suggested.

The absence of a plan for handling a sudden closure of a university which is no longer financially viable is causing an “unsustainable level of uncertainty” for students, according to the consultancy Public First and University of Warwick paper.

A £2.5 billion transformation fund should be created to help provide state-backed loans to universities which make a “compelling case” for restructuring to pre-empt an exit or forced closure, the report said.

If restructuring is not possible or effective, a special administration regime could be introduced for the university sector to allow for a “more orderly form of exit” so students are protected, it added.

There is a “contagion” risk to other universities if one institution collapses as it will lead to uncertainty and it could dissuade would-be international students from choosing the UK to study, the report warned.

It comes after the University and College Union (UCU) called on the Government to introduce an “emergency rescue package” to stave off “catastrophe” in the higher education sector.

University leaders have warned the financial position for institutions across the country has deteriorated rapidly as a result of a drop in overseas students and tuition fees paid by domestic students.

The Public First report calls for the issue to “be near the top” of the new Government’s priority list as “everyone shares the risk from a disorderly exit”.

“The current status quo – of very minimal protection in the case of a disorderly exit, and potentially significant systemic impact beyond that institution – is not optimal, and efforts should be made to strengthen it as a matter of urgency,” the paper said.

A three-step process should be introduced to pre-empt exit – or to manage it in a more orderly way if it does occur – amid the tightened financial circumstances facing the sector, according to the report.

It says first the role of England’s higher education watchdog, the Office for Students (OfS), should be rebalanced so it can take a “more proactive” approach to managing and forecasting financial risk – underpinned by a new statutory direction for it to prioritise collaboration in the sector.

The report then says a £2.5 billion Higher Education Enhancement and Transformation Scheme should be created to offer repayable loans to universities wanting to restructure, and a Higher Education Commissioner should be appointed to oversee the fund and uphold financial sustainability.

Finally, the paper suggests a new Special Administration Regime for higher education, modelled on that for further education colleges and other elements of national infrastructure including rail, could be created to allow for protection for students and other national public assets under the law.

On Monday, Education Secretary Bridget Phillipson said she expected universities to manage their own budgets without calling on the taxpayer.

The Government is expected to set out its “initial steps” about regulation and the OfS this week. It comes after Conservative peer Lord Wharton resigned as OfS chairman following the election.

The report said: “There is also a contagion risk to other universities, should one exit the market in a disorderly way.

“Lenders may look more cautiously at lending to other institutions. Students may ask more questions about security over their own provision. Staff may want greater clarity on long-term financial health.

“And perhaps most significantly under the current financial model, would-be international students may look elsewhere because of nervousness not just about their preferred UK university, but all potential universities.

“All of these ripple effects have the potential to cause seismic difficulties in other institutions unaffected directly by the exit of another institution.”

Professor Stuart Croft, vice-chancellor and president of the University of Warwick, said: “In principle, the potential ‘market exit’ of a higher education institution is a feature, not a bug, of the current regulatory framework.

“In practice, exit – orderly or otherwise – of an institution from the sector has not been adequately prepared or planned for.

“Action is required to both protect students and to ensure that the reputation of the higher education sector is safeguarded.”

Jonathan Simons, partner and head of education at Public First, said: “There is no playbook for how to manage institutional failure at scale – multiple institutions or even one large institution.

“Given the current political and economic environment, the absence of a plan in current legislation or policy is leading to an unsustainable level of uncertainty for university leaders, for students and for Government.”

A Universities UK (UUK) spokesperson said: “University finances is a real and increasingly pressing issue and while we agree with calls for a transformation fund to help increase efficiency, this alone will not provide the sustainable funding settlement the sector needs to provide the opportunities, skills and innovation the UK needs to increase growth both locally and nationally.”

A Department for Education spokesperson said: “We are committed to creating a secure future for our world-leading universities so these engines of growth can deliver for students, taxpayers, workers and the economy.

“We recognise the immediate financial strain that some providers are under and the Education Secretary has been clear that we are working closely with the Office for Students to monitor risks and protect students. We will set out further details shortly.”