Local education authorities and universities are complaining that their attempts to crack down on fraudulent grant applications are being penalised by Government policy. They want the Government to cover any financial losses incurred in the hunt for fraud.

Detecting 700 cases of fraud last year may have saved taxpayers at least Pounds 3 million on grants and loans but it cost institutions scarce time and resources.

Although the DFEE has called for a concerted attack on student fraud it has not been prepared to provide universities with incentives.

Toby Grainger, assistant head of student administration at the University of East London, said: "There is an underlying view, particularly at a senior level in universities, that we don't gain anything from exposing fraud. In fact, it's the Treasury which will save a lot of money by recouping losses from fraudulent claims. If we kick out students we lose their fees and student numbers drop. It's incredibly short-sighted of the Government to make us shoulder the costs."

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Ivor Widdison, administrator at the Council of Local Education Authorities, said: "We have made representations to the DFEE to look at this matter again. It seems very harsh if it costs us more money for trying to save money, by operating rigorous checks and detecting more fraud. We appreciate that this money has been paid up on an unauthorised basis but we are hoping that the department won't ask for reimbursement."

Both Mr Grainger and Mr Widdison are members of a specially convened forum, called the Close Interest Group, which allows a network of interested agencies to monitor fraudulent cases and practices. It includes representatives from UCAS, the Immigration Service, the Metropolitan Police Fraud Squad and the Student Loans Company.

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Financial abuse of the system is made easier for organised criminals adopting false names and addresses. A Liverpool case involved a criminal hacking into a DSS office computer system and forging details of 20 unemployed people to make up false identies, which were then registered at several universities. Each false identity could reap up to Pounds 5,000 from LEA grants, student loans and career development loans.

UCAS, which recently installed a Pounds 120,000 computer system to build a database of false names and addresses, agrees that the issue of fraud must not overtake its main function. Alan Bell of UCAS said: "Because we are central to the whole process it's easier for us to use technological systems to tackle the problem. But it certainly won't interfere with our priorities."