The Government is considering piloting a privately-backed student loans scheme for postgraduates, which could eventually replace the current loans system.

Ministers were this week examining the financial and political potential of a scheme where repayments would be made through the National Insurance system over a period of up to 20 years at market rates of interest.

The idea has interested Kenneth Clarke, Chancellor of the Exchequer, because it is likely to attract private investment, and Tim Boswell, further and higher education minister, because it could solve most of the Department for Education's student maintenance problems.

The DFE is looking at proposals for the scheme to be introduced for postgraduates at first, with a view to extending it to undergraduates and possibly further education students.

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The system, devised by the Education Funding Group at the London School of Economics, has also attracted the attention of the Conservative Party's higher education manifesto group and the Labour Party's further and higher education team, which are reviewing funding in the sector.

Nick Barr, a member of the group and senior lecturer in economics at the LSE, said ministers had dusted down the idea as they tried to solve problems with the present loans scheme, "There is a will to do it and a recognition that the present system is not going to be tenable for much longer," he said.

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Postgraduates have been seen as the best guinea pigs because they currently have little means of support (funding for the postgraduate bursary scheme is to be cut by 10 per cent from September), but their potential for high earnings would put them in the low risk category for private lenders.

If it worked, the scheme could help further education and part-time students by replacing the discretionary awards system, which has suffered in the face of local government budget cuts, as well as the present undergraduate loans system. The limit could be lifted on the amount borrowed, and repayments fixed at an extra 1p in the pound on National Insurance.

The LSE team has suggested that private investors, such as merchant banks and pension funds, could finance up to 90 per cent of the risk capital, particularly if students were paying market rates of interest. Linking repayments to National Insurance contributions would lower the risk of default.

It is expected the scheme would start paying for itself almost immediately, compared to the current loans system which is not expected to break even until 2014.

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