Universities could be heaping up a multi-million pound "cash mountain" because funding regulations put them off spending the money, a leading vice chancellor warned this week.

Big financial reserves set aside to cover the maintenance and replacement of buildings and equipment cannot be touched by many institutions without sending them into spiralling deficit, according to John Bull, vice chancellor of Plymouth University and treasurer of the Committee of Vice Chancellors and Principals.

Professor Bull fears that when the Treasury sees these "substantial sums" on university balance sheets it will conclude that it can continue with the cuts in capital funding that are already crippling the sector.

His claims are being considered by the ÖйúAƬ Funding Council for England, which is currently analysing universities' financial forecasts.

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John Rushforth, Hefce's chief auditor, said very early indications were that institutions were choosing to spend the money and worsen their financial position rather than build reserves.

Professor Bull argues that universities have been left in a "Catch 22" situation by the clash between accounting rules governing depreciation charges on universities' fixed assets and funding council regulations designed to protect investment of public money.

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Universities manage their money in line with requirements set by the Accounting Standards Board, which rule that they should save some of their income to cover the declining value of capital assets over a long period of time.

They must also operate within funding council financial memorandum rules which say they must not run a deficit in two consecutive accounting periods unless they have sufficient reserves to cover it. This presents few problems when institutions are generating surpluses. But when the sector as a whole falls into deficit, as it has now, it presents a dilemma, Professor Bull said.

"If you are operating at a loss and you have arrived at that after deducting depreciation charges you can be showing a loss but still have net cash flowing into your institution. The difficult question is, once you have retained this money, how do you spend it? If you spend it on buildings or staff all you do is put more pressure on your bottom line," he said.

Mr Rushforth said: "We understand what he is saying at a technical level and we are monitoring any increases in cash balances. It is true that if nothing changes and depreciation is covered then balances will increase. But the money can still be spent on capital replacement."

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Miles Hedges, chairman of the British Universities Finance Directors Group, suggested Professor Bull's analysis was too simple. "The real Catch 22 situation is that if we show a big deficit we get a black mark from the funding council, but if we take emergency action which affects provision to balance the books it then looks like we are managing," he said.