The clawback has been an annual headache for colleges which have to return money to the LSC if they do less well than expected, not on only in results, but particularly if they fall short on student numbers.
From this academic year, colleges which achieve 97 per cent of the targets set in their annual plans, on which LSC funding is based, will keep all the allocated cash. The measure is designed to help those colleges forced to make cuts to afford clawback payments.
In many cases, even with fewer students than planned, colleges have still had to pay for such things as staffing and equipment.
Funding claims are submitted by colleges retrospectively after the end of the academic year, based on the actual number of students and their exam results, and shortfalls have resulted in clawback. The 3 per cent limit, which could reduce clawback by pound;30 million annually, will depend on colleges submitting their funding claims in time.
Ken Pascoe, LSC policy director, said: "There was a 2 per cent tolerance previously. The new approach is to take the view that if colleges get close to delivering their plan in full they should get the money."
Most of the LSC's underspend in its first year is understood to be accounted for by cash sitting in college bank accounts, waiting to be returned and recycled the following year.
Clawback has trapped colleges into making promises they can not keep in the pursuit of government cash.
To avoid being under-funded, colleges have made over-optimistic plans for student numbers only to find themselves being penalised for under-delivering.
Now, colleges which do better than expected in basic skills and courses for 16 to 18-year-olds will be funded at 100 per cent for this extra activity, allowing them to make more realistic forecasts without worrying about taking on more students than they can afford.