Funding chiefs at the Learning and Skills Council are threatening the "nuclear option" against colleges where too many students fail to stay the course or pass exams.
Tough measures announced this week could see some colleges losing more than a quarter of their income from the council. This could force drastic measures such as dismissing the principal, merger with another college or closure.
Rob Wye, the LSC's director of strategy, said "notices of improvement"
would be served on colleges if more than a quarter of their courses had less than half the students going on to gain a qualification. This standard of performance would put colleges in a new category of "outright failure".
The notice would be served on the principal and the governors. If the college failed to improve its performance, it would face funding being withdrawn from the sub-standard courses.
The measures are being applied to long courses, such as GCSEs and NVQs, which form the bread-and-butter of a college's work.
Mr Wye said: "This is the nuclear option, where we're saying more than a quarter of what you're doing is not good enough and we're giving you notice to pull your socks up or else."
The performance of a few colleges is known to have fallen to this level already, although the LSC declined to identify them.
Roger Kline, a candidate for the general secretary's job at the University and College Union, said: "There may be a number of reasons colleges are in this position. It might be because they are dealing with particularly challenging students.
"The mission of FE is, in part, to take chances with people who might fail or drop out. All these measures will do is add to the climate of fear."
The enforcement measures, plus a previously announced lighter inspection regime for top-performing colleges, were published this week in the LSC's report Identifying and Managing Underperformance, which details how it aims to raise standards in line with the White Paper Further Education: Raising Skills, Improving Life Chances.
The Association of Colleges says only a few colleges are underperforming to the extent that the measures would be needed.
In bullish mood, the AoC was lobbying the House of Lords to support colleges in their attempt to win degree-awarding powers, as proposed in a Bill. John Brennan, the chief executive, said: "While we don't expect the powers to be taken by a large number, they are needed to allow colleges with large higher education programmes to offer even better programmes."