The authorities have already been told they could lose the funds set aside for further-education students from next year. They say they will fiercely oppose the proposal on the grounds that it is illegal, leaving them with responsibility for administering the grants but without the money to do so.
At the same time, the Universities and Colleges Admissions Service, Ucas, is making plans to bid for the whole grants system if the politicians put it out to tender. It has already set up a pilot scheme to prove that it is best placed to run a "one-stop shop" for university entrance and grants.
Officials at the Department for Education and Employment have written to local authorities' organisations to say that they want to hand over the further education grants system to the Further Education Funding Council, which funds the colleges. Because there would be no change in the law, the authorities would still have to consider all requests for grants even though they had no funds at all to distribute.
Instead, the money would be channelled through "access" funds run by colleges for students in hardship.
The authorities have protested angrily to government officials that the change would create an "irritating diversion" from the debate on the future of university and college funding. They say the Government has a legal duty to give them the money to distribute to students.
David Whitbread, education officer of the Association of County Councils, said that in general the existing system worked well.
He added: "We would have far less money to make awards but people would still be able to ask for them. We would argue that student support is a proper concern of elected bodies."
Another, potentially even more controversial move under consideration is a plan to remove the whole university grants system from local authorities.
Most of these grants are "mandatory" - the student is entitled to them on a means-tested basis and the authority has to pay them. They cost the Government pounds 2bn per year.
Ministers will not make an announcement about the future of this part of the system until at least next year, but a pilot scheme involving Ucas is currently running in 10 areas.
The admissions service believes it is ideally placed to run student grants, because it knows which universities students are going to almost as soon as they do. Under its pilot scheme, it sends the information through to local authorities so that they can process grants before they receive formal requests for them from the students.
Mike Scott, universities and colleges liaison officer for Ucas, said its system could save a lot of time. Although it worked with local authorities at present, it could easily operate independently of them. "Trials have shown that it saves at least two weeks in terms of sending the students' cheques out," he said.
A spokeswoman for the Department of Education and Employment said there were no current proposals to remove these "mandatory" grants from local authorities.The department was waiting to hear from Sir Ron Dearing's review of higher education.
"Only when he has reported will we be able to say what is happening," she said.