US Edition Dr Wendy Piatt, director general of the elite Russell Group, said institutions would face a "bleak future" if more money was not pumped into the system.
Universities could miss out on attracting top academics or postrgraduate students and may be tempted to recruit more international students to make up funding shortfalls, she said.
The comments were made in evidence to an independent review of student funding led by Lord Browne, the former head of BP.
His review is expected to make recommendations to the new coalition government in the autumn – setting out plans for a new system of fees, grants and loans for millions of undergraduates.
The Russell Group, which represents 20 leading research universities, including Oxford, Cambridge and University College London, has already called for the existing £3,225-a-year cap on fees to be lifted.
Giving evidence to a special hearing in Leicester, Dr Piatt was asked whether universities would consider opting out of state control altogether if they failed to receive more money.
"That would require a lot of consideration and we would hope not to have to go there, but we would certainly have to consider more radical options,” she said.
She warned that universities were already facing a £1.1 billion funding deficit by 2012/13, adding: "We are perilously close to undermining student quality. Universities are bending over backwards to protect quality of courses.
"I don't really see how, without any change in the system, there wouldn't be an undermining of the student experience."
The comments follow claims from Sir Roy Anderson, former head of Imperial College London, that top academic institutions should be privatised to form an elite US-style Ivy League.
He suggested that the best universities should be allowed to “float free” from the government's funding regime to charge unlimited fees – and admit more foreign students – putting them on a par with institutions such as Princeton, Harvard and Yale.
Addressing the fees review, Dr Piatt also said top British universities “may have to think about taking on more international students”.
"If there really is no more sources of funding, that may be a temptation,” she said. "We may start not attracting the leading academics and may even lose some of our own best people."
She also warned that some universities may be left to fail in a market-based system.
"We need to be very careful about the nuclear option, as it were, but we don't need to rule it out of court, it always needs to be a possibility," she said.
At the moment, Buckingham is the only independent university in Britain.
The latest comments will increase the pressure on the review team to push for a rise in tuition fees.
Some universities have also called for interest rates on student loans to increase to generate more cash for higher education. Loans are currently subsidised by the taxpayer at a low rate of interest.
In previous submissions to the fees review, Oxford and Cambridge have both called for universities to be allowed to charge higher fees.
Oxford said it needed more money to plug an funding gap of almost £100m a year. It spent around £16,000 teaching each undergraduate, but received only £8,000 through a combination of taxpayer contributions and tuition fees, it said.