A system that assumes a "quite good" institution is unable to get better, and thus denies them the funds that would enable them to get better, is probably not an optimal system for promoting merit. A system that rewards in proportion to merit would at least be able to recognise and reflect the dynamism of university research; research groups wax and wane as people come, go, get disheartened, get re-invigorated.
On the importance of funding middle-ground