The archbishop of Canterbury was forced to admit on Thursday that the Church of England holds a more than £1m investment in one of the main financial backers of Wonga, the payday lender the Most Rev Justin Welby had promised to compete "out of existence".

A spokesman for Lambeth Palace conceded that the Church of England's £5bn pension fund, which has a policy that explicitly bans it from investing in payday lenders, holds an investment in Accel Partners, a US venture capital firm that is one of Wonga's biggest investors.

Lambeth Palace said it had been "unaware" of the investment which is a "serious inconsistency" with its ethical investment policy, and comes after Welby's personal attack on the immorality of Wonga's business model.

Accel, which has also invested in Facebook and Spotify, was one of three funds that pumped $22m (£14m) into Wonga in 2009.

On Thursday, a spokesman for Lambeth Palace said: "We will be asking the Assets Committee of the Church Commissioners to investigate how this has occurred and to review the holding in this pooled investment vehicle.

"We will also be requesting the Church Commissions to investigate whether there are any other inconsistencies as normally all investment policies are reviewed by the Ethical Investment Advisory Group (EIAG)."

In its 2012 annual report the Church says its "new policy on high interest rate lending extends the exclusion on investment in doorstep lending companies to cover companies engaged in payday loans and pawnbroking."

The news came after Welby had warned Errol Damelin, the founder of Wonga, that: "We're not in the business of trying to legislate you out of existence, we're trying to compete you out of existence."

In an interview with Total Politics magazine Welby said he was throwing the weight of the Church behind credit unions to offer an alternative to Wonga, which charges an annual interest rate of 5,853%. Welby, who has served on the parliamentary Banking Standards Commission, offered to open up 15,000 churches to existing credit unions and offered volunteers to help run them.

Damelin said he welcomed competition from the Church but it is understood that the payday lender is about to launch a national advertising campaign setting out its "10 commitments" in a cheeky riposte to Welby.

"The archbishop is clearly an exceptional individual and someone who understands the power of innovation," Damelin said. "There is mutual respect, some differing opinions and a meeting of minds on many big issues. On the competition point, we always welcome fresh approaches that give people a fuller set of alternatives to solve their financial challenges. I'm all for better consumer choice."

Credit unions, which have an old-fashioned image and something of a chequered financial past, will have their work cut out if they are to challenge Wonga.

The lender spent £16m on advertising in 2011 and has a number of high-profile TV and football club sponsorships, including a four-year deal with Newcastle United starting in the 2013/14 season.

It has invested heavily in its website, through which it offers borrowers loans of up to £1,000, delivered to their bank accounts in less than 15 minutes. In contrast, membership of credit unions is restricted to interest groups, and several have gone bust in recent months with many citing bad debts as a factor.

The payday lending industry has boomed in recent years as stretched consumers have turned to short-term loans to get them through to the next wage packet.

While lenders claim they are meeting a need that mainstream lenders do not fulfil, critics say they target vulnerable customers, leading them into a spiral of debt. The entire industry is currently the focus of a Competition Commission investigation, after the Office of Fair Trading found "deep-rooted" problems in the sector.

Wonga said in March it welcomed any attempt to encourage responsible lending and that it had been "instrumental" in helping to raise industry standards.

The chief executive of the charity Citizens Advice, Gillian Guy, said other solutions were needed to meet consumers' need for small-scale short-term borrowing. "Credit unions can be a great option for some people, so it's good news that the Church of England is planning on boosting them," she said. "But at the moment, credit unions can't meet all the demand for short-term credit. We need a responsible short-term credit market that treats its customers fairly, and we want to see banks stepping up and offering short-term micro loans."

Matthew Reed, chief executive of the Children's Society, said families were being driven into the hands of lenders by changes to the government's social fund. "We are calling for local authorities, with government support, to help vulnerable families get access to interest-free, or very-low-cost credit, in a crisis. This will reduce the risk of them being forced to turn to high-cost money."