Two thousand years after the financial services industry was ejected from church premises, the Archbishop of Canterbury not only wants to invite the money-changers back in – he wants churchgoers to help them expand their lending.

Justin Welby is promoting credit unions as a credible alternative to the booming £2bn payday lending industry, and says it will help match often vulnerable, low-income borrowers with the most appropriate lenders. He is proposing that credit unions be allowed to use church halls and other properties in order to better access customers. Welby also wants to encourage churchgoers with financial expertise to help these lenders.

Welby, who sat on the parliamentary commission on banking standards and has been an outspoken critic of the financial industry, believes a successful credit union sector could pose a challenge to high-street and internet payday lenders, who target often vulnerable borrowers with expensive loans.

Malcolm Brown, the Church of England's director of mission and public affairs, yesterday said: "It is not about regulating them [payday lenders] out of business. If the market is functioning as it should, there should not be any need for them to exist."

The government has also pledged to spend £38m to strengthen credit unions.

Many high street banks have retreated from offering small, short-term loans in recent years, while demand from low-income groups has soared, sparking an explosion in lightly regulated payday lenders.

Welby's intervention comes as ministers and regulators also grapple with how best to curb the ballooning payday lending industry without choking off small-sum credit to low-income groups. Consumer minister Jo Swinson will meet with lenders as well as with debt charities and campaigners to discuss what she calls "widespread irresponsible lending".

Last night she said she would tell companies: "The industry needs to do so much more to get its house in order, particularly in terms of protecting vulnerable consumers. I am concerned that the lenders are not living to the spirit or the letter of the codes of practice."

Justin Welby, the archbishop of Canterbury. His intervention comes as regulators grapple with how to curb the payday lending industry. Photograph: Dominic Lipinski/PA

However, in a weekend column in the Sun newspaper Swinson made clear the government would not impose a cap on loan costs. "That could shut down short-term loans and force people towards illegal loan sharks or other extreme measures," she said. "The solution needs to be more sophisticated than this."

While Welby's plans stop short of inviting church commissioners, who oversee £5.5bn of the Church of England's wealth, to put financial muscle behind credit unions, he nevertheless wants the church to use other means at its disposal to get behind such lenders. The church is also building plans for its own in-house credit union for the clergy, which it hopes will eventually help it build expertise that can be shared with grassroots lenders.Labour's shadow treasury minister Chris Leslie said ministers had "consistently ducked clamping down on predatory pricing and extortionate interest charges". He said regulators already had the power to control costs and loan duration but the political will was absent.

Payday lenders have variously been accused of failing to properly compete with one another on the cost of loans; of conducting too few checks on the financial means of borrowers; and of using overly aggressive tactics to extract repayments.

The OFT referred the industry to the Competition Commmission last week, after repeated warnings that it must get its house in order met with only mixed responses.

One successful payday lender, Wonga.com last week increased customer loan costs to the equivalent of 5,853% APR. Speaking ahead of the meeting with Swinson, co-founder Eric Damelin claimed his company and others were being "used as political footballs". He claimed to be in favour of regulatory reform. "We don't want no regulation, as we want to keep the bad guys out".

At the top of the agenda for the meeting Swinson has called will be the new regulatory regime, which comes into force from April next year, under which industry must answer to the Financial Conduct Authority rather than the Office of Fair Trading. Officials from both the FCA and the OFT will address the meeting.

Last month the House of Common's public accounts committee said the OFT had been "ineffective and timid in the extreme" in regulating payday lenders.