The central bank's Prudential Regulation Authority (PRA) published proposals to reform regulation of credit unions, which are being promoted by policymakers and the Church of England as a viable alternative to costly pay-day lenders and a banking sector tarnished by scandals and the financial crisis.

The PRA, which supervises lenders and insurers, proposed the removal of existing rigid restrictions to give boards of credit unions more freedom to decide how their businesses are run.

"These changes will introduce a more risk-based and flexible regime for credit unions, with prudential standards that reflect the diverse business models they now operate. The new rules will raise standards where required," the central bank's Deputy Governor Andrew Bailey said in a statement.

The 50-year-old credit union movement has typically served the less well off in society but is now revamping itself to attract a wider range of customers by offering accounts, mortgages and savings products.

The British government has allocated 38 million pounds ($59.9 million) to support the sector's expansion and boost competition in a banking industry dominated by the Big Four of HSBC (>> HSBC Holdings plc), Barclays (>> Barclays PLC), Lloyds (>> Lloyds Banking Group PLC) and RBS (>> Royal Bank of Scotland Group plc).

The Association of British Credit Unions' website says there were 362 credit unions serving 1.2 million customers by the end of last year. Loans totalled 718 million pounds with deposits of 1 billion pounds, still tiny compared with the Big Four.

A key aim of the PRA's proposals is to give consumers confidence that they will not lose their money if a credit union fails. Deposits would be capped at 85,000 pounds and money must be handed back within seven days in the event that a credit union collapses. In lending, no single loan would be allowed to exceed 500,000 pounds.

(Editing by Susan Fenton and David Goodman)

By Huw Jones