Church vs. payday lenders - whose side is God on?

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Payday loan companies are used to coming under fire, but their latest critic might come as an unholy surprise. The leader of the Church of England weighed into the debate surrounding lenders of short-term cash loans — saying he wanted to "compete" them out of business.

The Archbishop of Canterbury, Justin Welby, said he had a "very good conversation" with the founder and CEO of Wonga, one of Britain's best-known payday lenders.

"I said to him quite bluntly we're not in the business of trying to legislate you out of existence, we're trying to compete you out of existence. He's a businessman; he took that well," he said in an interview with Total Politics, a U.K. political magazine.

(Read More: Payday Loans Cost Economy $1 Billion in 2011: Study)

The Church of England plans to take on payday lenders such as Wonga by launching its own credit unions, and has already created a co-operative for clergy and church staff.

Welby, who became head of the Church of England in March, and sits on the U.K.'s Parliamentary Banking Standards Commission, said these unions – where members pool their savings to get credit at a low interest rate – would help boost competition in the banking sector.

In response to Welby's comments, Wonga CEO Errol Damelin described the Archbishop as an "exceptional individual" and said he welcomed competition – even from the Church.

(Read More: UK Banking Commission Findings 'May Be Ignored')

"On his ideas for competing with us, Wonga welcomes competition from any quarter that gives the consumer greater choice in effectively managing their financial affairs," Damelin said in a statement on Thursday.

Earlier this month, Wonga increased the annual interest rate on its loans to 5,853 percent.

Payday loans have become big business since the start of the recession, offering loans that are essentially advances on wages, and are meant to be repaid on the next payday. Lenders have been criticized by watchdogs and debt charities for their high interest rates and their targeting of struggling customers.

(Read More: How Some Payday Lenders Charge Over 700% on Loans)

The U.K.'s Office of Fair Trading estimates the industry was worth up to £2.2 billion ($3.4 billion) in 2011/12 – a significant rise from £900 million ($1.4 billion) in 2008/09. The watchdog raised concerns about "irresponsible lending" and accused firms of granting customers loans they could not afford to repay, exacerbating their financial difficulties.

-- By CNBC's Katrina Bishop. Follow her on Twitter @KatrinaBishop