Interest rates will not increase for loans that have already been issued. It will only affect new loans where the credit union chooses to apply the 3 per cent limit.
Credit unions are mutual financial organisations that take deposits and give loans to their members. There are around 400 credit unions in the UK, with almost one million members.
Under the current rules, credit unions can charge a maximum interest rate of 2% each month on the loans they provide. This limit means that credit unions often make a loss on the smaller, short-term loans that they offer due to the high administrative costs compared to the value of the loan.
Raising the cap to 3% will allow credit unions to break even on these types of loans. It will help ensure that they can operate more efficiently, be more stable, and free up money to lend to customers. This consultation responds to calls from the credit union sector.
The Economic Secretary to the Treasury, Sajid Javid said: "Credit unions provide an invaluable service to people on lower incomes, offering sound financial advice and responsible lending.
"Allowing the maximum rate of interest to increase will help credit unions become more stable, so consumers on lower incomes have greater access to reliable, affordable credit, and don't have to resort to more expensive means, such as payday lenders."
An increase in the interest rate would be permissive: it would not require credit unions to increase the interest rate that they charge, but allows them to do so.
Even with a 1% increase in the monthly rate of interest, credit union loans will still be substantially cheaper than the alternatives for consumers who might find it difficult to access mainstream sources of finance.