ILCU chief Kieron Brennan

Finance minister Brian Lenihan has watered down new rules on credit unions, restricting wide-ranging "stop and search" powers granted to the Financial Regulator under the Central Bank Reform Bill.

The minister's amendments to the controversial "Section 35" rules drop powers that would have allowed the registrar of credit unions – the regulator for the cooperative lenders – to direct the business of individual credit unions. The revisions mean the registrar will now be limited to making rules, rather than giving directions, as the original language allowed.

The tougher Section 35 rules were drafted to balance a relaxation in limits on long-term lending, which had been granted to allow credit unions to help distressed borrowers restructure loans.

Lenihan's changes followed weeks of lobbying by credit unions' representatives from both the Irish League of Credit Unions (ILCU) and the Credit Union Development Association (CUDA). The credit unions had originally agreed to new restrictions in principle, but were surprised at how extensive and potentially intrusive the regulations turned out to be.

The registrar is understood to be happy that his office will still get the power it originally sought and the minister is still going to implement the main provisions of Section 35.

The Financial Regulator has been very concerned about the stability and solvency of credit unions in recent weeks. Last Wednesday the regulator published a consultation paper proposing a statutory bailout fund for credit unions that become insolvent. The regulator's favoured option is a fund that replaces ILCU's existing €119m savings protection scheme, which is a private fund outside the regulator's control.

While CUDA welcomed the suggestion, ILCU is understood to be furious with what its officials see as a power grab that is damaging confidence among its members. The league's board has not yet decided how to respond to the consultation paper, but it may decline to make a formal submission before the 16 August deadline as an expression of its resentment at how the process has been handled, informed sources said.

Meanwhile the regulator is continuing its aggregate stress test of the country's 414 credit unions and detailed examinations of the 100 biggest institutions.

Officials are particularly concerned that credit unions which have lent to small businesses or for property development could face rapid and overwhelming loan losses, putting members' savings at risk.

Some credit unions have increased bad-debt provisions by 300% in the last year, while the average across credit unions is 85%, regulatory sources said.

ILCU has revealed five of its member credit unions have low solvency levels "in danger of going below 100%" and had received assistance from the savings protection scheme. It is understood none of the credit unions represented by the Credit Union Development Association are in danger of insolvency.

Regulatory officials fear that even a little more stress in the financial system could push many more credit unions to the brink, quickly overwhelming the movement's internal resources. ILCU chief executive Kieron Brennan maintains its members have strong enough reserves to deal with any problems.