Last updated: April 20, 2011 5:42 pm

Banks ordered to repay loan insurance

Millions of consumers are set to share in the largest UK compensation pay-out in almost a decade, after the banking sector lost a High Court challenge over the sale of controversial loan insurance.

In the latest twist in a long-running dispute over payment protection insurance, the court dismissed an appeal brought by the banks against regulatory changes that would force them to refund past policies worth billions of pounds.

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Banks have been attacked for selling PPI, which covers personal loan repayments if the borrower loses their job through illness or redundancy, at overinflated prices to customers who may not have needed it.

The Financial Services Authority has introduced changes to the way PPI is sold and wants to apply these to past policies – which would open the door to mis-selling claims.

The regulator estimates the changes would cost the industry £4.5bn. But the British Bankers’ Association, which is representing the banks in the case, warned that the impact could be significantly greater.

As the largest provider of PPI, with about a third of the market, Lloyds Banking Group alone could face a bill of up to £1.5bn, according to analysts.

The BBA said on Wednesday that it was disappointed and would consider appealing against the court’s decision.

It is unclear whether further action would be supported by the banks. The Lloyds board is split on whether it would back an appeal, according to people familiar with its thinking. Some senior executives having questioned the benefit of another long legal process.

Consumer groups welcomed Wednesday’s ruling. Consumer Focus said it was a “huge win” for millions of borrowers, while Citizens Advice said it was “very significant and should mark the beginning of the end of the PPI scandal”. To date more than 1.5m customers have complained about PPI. Many say they were unaware they had paid for the product, or were advised to buy insurance they were subsequently unable to claim on.X

The PPI dispute hinges on a disagreement between banks and the City watchdog about how past complaints should be dealt with.

The FSA wants to alter the way PPI is sold so that consumers are made aware it is optional. In addition, it wants lenders to contact 2m existing customers who may have been mis-sold cover over the past five years, but have not yet requested compensation.

Banks claim this would unfairly apply new rules to retrospective sales.

Banks have rejected about 60 per cent of all complaints, with some providers rejecting almost all claims. However, cases that were subsequently sent to the Financial Ombudsman were overwhelmingly found in favour of the customer.

The size of redress dwarfs previous successful consumer complaints for products such as mortgage endowments and split-capital investment trusts and is second only to the £11bn paid to pension savers who were given bad financial advice between 1988 and 1994.

Nineteen providers have already been fined for poor selling practises including HFC Bank, a subsidiary of HSBC and Alliance & Leicester, which was fined £7m in October 2008. At the time, it was the largest FSA fine ever levied against a retail bank.

Investors showed little concern about the ruling. Shares of Britain’s biggest banks remained relatively flat on Wednesday. Lloyds’ shares edged up 0.5 per cent to 58.65p, while those of Barclays, HSBC and RBS rose by 1-2 per cent.

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