The final bill for the payment protection insurance scandal could reach £20bn

The massive payment protection insurance (PPI) scandal just goes from bad to worse. Lloyds Banking Group, by far the most enthusiastic pedlar of these largely worthless policies, has just been hit with a £4.3 million fine from the City watchdog – not for wrongly selling them in the first place, but for delays in paying out compensation to its customers.

Britain’s banks have already made provisions of £13 billion for PPI compensation, although many in the industry believe the final bill could be nearer £20 billion, surpassing even the pension mis-selling scandal of the 1980s. As the largest seller of PPI policies, Lloyds has set aside the largest amount in compensation – £5.3 billion – but that figure could well rise again when the bank reports its full year results next week.

Bailed-out Lloyds is the first bank to be fined for dragging its heels on reimbursing customers, although other banks have been hit with penalties from the regulator for mishandling PPI complaints. In its ruling, the regulator said Lloyds’s redress payment systems “fell well below the standard the FSA expects”. The size of the fine – which would have been £6 million had Lloyds not settled at an early stage – reflects how seriously the FSA regards Lloyds’s transgressions.

More than 140,000 of the banks customers had to wait over a month for their compensation cheques and nearly 9,000 waited over six months. And payments to 25,000 customers seem to have “inadvertently dropped out of the process”, according to the FSA. Such was the chaos of the compensation process, bank employees handling the claims were unable to explain why they delayed or fast-tracked payments, nor could they give customers any idea of when the money might come through.

Lloyds argues that, like the rest of the industry, it has simply been overwhelmed by the deluge of claims, a material proportion of which are almost certainly bogus. But the FSA fine is another blow to what little reputation the banks have left; prompt compensation payment and an apology might go some way to restoring customer trust but Lloyds at least seems incapable of that.

It’s also a blow for Lloyds’s embattled chief executive, Antonio Horta Osario, who looked to have made a smart move a couple of years ago when, newly installed at the bank, he broke ranks with the other high street lenders and gave up the long-running legal fight waged by the banks against paying out. Caught on the hop, his high street rivals were forced to follow suit.

“It is the sensible, prudent and right thing to do,” he said at the time. Back then, in 2011, Lloyds’s estimate of its PPI bill was £3.2 billion, a figure Horta Osario admitted was larger than he had expected. The sheer scale of the mis-selling scandal has astonished everyone, even the regulator. No wonder the banks are lobbying hard for a deadline on claims, with April 2014 being mooted as the cut-off point. The banks argue that a deadline will encourage more people to claim but the payment delays by Lloyds do nothing to strengthen their case that a time limit would be in anyone’s interests but their own.

PPI has also spawned an aggressive, multibillion pound business in claims management. Firms handling the claims, which could easily be made by individuals, at no cost, take a lucrative chunk of the compensation in fees and some even charge up-front fees with no certainty that there will be any compensation at all.

Then there’s the avalanche of spam texts and cold calls – there can barely be a mobile phone owner in the country who has not received text messages telling them they are in line for PPI compensation. The figure will have been plucked out of the air, as will the name of the bank, but those who respond will find their details sold on to claims management companies.

The madness of the PPI claims industry is graphically demonstrated by the recent revelation from bank chief executive Paul Lynam of a spam call to his offices. Not because the call went to the headquarters of his Secure Trust Bank, but because it went to the emergency number in the bank’s lift. As far as we know, the elevator has decided against pursuing a claim.

Fiona Walsh writes for the Guardian newspaper in London