LONDON (Reuters) - The number of claims against British banks for mis-sold insurance on loans and mortgages has reached "staggering" levels and will take years to pay back, the head of the Financial Ombudsman Service said.
The industry has already set aside about 14 billion pounds to deal with the biggest mis-selling scandal in British history and banking sources have told Reuters the total cost could reach 25 billion pounds.
"We're assuming that this is a multi-year challenge," Chief Financial Ombudsman Natalie Ceeney told Reuters in an interview.
Payment Protection Insurance was meant to protect borrowers against sickness or redundancy but the policies were often sold to customers who did not want or need them.
The Ombudsman, which steps in when banks and their customers cannot reach an agreement, is currently seeing as many as 2,500 complaints relating to PPI each day.
"The scale of the current volume has taken everyone by surprise. They have been at a staggeringly high level for a good few months now."
The British Bankers Association, a lobby group, has asked Britain's financial regulator to set an April 2014 deadline as the industry strives to move on from the affair.
Ceeney said any time limit on claims must be in the interests of consumers as well as banks and that it could be difficult to ensure that every customer entitled to compensation is made aware of the fact.
"There are some real challenges in setting time-bars in the interests of consumers as well as banks," she said.
Banking sources have told Reuters that the industry is pessimistic about the chances of a deadline being introduced although the Financial Services Authority said in January it would consider the proposal.
"There doesn't seem to be any traction left in the negotiations," one senior banking executive said.
Banks have recently increased the amount of cash set aside for claims. Britain's biggest retail bank Lloyds (LLOY.L) on Friday increased the estimate of its final compensation bill to 6.8 billion pounds, more than any other bank.
Lloyds Chief Executive Antonio Horta-Osorio has blamed claims firms, which handle the paperwork for customers in return for a chunk of the compensation, for inflating the bill by submitting false claims. However, Ceeney said the Ombudsman had not seen evidence to support that.
She said that, in one in five of the cases received by the Ombudsman where banks claimed customers didn't hold a PPI policy, the Ombudsman found, after further investigation, that the customer did in fact have one.
Ceeney also rejected Horta-Osorio's claims that some claims firms were guilty of fraud. She said statistics from the Ombudsman last year showed only 3.5 percent of complaints were without foundation.
"When I hear customers being called fraudsters I get quite angry," she said. For a customer to say 'Did I have PPI?' isn't fraud, it's a legitimate question."
Ceeney said the claims management industry would not have built up around PPI had banks dealt with the problem earlier instead of challenging the financial regulator in court.
"It's allowed a claims management industry to thrive. Had they sorted this out earlier the claims management industry would not have got here and would not be thriving," she said.
Reporting by Matt Scuffham; Editing by Steve Slater and Paul Casciato