Lloyds, which owns Halifax and Bank of Scotland, has set aside another £900m to cover compensation, dealing a further blow after the bank only narrowly passed a European health check.
The policies were designed to cover repayments if customers fell ill or lost their jobs, but were often sold to people who were ineligible to claim.
The compensation overshadowed a 41 per cent rise in Lloyds’ underlying profits for the third quarter to £2.2bn following an improvement in bad debts.
The bank is hoping to resume dividend payments after a barren six year period following the 2007/2008 financial crisis.
Bottom line pre-tax profits came in at £751m, after taking into account the £900m set aside for PPI.
Analysts at Citi said they expect Lloyds to set aside another £1bn for PPI compensation next year and Lloyds’ finance director George Culmer said he could not rule out further increases.
The new mis-selling charge comes two days after the bank, 25 per cent-owned by the Government, only narrowly passed a test set by regulators to assess whether banks have enough capital to weather another economic crash.
Lloyds was the worst performing British bank in the European stress test.
The bank faces a further test by the Bank of England in December which will measure its resilience against scenarios including a 35 per cent decline in house prices and a rise in interest rates to six per cent.
Lloyds’ ability to pay a dividend will be dependent on its performance in the BoE tests.
Keith Bowman, equity analyst at Hargreaves Lansdown, said: “Profit has exceeded expectations, with the group’s exposure to a recovering UK economy clearly playing its part.
“Costs more broadly remain a management focus, whilst the prospect of a return to dividend payments continues to be dangled.”
Halifax’s managing director David Nicholson said the Yorkshire-based bank performed strongly over the three months to September 30.
“Halifax is in great shape. We’re the most switched-to bank,” he said.
Some 1.2 million people have switched their accounts through the switching service over the past year and of these, 250,000 people have switched to Halifax.
“That makes Halifax the number one switch-to brand,” said Mr Nicholson.
Halifax’s Savers Prize Draw, which enters customers into a monthly prize draw as well as paying interest, has now signed up 2.3 million customers.
Halifax started the year with plans to lend £10bn to 80,000 first-time buyers and by the end of September it had lent £9.6bn to 72,000 customers.
“We’re in very healthy shape,” said Mr Nicholson.
Halifax now has 4.4 million active digital customers, who use tablets and desktops to access their accounts, and 2.1 million mobile banking users.