U.K. banks have rightly decided not to pursue their appeal against the mis-selling of Payment Protection Insurance (PPI). PPI policies provided a sum of money each month to fully cover — or cover a percentage of — the payment due on secured and unsecured loans in the event of unemployment or sickness. Banks increased their profits by incorporating the cost of a one-off PPI premium into consumer loans. Some borrowers complained when they found themselves paying extra interest, and borrowers complained that they were unaware of having taken out the insurance policy.

The U.K. banks’ decision to withdraw the appeal has been presented as a surrender of sorts, but their action has brought certainty to an issue that could have been subject to further legal appeal. At the same time, the banks have or will be making material financial provision to meet claims on their financial statements for Q1 or Q2 2011. The banks will now set up units to review the sale of PPI and determine whether and how much compensation is due to borrowers past and present who have taken out PPI. Industry estimates suggest that, collectively, the banks will set aside up to GBP 10 billion for compensation claims.

There are longer-term consequences. The episode will inhibit the public’s regeneration of trust and faith in banking institutions and their products and services. Customers will be increasingly wary of cross-selling and bundled retail financial services products. Banks will be inhibited in sale and distribution of other, valid insurance products. Longer term, this debacle will impact banks’ profitability. Fee-based products and services — regardless of whether they are sold on a commission-fee or advisory-fee basis — provide high-margin net revenue for banks because they are distributed through existing distribution channels. That fee income will be difficult to replicate. Insurance companies that provide PPI products are unlikely to find alternative distribution channels that will reach a similar volume of sales.