PPI is hugely lucrative for banks, credit card issuers and other lenders
The Financial Services Authority (FSA) is delaying its plans to combat the mis-selling of payment protection insurance (PPI).
Criticism from the financial industry has forced the FSA to extend its consultation by another six weeks.
The FSA's own consumer panel said this pressure was to blame for delaying the fair treatment of consumers.
PPI is supposed to help people repay their loans if they fall ill or lose their jobs.
In September 2009, the FSA proposed a comprehensive overhaul of the rules not only on selling PPI, but also of the way that lenders and insurance brokers should deal with complaints about past mis-selling.
The FSA was responding in part to a huge upsurge in complaints filtering through to the Financial Ombudsman Service.
Consumer organisations have welcomed the suggested rule changes, but not the lenders and insurance brokers for whom PPI sales are very lucrative.
"We are disappointed that the industry has responded so critically to our proposals but we remain 100% committed to bringing about genuine, lasting change in the PPI market," said Dan Waters, of the FSA.
"We do, however, recognise the importance in ensuring that genuine concerns have been listened to."
The revised consultation document from the FSA - 170 pages long - reveals why the banks, other lenders, and insurance brokers are so worried.
They argued that they would have to pay between £700m and £1.2bn over five years in redress just to those consumers who had complained about being mis-sold PPI, including administrative costs.
This was far more than the FSA first thought.
On top of that, the FSA now agrees that redress paid to people who have not complained, but who are uncovered by firms who are forced to review their past sales practices going back to 2005, might range from £1bn to £3bn.
The regulator is also now assuming that the industry will have to deal with 500,000 complaints in the first 12 months after its new rules come into force.
That is because of the continuing rise in PPI complaints already being made, and the impact of the publicity that would surround the introduction of the FSA's plans.
Last September, it estimated there would be just another 158,000 complaints for firms to deal with.
Despite meeting resistance from the insurance industry and lenders to its latest plans, the FSA said it was in no doubt that reforms were still needed.
"We have well-founded and adequately evidenced concerns about widespread weaknesses in PPI sales practices, and in PPI sales complaint handling, which have given rise to the risk of significant ongoing consumer detriment, and that we need to address these in order to protect consumers and meet our statutory objectives," the FSA.
Among the criticisms of the FSA's package of measures were that:
• it had not shown there was a genuine problem with either sales or complaints handling
• new rules on dealing with complaints were not appropriate
• it had underestimated the huge cost to the financial services industry
• it might not have the legal powers to enforce its plans for firms to deal with complaints they had previously rejected.
The consumers association Which? demanded that the FSA "stand firm".
"After years of mis-selling and poor complaints handling by the industry, consumers want to see action on PPI, not more consultations," said Peter Vicary-Smith, of Which?.
"With a question mark over how much of the Financial Services Bill will become law, it is vital that the FSA's original plans to force firms to review rejected complaints are implemented quickly."
The further consultation period prompted by industry criticism was dimly received by the FSA's own consumer panel.
"For too long, firms have been letting down their PPI customers by not handling their complaints fairly," said Adam Phillips, chairman of the panel.
"Now the industry seems determined to fight against the FSA introducing new rules and guidance which would ensure consumers receive a fairer outcome if they make a complaint," he added.
The sale of PPI has long been regarded as a "protection racket" by consumer groups.
They have accused banks and brokers of selling expensive polices to people who either did not need them or who would be excluded in any case from making a claim.
The Competition Commission found that in 2006 lenders made excess profits of £1.4bn when selling the insurance, and last year proposed that lenders be banned from selling PPI polices at the same time as making a loan to a borrower.
Last September the FSA ordered banks and other lenders to compensate customers who may have been mis-sold PPI, especially the so-called "single-premium" variety that until recently was commonly sold to people when they took out unsecured personal loans.
The sale of that version of the insurance was banned earlier last year by the FSA.