Britain’s banks and lenders face the prospect of a Government inquiry after Citizens Advice lodged a "super complaint" to the Office of Fair Trading (OFT) about the sale of payment protection insurance.

The consumer group described the policies, which cover debt repayments if the card-holder or borrower becomes unemployed or is too ill to work, as a £5 billion "protection racket".

The group claimed the policies were too expensive and being mis-sold to people who would never be able to claim on them.

The OFT is required to respond publicly within 90 days and could start a formal investigation. The news led to slump in banking stocks, with investors fearful that any inquiry could lead to regulations that would hit lenders’ profits.

By lunchtime, HBOS was down 13p to 857.5p, Lloyds TSB was 6p lower at 474.25p and Barclays sank 3p to 568p.

David Harker, the chief executive of Citizens Advice, said it was a "scandal" that nothing had been done to regulate the sale of the policies.

"We badly need an official investigation of how this market is operating, leading to effective regulation that ensures a fair deal for all consumers, and which also protects the most vulnerable," he said.

Citizens Advice said the policies could cost the equivalent of 25 per cent of a loan's value, and that the cover was often paid for by increasing the amount of money people borrowed.

The group said that it had come across cases where the unemployed or mentally ill had been persuaded into buying the insurance.

In one case, a woman saw the total value of her loan soar from £17,800 to £22,962 as a result of PPI premiums.

It said policies offered by mainstream lenders often excluded cover for problems such as bad backs, which were a common cause of people not being able to work.

It found that 85 per cent of its clients who had claimed on one of the policies had been unsuccessful, despite the industry claiming that just 15 per cent of claims are turned down.

The group also found that delays in the payment of claims could lead to policyholders being pursued by debt collectors and threatened with court action.

Citizens Advice also wants the Financial Services Authority to develop a PPI policy, setting out minimum standards lenders must comply with and introducing a cap on the cost of premiums.

Many banks refuse to publish details of the margins they make on the policies, but a report earlier this year by CSFB estimated that 14 per cent of Lloyds TSB’s total profits came from the products.

A super complaint can be made by a number of designated consumer groups, requesting the OFT investigates an issue that it thinks is working against the interests of consumers. The National Consumer Council has previously lodged a super complaint against the doorstep credit market.

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