Lloyds Banking Group has set aside £3.2 billion to pay customers who have been mis-sold payment protection insurance (PPI).
The UK's banks were told they would have to pay back customers who were mis-sold the insurance when they took out a loan after a High Court judge ruled against their appeal last month.
They had been trying to overturn the Financial Services Authority's ruling that they should contact all past PPI customers, informing them of their right to complain if they felt they had been mis-sold the policy.
Lloyds' decision to make the large provision led to a £3.47 billion loss in the first quarter of the year, a figure in stark contrast to the £721 million profit it made in the first three months of 2010.
The decision to pay out on PPI claims has been praised and could influence other banks to do the same.
"This is great news for the millions of Lloyds customers who have been mis-sold PPI. It's refreshing to see a bank break ranks from its peers and do the right thing by its customers," said Which? chief executive director, Richard Lloyd.
"The rest of the UK's banks must now follow suit and draw a line under the great PPI mis-selling scandal by withdrawing their legal challenge of the Financial Services Authority and proactively reimbursing the millions of customers who were mis-sold PPI."
The Financial Services Consumer Panel said it hoped that as the bank with the largest liability 'we hope that they will lead the way in bringing this sorry tale to an end'.
Lloyds' balance sheet was also hit by a £1.1 billion charge to account for falls in the commercial property market in the Republic of Ireland, while it expects the bank levy to cost £260 million this year.
Costs incurred by its forced sell off of 600 branches in the UK are also expected to rise.
The 41% Government owned bank said that in the first quarter of the year, it had provided £5.8 billion of gross mortgage lending to UK homeowners and £10.3 billion to UK businesses, £3.3 billion of which was to small and medium-sized firms.
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