Around seven million people are set to share up to £1.3 billion in compensation after 13 high street banks and credit card companies agreed to offer redress for mis-sold credit card and identity theft protection.
The Financial Conduct Authority (FCA) said banks and credit card firms, together with card insurer CPP Group, have agreed to a compensation package which will see millions of customers contacted by CPP.
Major lenders including Barclays, HSBC, Royal Bank of Scotland and Lloyds Banking Group have signed up to the compensation scheme, which is the latest blow to the banking industry after the multibillion-pound payment protection insurance (PPI) scandal.
The scandal involved 23 million policies and saw customers given misleading and unclear information about the insurance.
CPP has already been fined a joint record £10.5 million by the City watchdog.
FCA boss Martin Wheatley said: "We believe this will be a good outcome for customers who may have been mis-sold the card and identity protection policies."
The FCA said compensation will depend on the type of policy held and hold long they had it.
If customers are due compensation, they will be entitled to the amount paid for their policy since January 14 2005, plus 8% interest on any sum owed.
Shares in CPP, which was recently handed a three-year £36 million funding lifeline by its banks, plunged more than 20% today as investors balked at the cost of the redress scheme.
While CPP sold some policies directly to customers, banks and credit card companies also introduced millions of people to CPP.
The FCA said banks and credit card firms "must share the responsibility for putting things right".
Card protection, which cost around £30 a year, and identity protection, which cost about £80 a year, were "widely mis-sold" by York-based CPP, the FCA said.
The watchdog criticised CPP for promising customers up to £100,000 of insurance cover for their cards - something they did not need because they were already covered by their banks.
It found CPP "greatly exaggerated" the risks and consequences of identity theft.
Unlike the PPI compensation deal which involves customers contacting lenders, CPP will get in touch with customers, starting from the end of the month.
Banks, credit card firms and CPP will also advertise in newspapers to ensure people hear about the compensation.
The FCA said customers will not need to use claims management companies to receive compensation.
Customers will need to vote on the redress programme - called a scheme of arrangement - before it can begin paying out in the spring.
It needs the backing of a majority of customers, as well as 75% of voting customers.
The FCA said its main concern has been to "ensure customers get a fair deal", adding that the scheme has been set up in a "simple and standardised" way to recompense people.
The 13 companies which have signed up to the redress scheme are Bank of Scotland, Barclays, Canada Square Operations (formerly Egg Banking), Capital One, Clydesdale Bank, Home Retail Group Insurance Services, HSBC, MBNA, Morgan Stanley, Nationwide Building Society, Santander, RBS and Tesco Personal Finance.
The FCA said its £1.3 billion estimate is based on valid claims from all seven million customers who were sold or renewed the 23 million policies, but added that actual compensation will depend on the number of valid claims received.
Customers who do make a claim will have their policy cancelled, even if their claim is rejected.
The compensation scheme also needs High Court approval.
The mis-selling scandal ran between 2005 and 2011, during which time CPP sold 4.4 million policies and renewed almost 19 million.
Of the 4.4 million policies, it is believed only around 300,000 were sold directly by CPP, while lenders were responsible for around 4.1 million.
Many customers were sent new bank cards with CPP stickers on them and had to activate their cards by going through a CPP call centre, when they were offered the insurance.
The Financial Ombudsman Service said it received 247 new complaints about card protection insurance between April and June and is currently finding in favour of consumers in three quarters of cases.
A spokesman said: "While card protection insurance can be useful for some people, in many of the cases we see the consumer neither wanted nor required the cover.
"There are a number of provisions in place that provide you with some protection if your identity is stolen - so don't feel pressured into taking out an insurance policy on the spur of the moment."
CPP has set aside £54 million to cover the cost of the scandal, up from £51.7 million at the end of December.
The company said it will only be responsible for compensating customers it sold to directly.
Its new debt facilities are based on 25% or fewer people making successful claims - which if exceeded could see it breach its banking covenants.
CPP also published results showing it swinging into the red in the first six months of the year, with pre-tax losses of £11.7 million compared with £1.7 million profits a year earlier.
The company, which was founded more than 30 years ago by entrepreneur Hamish Ogston, said revenues plunged 27% to £99.7 million in the first half.
It now has 7.9 million live policies, compared with 10.1 million a year earlier.
Renewal rates have dipped to 71.3% from 73.5% six months earlier.
Outgoing chief executive Paul Stobart said: "We are in the early stages of rebuilding the group and although challenges and uncertainties remain, particularly in relation to the upcoming past business review programme, we are focused on moving the business forward with a view to realising the potential opportunities that will deliver our future growth."
CPP now employs around 1,100 staff worldwide, including more than 700 in the UK.
Its workforce has shrunk from more than 1,500 during 2012.
CPP major shareholder Mr Ogston said the £1.3 billion quoted by the FCA was "b******s" and a "ridiculous figure".
He said: "There's never been a compensation redress scheme in history where it's been 100% (success rate)."
He accused the regulator of "sensationalism, by quoting a huge 100% rate".
But Mr Ogston, the company's 57% shareholder who stood down from CPP's board in June, refused to comment further.
Barclays' managing director for customer service Paul Maddox said " some sales practices regarding past identity fraud and card protection policies were below acceptable standards, and were not in the interests of our customers".
He added: "We are determined to put things right for Barclays customers who are eligible for redress payments as swiftly as possible through this new scheme."
RBS said: "We are working collectively with CPP and those involved in the scheme to achieve the best outcome for those customers affected."