LONDON (Reuters) - British bank Lloyds took a shock £3.2 billion ($5.3 billion) charge yesterday to cover compensation for people sold insurance they could never claim or did not know they were buying.The hefty charge signalled far higher than expected costs for the whole industry to resolve a mis-selling issue that has dogged it for years, sending shares in British banks into retreat.Together with loan losses in crisis-hit Ireland and higher funding costs, the charge tipped the rescued bank into loss for the first quarter and raised fears about its recovery prospects.Lloyds, 41-percent owned by the British government after a credit crisis bailout, made the provision against payment protection insurance (PPI) complaints after banks lost a British court case on the way policies were sold to millions of customers.The policies were typically taken out alongside a personal loan, mortgage or purchase to cover repayment if the borrower was unable to pay due to unemployment, sickness or accident.But policies were mis-sold, to self-employed or unemployed people who would not have been able to claim, and to consumers did not realise they were taking out a policy. A court ruled last month the banks were at fault.Banks have until May 10 to appeal that ruling, but Lloyds said it would not do so, a serious blow to any industry defence because it is the biggest player.The British Bankers Association (BBA) said it was still considering whether to mount a new legal challenge.Investec analyst Gareth Hunt said Lloyds’ PPI charge was double what the market expected, and that other lenders embroiled in the saga faced booking hits as well.“At least it is clear, we now know what the charge is and the bank can move forward, but it is definitely bigger than expected. It does suggest everyone else will share some of the same pain,” said Hunt.Lloyds shares tumbled 8.5 percent to 53.05 pence by midday, the worst British blue-chip performer.It dragged the shares further away from the 63 pence level, the average price at which Britain bought its Lloyds stake, leaving taxpayers sitting on a hefty loss.“We knew they were going to take a hit, but the extent has taken the market by surprise,” said Craig Yeaman at Saracen Fund Managers, who recently sold all his Lloyds shares.Britain’s watchdog has estimated customers were overcharged by £1.4 billion a year from the sale of PPI insurance products. The industry was expected to suffer a hit of around £5 billion, but the scale of Lloyds’ charge could almost double that, analysts said.There are about 12 million outstanding policies. How that breaks down among lenders is unclear, but Lloyds is estimated to have about one-third of the market.Losses from bad loans at Lloyds rose to £2.6 billion in the first quarter, up from £2.4 billion a year ago but down from £3.8 billion in the previous quarter. It said the first quarter hit was £500 million more than it expected, mainly due to Ireland, where its impairment charge reached £1.1 billion.The double blow from the insurance mis-selling provision and Ireland pushed Lloyds into a first-quarter statutory loss of £3.5 billion, down from a £721 million profit a year ago.Lloyds’s net interest margin the difference between what a bank charges for loans and what it pays to borrow also fell to 2.07 percent from 2.12 percent at the end of last year.