Lloyds warned of a long, hard economic recovery and set aside an extra £375 million ($609 million) to compensate people mis-sold insurance, underscoring the challenge facing Britain's banks as they battle to recover from financial crisis.

Lloyds said it made a first-quarter statutory pretax profit of £288 million, down from £316 million in the previous quarter, but significantly better than a £3.5 billion loss in the first quarter of 2011.

Bad debts fell 36 per cent from a year ago to £1.7 billion and the bank cut its non-core assets by £12.4 billion in the quarter, shrinking its bad loans faster than expected.

Deutsche Bank analysts said profit, net interest margin and bad debt charges were all better than expected.

Lloyds, 40 per cent owned by the government after a bailout during the 2008 crisis, said it was making progress in reducing its loan book, cutting costs and reining in bad debts - all key parts of its recovery plan.

But its planned sale of 632 branches is dragging on, highlighting the tough market facing sellers of British banking assets, and it struck a downbeat tone about the UK economy, which tipped back into recession last quarter.

"We think that the economy will be reasonably flat this year, but it is going to be a long and difficult recovery," chief executive Antonio Horta-Osorio said.

Barclays chief executive Bob Diamond said last week he had become more cautious about Britain's prospects and the bleak assessment was endorsed on Monday by National Australia Bank's decision to shrink its UK business and cut 1,400 jobs, blaming an exceptionally tough economic environment.

Britain's biggest retail bank in terms of customers reported a surge in compensation claims for Payment Protection Insurance mis-selling in February and March, partly fuelled by aggressive marketing from claims management companies.-Reuters