British banking group Lloyds TSB today surprised the City by reporting an increase in full-year profits to £3.47 billion - against predictions profits would fall - although the bank was hit by a more than one-fifth increase in its provisions for bad and doubtful debts to more than £1 billion.

Britain's fifth-largest bank, which has been at the centre of heated speculation it is poised to receive a bid approach, pushed up pre-tax profits for the full year by 4 per cent, against expectations in the City that profits would fall by the same amount.

The shares gained nearly 3.5 per cent this morning, rising 18.5p to 559.5p.

The bank's success was driven by a 15 per cent leap in profits at its insurance and investments division to £908 million. Lloyds TSB's newly energised wholesale and international banking unit also drove up profits by a fifth to more than £1.5 billion.

The troubled retail banking division, however, saw profits fall by 3 per cent to £1.68 billion amid a £50 million increase in provisions for claims by disgruntled customers. Lloyds TSB has come under fire over recent years for having a poor level of customer service, although the bank claims it has made great strides to tackle this.

Excluding provisions and the strengthening of the bank's capital reserves, overall group pre-tax profits rose by 9 per cent to more than £3.7 billion.

The bank, led by chief executive Eric Daniels, maintained that Lloyds TSB was experiencing "good levels of earnings momentum" and that costs remained firmly under control.

"Our market shares are either stable, or growing, in most of our key product lines," Mr Daniels said. "Most importantly, our customer relationship programmes are being effectively implemented and we are delivering higher revenues per customer in our retail and corporate banking business."

However, Lloyds TSB was forced to increase its impairment losses on bad loans and customer advances by 21 per cent to £1.09 billion. This follows similar moves by rivals such as Barclays, the third largest bank, which has also voiced concerns about the growing struggles some of its customers are having with repaying their debts.

This time last year, the bad debt charge for Lloyds TSB was £903 million.

Helen Weir, the finance director, said tightened lending criteria introduced by the bank should help to improve the quality of its loan book later this year. "We expect a further deterioration in the retail credit environment; however, as a result of the improved quality of new business written in the last 12 months, we expect greater stability in the second half of 2006," she said.

Ms Weir also revealed that Lloyds TSB injected £220 million into its pension scheme last year to help tackle a £2.91 billion deficit. She said the bank was currently considering other ways of reducing its pensions funding shortfall.

The final dividend was held firm at 23.5p, taking the full-year payout to 34.2p a share.

Shares in Lloyds TSB closed last night at 541p, valuing the bank at more than £30 billion.

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