UPDATE 1-UK watchdog agrees compensation for mis-sold card insurance

* Latest embarrassment for banks, though sums modest

* First payments not expected until spring 2014

LONDON, Aug 22 (Reuters) - Britain's markets watchdog saidit had reached a deal with insurer CPP and 13 highstreet banks and credit card issuers to pay customerscompensation of up to 1.3 billion pounds ($2.04 billion) formis-sold credit card insurance.

It is the latest mis-selling scandal to hit Britain's banks,which have been forced to increase their capital buffers partlybecause of huge compensation payments.

"Seven million customers, who between them bought andrenewed about 23 million policies, will soon receive a letterfrom CPP giving more information on the process," the FinancialConduct Authority said in a statement on Thursday.

"The involvement of the banks and credit card issuersreflects the fact that they introduced customers to CPP'sproducts and so must share responsibility for putting thingsright."

Banks are still paying out compensation for mis-sellingpayment protection insurance (PPI), which so far has totalledwell over 10 billion pounds.

The Financial Services Authority, which was replaced by theFCA in April, fined CPP 10.5 million pounds in November formis-selling. Card protection insurance costs about 30 pounds ayear, with identity protection about 80 pounds annually.

The FCA said customers were given misleading and unclearinformation about the policies and ended up buying protectionthey did not need.

The banks, credit card issuers and CPP have agreed to a"scheme of arrangement" which seeks to make processing claimssimpler and easier, subject to High Court approval.

The banks and credit card issuers are Bank of Scotland, Barclays, Canada Square Operations, CapitalOne, Clydesdale Bank, Home Retail Group Insurance Services, HSBC, MBNA, Morgan Stanley, Nationwide, Santander, RBS and Tesco Personal Finance.

The FCA said the first payments were not due until spring2014.