Thousands of legitimate complaints were ignored or effectively treated with contempt, in some cases creating real hardship.
Some customers are thought to have suffered massive financial loss or even the threat of losing their home after being given bad advice or sold rip-off products by the group, which is 84 per cent-owned by the British taxpayer.
The fine was imposed by the City watchdog, the Financial Services Authority, which is investigating other high street banks for similar offences. Its inquiry related to the way complaints were dealt with in 2009, although its figures show problems continued last year.
NatWest generated 84,300 customer complaints in the first half of last year, which were subsequently referred to the Financial Ombudsman. Some 66 per cent of home loan complaints were upheld, along with 46 per cent on insurance policies and 23 per cent on general banking.
Royal Bank of Scotland generated 38,100 customer complaints in the same period. An overwhelming 71 per cent of mortgage complaints were upheld.
The fine comes in the wake of yesterday's revelations that RBS chief executive Stephen Hester is set to receive a total of £7m, just over two years after the bank received a taxpayer funded bailout worth billions of pounds.
This payment includes a £2.5m bonus awarded despite warnings to the banks from the Prime Minister not to be 'over-generous' in payments.
RBS's catalogue of failings included delays in responding to customers and poor quality investigations into complaints.
The ombudsman found that complaints handlers failed to obtain and take into account all relevant information when making a decision.
The group also issued correspondence which failed to fully address all of the concerns raised by customers, while it did not explain why complaints had been upheld or rejected.
Customers were also not given information on their right to refer their complaint to the Financial Ombudsman Service within the appropriate time period.
Overall, the FSA said that 53 per cent of the cases it reviewed showed deficient complaint handling, while in 62 per cent of cases the bank failed to follow FSA rules on giving people information on the Financial Ombudsman Service.
In 31 per cent of cases it did not demonstrate fair outcomes for consumers.
The regulator said the problems stemmed from the fact that the bank did not give staff adequate training and guidance on how to properly handle a complaint.
It also failed to monitor complaint handling in branches and the management information produced was not sufficient to assess whether customers were being treated fairly.
The magnitude of Stephen Hester's remuneration in the light of these failings is likely to be viewed by many as an insult to taxpayers who bailed the bank out.
Chief executive Hester was employed by RBS at the height of the 2008 financial crisis to turn its fortunes around.
Value for YOUR money? RBS, which is 84 per cent owned by the tax payer, has been fined £2.8 million for 'multiple failings' in the way it handled customers' complaints by the Financial Services Authority
He turned down a £1.6m bonus last year but it is believed he will take this year's cash and shares bonus when it is offered to him next month.
Speaking yesterday, David Cameron warned against 'banker-bashing' saying it was too easy to make banks the scapegoats for the recession.
He said that the details of Mr Hester's pay packet was 'pure speculation' but warned RBS should not pay out massive bonuses.
Mr Cameron told the BBC's Andrew Marr Show: 'On the general, I want to see the bonus pool smaller than last year, on the specific, Royal Bank of Scotland, as you rightly say, is owned by the Government.
'They should not be leading the way on bonuses, they should be a back-marker.'
Mr Cameron said he understood the public's anger over bankers' bonuses.
He said: 'I feel it because frankly the whole country has suffered from irresponsible lending practices, irresponsible behaviour.
'But we need to recognise though that there were a lot of people to blame for the mess we are in and that we shouldn't just think it's an easy scapegoat to pick one in view.
'Governments made mistakes, regulators made mistakes, politicians made mistakes, everyone was involved. Opposition made mistakes, dare I say it.'
David Cameron: 'Bankers should not be leading the way on bonuses, they should be a back-marker'
Mr Cameron said banks needed to be more 'socially responsible', adding the Financial Services Authority had 'set out a very tough set of rules on bonuses', which now applied to 2,500 companies.
He added: 'Do we still need the banks to do more to demonstrate their social responsibility? Yes we do. But we as a Government and a country have got to get a settlement where we recognise that a successful banking sector is part of a successful market economy.
'What I want to see is socially responsible banks, behaving responsibly, lower bonus pools than last year's, responsible levels of remuneration and proper agreements on levels of lending to businesses large and small and being good citizens in the community.'
Sources at the bank described Cameron's comments as 'helpful' saying that bonuses had previously been paid out in shares spread over three years.
Shadow Chancellor Alan Johnson said the Government had failed to live up to the promise of the Coalition Agreement of dealing with the issue of bankers' bonuses.
The Government had legislation on the statute books which would allow it to force the banks to publish pay-outs of more than £1 million in bonuses but it had failed to do so, he told Sky News.
It's estimated that the City could pay out an astonishing £7billion in pay and bonuses this year.
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