Westpac will pay about $11 million in compensation to interest-only home loan customers who were not switched to principal repayments when they should have been.
The refunds will go to 9,400 customers who held owner-occupier interest-only variable home loans, most of which had interest-only periods that expired between 2009 and 2016.
A processing error led to these customers continuing to make interest-only repayments after the interest-only period ended, rather than being switched to principal and interest repayments.
As a result, customers were left with less time to repay the principal amount of their loans and would have also have paid more in interest.
Westpac's consumer chief executive George Frazis apologised for the error and said the company had now automated its switching process to ensure it does not happen again.
"We are contacting customers proactively and will provide compensation to anyone who we believe has been financially disadvantaged," Mr Frazis said.
The Australian Securities and Investments Commission said the lender will refund the additional interest paid from when the loan was contracted and will discount the interest rate for the remaining term of the loan.
"This remediation has been designed so that customers pay no more interest over the life of the loan than they would have if the system error had not occurred," ASIC said.
ASIC acting chair Peter Kell said banks must ensure proper systems processes and oversight are in place.
"All banks should be reviewing their systems to ensure that they minimise the chance of any such errors occurring, and that any risks to customers are identified early," Mr Kell said.
Westpac will take around 12 months to complete the compensation process, and is also reviewing interest-only investor loans that may have been impacted by the issue.