Meanwhile, Royal Bank of Scotland chief executive Stephen Hester has again warned the Government that industry reform plans risk creating problems.
"The industry knew there was a problem with PPI but no-one was prepared to be the first mover," Ms Gadhia told the Parliamentary Commission on Banking Standards.
She spent five years with RBS until 2006, overseeing the Virgin One account it then managed.
PPI has been highly costly for the industry. RBS booked another £400m charge last month – bringing the provision so far to £1.7 billion. Lloyds Banking Group, owner of Bank of Scotland, has put aside £5.3bn.
Ms Gadhia told the commission that the key to stimulating competition within the sector was making it easier for customers to switch accounts.
Benny Higgins, chief executive of another Edinburgh-based challenger, Tesco Bank, told the inquiry that switching rates for personal current accounts are just 3% a year, against 20% in the grocery market.
From next September new rules come into place to give banks a seven-day deadline to transfer a customer to a competitor.
RBS chief executive Stephen Hester attacked a cornerstone of the Government's banking reform agenda by warning that plans to protect their retail banking operations by ring-fencing them from riskier activities such as investment banking could create a "moral hazard". He said: "You are giving a charter in everyone's minds for the next time there is a problem inside the ring fence, it [the bank] gets bailed out by one mechanism or another."
Lloyds chief executive Antonio Horta-Osorio called for retail banks to be able to offer derivative products, a practice from which they could be barred under current ring-fencing plans.