20-F 1 dp145968_20f.htm FORM 20-F

 

 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 20-F

 

(Mark One)

REGISTRATION STATEMENT PURSUANT TO SECTION 12(b) OR (g) OF THE SECURITIES EXCHANGE ACT OF 1934

OR 

ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 2020

OR

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                           to                          .

OR

Commission file number: 1-14554

 

BANCO SANTANDER-CHILE
(d/b/a Santander and Banco Santander)
(Exact name of Registrant as specified in its charter)

 

SANTANDER-CHILE BANK
(d/b/a Santander and Banco Santander)
(Translation of Registrant’s name into English)

 

Chile
(Jurisdiction of incorporation or organization)

 

Bandera 140, 20th floor
Santiago, Chile
Telephone: 011-562-320-2000
(Address of principal executive offices)

 

Robert Moreno Heimlich
Tel: 562-2320-8284, Fax: 562-696-1679, email: robert.moreno@santander.cl
Bandera 140, 20th Floor, Santiago, Chile

(Name, Telephone, E-mail and/or Facsimile number and Address of Company Contact Person)

 

Securities registered or to be registered pursuant to Section 12(b) of the Act:

 

Title of each class 

Trading Symbols 

Name of each exchange on which registered 

American Depositary Shares (“ADS”), each representing the right to receive 400 Shares of Common Stock without par value BSAC New York Stock Exchange
     
Shares of Common Stock, without par value* BSAC New York Stock Exchange

____________________

*Santander-Chile’s shares of common stock are not listed for trading, but only in connection with the registration of the American Depositary Shares pursuant to the requirements of the New York Stock Exchange.

 

 
 

Securities registered or to be registered pursuant to Section 12(g) of the Act:

 

None
(Title of Class)

 

Securities for which there is a reporting obligation pursuant to Section 15(d) of the Act:

 

None
(Title of Class)

 

Indicate the number of outstanding shares of each of the issuer’s classes of capital or common stock as of the close of the period covered by the annual report.

 

188,446,126,794 Shares of Common Stock, without par value

 

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.

 

Yes No

 

If this report is an annual or transition report, indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

 

Yes No

 

Note – Checking the box above will not relieve any registrant required to file reports pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 from their obligations under those Sections.

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

 

Yes No

 

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).

 

Yes No

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act.

 

Large Accelerated Filer   Accelerated Filer   Non-accelerated Filer   Emerging growth company  

 

If an emerging growth company that prepares its financial statements in accordance with U.S. GAAP, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards† provided pursuant to Section 13(a) of the Exchange Act.

 

† The term “new or revised financial accounting standard” refers to any update issued by the Financial Accounting Standards Board to its Accounting Standards Codification after April 5, 2012.

 

Indicate by check mark whether the registrant has filed a report on and attestation to its management’s assessment of the effectiveness of its internal control over financial reporting under Section 404(b) of the Sarbanes-Oxley Act (15 U.S.C. 7262(b)) by the registered public accounting firm that prepared or issued its audit report.

 

Indicate by check mark which basis of accounting the registrant has used to prepare the financial statements included in this filing:

 

U.S. GAAP

 

International Financial Reporting Standards as issued by the International Accounting Standards Board

 

Other

 

If “Other” has been checked in response to the previous question, indicate by check mark which financial statement item the registrant has elected to follow.

 

Item 17 Item 18

 

If this is an annual report, indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

 

Yes No
 
 
 

table of contents

____________________

Page

 

CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS 1
CERTAIN TERMS AND CONVENTIONS 3
PRESENTATION OF FINANCIAL INFORMATION 3
PART I 4
ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS 4
ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE 4
ITEM 3. KEY INFORMATION 4
ITEM 4. INFORMATION ON THE COMPANY 45
ITEM 4A. UNRESOLVED STAFF COMMENTS 69
ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS 69
ITEM 6. DIRECTORS, SENIOR MANAGEMENT AND EMPLOYEES 144
ITEM 7. MAJOR SHAREHOLDERS AND RELATED PARTY TRANSACTIONS 156
ITEM 8. FINANCIAL INFORMATION 160
ITEM 9. THE OFFER AND LISTING 160
ITEM 10. ADDITIONAL INFORMATION 161
ITEM 11. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 178
ITEM 12. DESCRIPTION OF SECURITIES OTHER THAN EQUITY SECURITIES 201
PART II 202
ITEM 13. DEFAULTS, DIVIDEND ARREARAGES AND DELINQUENCIES 202
ITEM 14. MATERIAL MODIFICATIONS TO THE RIGHTS OF SECURITY HOLDERS AND USE OF PROCEEDS 202
ITEM 15. CONTROLS AND PROCEDURES 202
ITEM 16. [RESERVED] 204
ITEM 16A. AUDIT COMMITTEE FINANCIAL EXPERT 204
ITEM 16B. CODE OF ETHICS 204
ITEM 16C. PRINCIPAL ACCOUNTANT FEES AND SERVICES 204
ITEM 16D. EXEMPTIONS FROM THE LISTING STANDARDS FOR AUDIT COMMITTEES 205
ITEM 16E. PURCHASES OF EQUITY SECURITIES BY THE ISSUER AND AFFILIATED PURCHASERS 205
ITEM 16F. CHANGE IN REGISTRANT’S CERTIFYING ACCOUNTANT 205
ITEM 16G. CORPORATE GOVERNANCE 205
ITEM 16H. MINE SAFETY DISCLOSURE 206
PART III 206
ITEM 17. FINANCIAL STATEMENTS 206
ITEM 18. FINANCIAL STATEMENTS 206
ITEM 19. EXHIBITS 207

 

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CAUTIONARY STATEMENT CONCERNING FORWARD-LOOKING STATEMENTS

 

We have made statements in this Annual Report on Form 20-F that constitute forward-looking statements within the meaning of Section 27A of the Securities Act of 1933, as amended, Section 21E of the Securities Exchange Act of 1934, as amended, and the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements appear throughout this report and include statements regarding our intent, belief or current expectations regarding:

 

·asset growth and alternative sources of funding;

 

·growth of our fee-based business;

 

·financing plans;

 

·impact of competition;

 

·impact of regulation;

 

·exposure to market risks including:

 

·interest rate risk;

 

·foreign exchange risk; and

 

·equity price risk;

 

·projected capital expenditures;

 

·liquidity;

 

·trends affecting:

 

·our financial condition; and

 

·our results of operation.

 

The sections of this Annual Report which contain forward-looking statements include, without limitation, “Item 3. Key Information—Risk Factors,” “Item 4. Information on the Company—B. Business Overview—Competition,” “Item 5. Operating and Financial Review and Prospects,” “Item 8. Financial Information—A. Consolidated Statements and Other Financial Information—Legal Proceedings,” and “Item 11. Quantitative and Qualitative Disclosures About Market Risk.” Our forward-looking statements also may be identified by words such as “believes,” “expects,” “anticipates,” “projects,” “intends,” “should,” “could,” “may,” “seeks,” “aim,” “combined,” “estimates,” “probability,” “risk,” “VaR,” “target,” “goal,” “objective,” “future” or similar expressions.

 

You should understand that the following important factors, in addition to those discussed elsewhere in this Annual Report and in the documents which are incorporated by reference, could affect our future results and could cause those results or other outcomes to differ materially from those expressed in our forward-looking statements:

 

·changes in capital markets in general that may affect policies or attitudes towards lending to Chile or Chilean companies;

 

·changes in economic conditions;

 

·the monetary and interest rate policies of Central Bank (as defined below);

 

·inflation;

 

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·deflation;

 

·unemployment;

 

·increases in defaults by our customers and impairment losses;

 

·decreases in deposits;

 

·customer loss or revenue loss;

 

·unanticipated turbulence in interest rates;

 

·movements in foreign exchange rates;

 

·movements in equity prices or other rates or prices;

 

·the effects of non-linear market behavior that cannot be captured by linear statistical models, such as the VaR model we use;

 

·changes in Chilean and foreign laws and regulations;

 

·changes in taxes;

 

·competition, changes in competition and pricing environments;

 

·our inability to hedge certain risks economically;

 

·the adequacy of loss allowances;

 

·technological changes;

 

·changes in consumer spending and saving habits;

 

·changes in demographics, consumer spending, investment or saving habits;

 

·increased costs;

 

·unanticipated increases in financing and other costs or the inability to obtain additional debt or equity financing on attractive terms;

 

·changes in, or failure to comply with, banking regulations;

 

·acquisitions or restructurings of businesses that may not perform in accordance with our expectations;

 

·our ability to successfully market and sell additional services to our existing customers;

 

·disruptions in client service;

 

·damage to our reputation;

 

·natural disasters;

 

·implementation of new technologies;

 

·the Group’s exposure to operational losses (e.g., failed internal or external processes, people and systems);

 

·an inaccurate or ineffective client segmentation model; and

 

·The COVID-19 pandemic or other pandemics.

 

You should not place undue reliance on such statements, which speak only as of the date at which they were made. The forward-looking statements contained in this report speak only as of the date of this Annual Report, and we do not undertake to update any forward-looking statement to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

 

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CERTAIN TERMS AND CONVENTIONS

 

As used in this annual report (the “Annual Report”), “Santander-Chile”, “the Bank”, “we,” “our” and “us” or similar terms refer to Banco Santander-Chile together with its consolidated subsidiaries.

 

When we refer to “Santander Spain,” we refer to our parent company, Banco Santander, S.A.. References to “the Group,” “Santander Group” or “Grupo Santander” mean the worldwide operations of the Santander Spain conglomerate, as indirectly controlled by Santander Spain and its consolidated subsidiaries, including Santander-Chile.

 

As used in this Annual Report, the term “billion” means one thousand million (1,000,000,000).

 

In this Annual Report, references to “$”, “U.S.$”, “U.S. dollars” and “dollars” are to United States dollars; references to “Chilean pesos,” “pesos” or “Ch$” are to Chilean pesos; references to “JPY” or “JPY$” are to Japanese Yen; references to “AUD” or “AUD$” are to Australian dollars; references to “CHF” or “CHF$” are to Swiss francs; references to “CNY” or “CNY$” are to Chinese yuan renminbi; and references to “UF” are to Unidades de Fomento. The UF is an inflation-indexed Chilean monetary unit with a value in Chilean pesos that changes daily to reflect changes in the official Consumer Price Index (“CPI”) of the Instituto Nacional de Estadísticas (the Chilean National Institute of Statistics) for the previous month.

 

As used in this Annual Report, the terms “write-offs” and “charge-offs” are synonyms.

 

In this Annual Report, references to the Audit Committee are to the Bank’s Comité de Directores y Auditoría.

 

In this Annual Report, references to “BIS” are to the Bank for International Settlement, and references to “BIS ratio” are to the capital adequacy ratio as calculated in accordance with the Basel Capital Accord. References to the “Central Bank” are to the Banco Central de Chile. References to the “SBIF” are to the Superintendency of Banks and Financial Institutions. References to the “FMC” are to the Financial Market Commission, into which the SBIF merged on June 1, 2019.

 

PRESENTATION OF FINANCIAL INFORMATION

 

Santander-Chile is a Chilean bank and maintains its financial books and records in Chilean pesos and prepares its consolidated financial statements in accordance with International Financial Reporting Standards (“IFRS”) as issued by the International Accounting Standards Board (“IASB”). Any reference to IFRS in this document is to IFRS as issued by the IASB.

 

As required by local regulations, our locally filed consolidated financial statements have been prepared in accordance with the Compendium of Accounting Standards issued by the FMC, the Chilean regulatory agency (“Chilean Bank GAAP”). Therefore, our locally filed consolidated financial statements have been adjusted to IFRS in order to comply with the requirements of the Securities and Exchange Commission (the “SEC”). Chilean Bank GAAP principles are substantially similar to IFRS but there are some exceptions. For further details and a discussion of the main differences between Chilean Bank GAAP and IFRS, see “Item 5. Operating and Financial Review and Prospects—Accounting Standards Applied in 2019.”

 

This Annual Report contains our consolidated financial statements as of December 31, 2020 and 2019 and for the years ended December 31, 2020, 2019 and 2018 (the “Audited Consolidated Financial Statements”). Such Audited Consolidated Financial Statements have been prepared in accordance with IFRS as issued by the IASB, and

have been audited by the independent registered public accounting firm PricewaterhouseCoopers Consultores Auditores SpA for the years ended December 31, 2020, 2019 and 2018. See page F-2 of the Audited Consolidated Financial Statements as of December 31, 2020 and 2019 and for the years ended December 31, 2020, 2019 and 2018 for the audit report issued by PricewaterhouseCoopers Consultores Auditores SpA. The Audited Consolidated Financial Statements have been prepared from accounting records maintained by the Bank and its subsidiaries.

 

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The notes to the Audited Consolidated Financial Statements form an integral part of the Audited Consolidated Financial Statements and contain additional information and narrative descriptions or details of these financial statements.

 

We have formatted our financial information according to the classification format for banks in Chile for purposes of IFRS. We have not reclassified the line items to comply with Article 9 of Regulation S-X. Article 9 is a regulation of the SEC that contains formatting requirements for bank holding company financial statements.

 

Functional and Presentation Currency

 

The Chilean peso is the currency of the primary economic environment in which the Bank operates and the currency that influences its structure of costs and revenues, and in accordance with International Accounting Standard 21 – The Effects of Changes in Foreign Exchange Rates has been defined as the functional and presentation currency. Accordingly, all balances and transactions denominated in currencies other than the Chilean peso are treated as “foreign currency.” See “Note 1—Summary of Significant Accounting Principles—e) Functional and presentation currency.” For presentation purposes, we have translated Chilean pesos (Ch$) into U.S. dollars (U.S.$) using the rate as indicated below under “Exchange Rates,” for the financial information included in this Annual Report.

 

Loans

 

Unless otherwise specified, all references herein (except in the Audited Consolidated Financial Statements) to loans are to loans and financial leases before deduction for loan loss allowance, and, except as otherwise specified, all market share data presented herein is based on information published periodically by the FMC.

 

Outstanding loans and the related percentages of our loan portfolio consisting of corporate and consumer loans as defined in the section entitled “Item 4. Information on the Company—B. Business Overview” are categorized based on the nature of the borrower. Outstanding loans and related percentages of our loan portfolio consisting of corporate and consumer loans in the section entitled “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information” are categorized in accordance with the reporting requirements of the FMC, which are based on the type and term of loans.

 

Non-performing loans are also presented in accordance with reporting requirements of the FMC and include the entire principal amount and accrued but unpaid interest on loans for which either principal or interest is past-due for 90 days or more. Restructured loans for which no payments are past-due are not ordinarily classified as non-performing loans. See “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”

 

At the end of each reporting period the Bank evaluates the impairment of the loan book. For December 31, 2020, 2019 and 2018 this has been assessed in accordance with IFRS 9 and for prior periods in accordance with IAS 39.

 

Effect of Rounding

 

Certain figures included in this Annual Report and in the Audited Consolidated Financial Statements have been rounded up for ease of presentation. Percentage figures included in this Annual Report have not in all cases been calculated on the basis of such rounded figures but on the basis of such amounts prior to rounding. For this reason, certain percentage amounts in this Annual Report may vary from those obtained by performing the same calculations using the figures in the Audited Consolidated Financial Statements. Certain other amounts that appear in this Annual Report may not sum due to rounding.

 

Economic and Market Data

 

In this Annual Report, unless otherwise indicated, all macroeconomic data related to the Chilean economy is based on information published by the Central Bank, and all market share and other data related to the Chilean financial system is based on information published by the FMC and our analysis of such information.

 

Exchange Rates

 

This Annual Report contains translations of certain Chilean peso amounts into U.S. dollars at specified rates solely for the convenience of the reader. These translations should not be construed as representations that the Chilean peso amounts actually represent such U.S. dollar amounts, were converted from U.S. dollars at the rate indicated in preparing the Audited Consolidated Financial Statements, could be converted into U.S. dollars at the rate indicated, were converted or will be converted at all.

 

Unless otherwise indicated, all U.S. dollar amounts at any year end, for any period have been translated from Chilean pesos based on the interbank market rate published by Reuters at 1:30 pm on the last business day of the period. On December 31, 2020 the exchange rate in the Informal Exchange Market as published by Reuters at 1:30 pm was Ch$712.47, or 0.17% more than the observed exchange rate published by the Central Bank for such date of Ch$711.24 per U.S.$1.00. The Federal Reserve Bank of New York does not report a noon buying rate for the Chilean peso.

 

The U.S. dollar equivalent of one UF was U.S.$40.87 as of December 31, 2020, using the observed exchange rate reported by the Central Bank as of December 30, 2020 of Ch$711.24 per U.S.$1.00.

 

PART I

 

ITEM 1. IDENTITY OF DIRECTORS, SENIOR MANAGEMENT AND ADVISERS

 

Not applicable.

 

ITEM 2. OFFER STATISTICS AND EXPECTED TIMETABLE

 

Not applicable.

 

ITEM 3. KEY INFORMATION

 

A. Selected Financial Data

 

The following table presents selected historical financial information for Santander-Chile as of the dates and for each of the periods indicated. Financial information for Santander-Chile as of and for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 has been derived from our audited consolidated financial statements prepared in accordance with IFRS. In the F-pages of this Annual Report on Form 20-F, our audited financial statements as of December 31, 2020 and 2019 and for the years ended December 31, 2020, 2019 and 2018 are presented. The audited financial statements for 2017 and 2016 are not included in this document, but they can be found in our previous Annual Reports on Form 20-F. These consolidated financial statements differ in some respects from our locally filed financial statements as of and for the years ended December 31, 2020, 2019, 2018, 2017 and 2016 prepared in accordance with Chilean Bank GAAP. See “Item 4. Information on the Company—Differences between IFRS and Chilean Bank GAAP.”

 

The following table should be read in conjunction with, and is qualified in its entirety by reference to, our Audited Consolidated Financial Statements appearing elsewhere in this Annual Report.

 

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  As of and for the years ended December 31,
   2020  2020  2019  2018  2017  2016
  In U.S.$ thousands(1)     In Ch$ millions (2)  
CONSOLIDATED STATEMENT OF INCOME DATA (IFRS)                  
Net interest income    2,237,074    1,593,848    1,416,964    1,414,368    1,326,691    1,281,366 
Net fee and commission income    375,143    267,278    287,086    290,885    279,063    254,424 
Financial transactions, net (3)    210,251    149,797    201,692    105,082    129,752    140,358 
Other operating income    11,518    8,206    13,001    23,129    62,016    6,427 
Net operating profit before provision for loan losses    2,833,985    2,019,129    1,918,743    1,833,464    1,797,522    1,682,575 
Provision for loan losses    (671,276)   (478,264)   (323,311)   (317,408)   (302,255)   (342,083)
Net operating income    2,162,709    1,540,865    1,595,432    1,516,056    1,495,267    1,340,492 
Total operating expenses    (1,188,808)   (846,990)   (801,890)   (754,314)   (778,950)   (756,041)
Operating income    973,901    693,875    793,542    761,742    716,317    584,451 
Income from investments in associates and other companies (4)    1,948    1,388    1,146    1,324    1,144    3,012 
Income before tax    975,849    695,263    794,688    763,066    717,461    587,463 
Income tax expense    (200,055)   (142,533)   (175,074)   (167,144)   (145,031)   (109,031)
Income from continuing operations    775,794    552,730    619,614    595,922    572,430    478,432 
Income from discontinued operations (4)            1,699    3,771    2,819     
Net income for the year    775,794    552,730    621,313    599,693    575,249    478,432 
Net income for the period attributable to: Equity holders of the Bank    768,613    547,614    619,091    595,333    562,801    476,067 
Non-controlling interests    7,181    5,116    2,222    4,360    12,448    2,365 
Net income attributable to Equity holders of the Bank per share    4.08    2.91    3.29    3.16    2.99    2.53 
Net income attributable to Equity holders of the Bank per ADS    1,631    1,162.38    1,314.10    1,263.71    1,406.96    1,010.51 
Weighted-average shares outstanding (in millions)    188,446    188,446    188,446    188,446.1    188,446.1    188,446.1 
Weighted-average ADS outstanding (in millions)    471.1    471.1    471.1    471.1    471.1    471.1 
CONSOLIDATED STATEMENT OF FINANCIAL POSITION DATA (IFRS)                              
Cash and deposits in banks    3,934,605    2,803,288    3,554,520    2,065,441    1,452,922    2,279,389 
Cash items in process of collection    635,764    452,963    355,062    353,757    668,145    495,283 
Investments under resale agreements                        6,736 
Financial derivative contracts    12,677,144    9,032,085    8,148,608    3,100,635    2,238,647    2,500,782 
Trading investments                      485,736    396,987 
Interbank loans, net                      162,213    268,672 
Loans and accounts receivable from customers, net                      26,772,544    26,147,154 
Available-for-sale investments                      2,574,546    3,388,906 
Financial assets held for trading    187,682    133,718    270,204    77,041         
Loans and account receivable at amortized cost    46,743,161    33,303,100    31,775,420    29,331,001         
Loans and account receivable at fair value through other comprehensive income    97,311    69,331    66,065    68,588         
Debt instrument at fair value through other comprehensive income    10,053,114    7,162,542    4,010,272    2,394,323         
Equity instruments at fair value through other comprehensive income    769    548    482    483         
Investments in associates and other companies    14,591    10,396    10,177    32,003    27,585    23,780 
Intangible assets    115,846    82,537    73,389    66,923    63,219    58,085 
Property, plant, and equipment    338,055    240,854    252,346    253,586    242,547    257,379 
Rights of use assets    207,724    147,997    155,987             
Current taxes            11,648             
Deferred taxes    724,929    516,490    451,388    397,515    371,091    359,600 
Other assets    2,452,558    1,747,374    1,439,146    991,216    764,410    847,272 
TOTAL ASSETS    78,183,254    55,703,223    50,574,714    39,132,512    35,823,605    37,030,025 
Deposits and other demand liabilities    20,437,202    14,560,893    10,297,432    8,741,417    7,768,166    7,539,315 

 

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  As of and for the years ended December 31,
   2020  2020  2019  2018  2017  2016
  In U.S.$ thousands(1)     In Ch$ millions (2)  
Cash items in process of being cleared    507,574    361,631    198,248    163,043    486,726    288,473 
Obligations under repurchase agreements    1,361,191    969,808    380,055    48,545    268,061    212,437 
Time deposits and other time liabilities    14,852,262    10,581,791    13,192,817    13,067,819    11,913,945    13,151,709 
Financial derivative contracts    12,658,301    9,018,660    7,390,654    2,517,728    2,139,488    2,292,161 
Interbank borrowings    8,882,618    6,328,599    2,519,818    1,788,626    1,698,357    1,916,368 
Issued debt instruments    11,515,119    8,204,177    9,500,723    8,115,233    7,093,653    7,326,372 
Other financial liabilities    258,703    184,318    226,358    215,400    242,030    240,016 
Obligation for lease contract    209,953    149,585    158,494             
Current taxes    18,214    12,977        8,093    6,435    29,294 
Deferred taxes    181,752    129,493    99,157    15,470    9,663    7,686 
Provisions    464,109    330,664    326,130    305,271    303,798    292,210 
Other liabilities    1,636,354    1,165,853    2,806,325    900,408    745,363    795,785 
TOTAL LIABILITIES    72,983,352    51,998,449    47,096,211    35,887,053    32,675,685    34,091,826 
Capital    1,251,004    891,303    891,303    891,303    891,303    891,303 
Reserves    3,289,374    2,343,580    2,122,742    1,923,022    1,781,818    1,640,112 
Valuation adjustments    (35,500)   (25,293)   (8,856)   11,352    (2,312)   6,640 
Retained earnings    576,166    410,501    393,681    373,619    435,228    370,803 
Attributable to Equity holders of the Bank    5,081,043    3,620,091    3,398,870    3,199,296    3,106,037    2,908,858 
Non-controlling interest    118,858    84,683    79,633    46,163    41,883    29,341 
TOTAL EQUITY (5)    5,199,902    3,704,774    3,478,503    3,245,459    3,147,920    2,938,199 
TOTAL LIABILITIES AND EQUITY    78,183,254    55,703,223    50,574,714    39,132,512    35,823,605    37,030,025 

 

   As of and for the years ended December 31,
   2020  2019  2018  2017  2016
CONSOLIDATED RATIOS                         
(IFRS)                         
Profitability and performance:                         
Net interest margin (6)    3.8%   4.0%   4.3%   4.3%   4.3%
Return on average total assets (7)    1.0%   1.4%   1.6%   1.6%   1.4%
Return on average equity (8)    14.8%   18.0%   18.4%   19.2%   16.8%
                          
Capital:                         
Average equity as a percentage of average total assets (9)    6.7%   8.0%   8.8%   8.5%   8.1%
Total liabilities as a multiple of equity (10)    14.0    13.5    11.1    10.4    11.6 
Credit Quality:                         
Non-performing loans as a percentage of total loans (11)    1.4%   2.1%   2.1%   2.3%   2.1%
Allowance for loan losses as percentage of total loans(12)    3.0%   2.7%   2.9%   2.9%   2.9%
Operating Ratios:                         
Operating expenses /operating revenue (13)   41.9%   41.8%   41.1%   43.3%   44.9%
Operating expenses /average total assets    1.4%   1.9%   2.0%   2.3%   2.1%
OTHER DATA                         
CPI Inflation Rate (14)    3.0%   3.0%   2.6%   2.3%   2.7%
Revaluation (devaluation) rate (Ch$/U.S.$) at year end (14)    4.5%   (7.1%)   (13.1%)   7.8%   5.7%
Number of employees at period end    10,470    11,200    11,305    11,068    11,354 
Number of branches and offices at period end    358    377    380    385    423 

____________________

(1)Amounts stated in U.S. dollars at and for the year ended December 31, 2020 have been translated from Chilean pesos at the interbank market exchange rate of Ch$712.47 = U.S.$1.00 as of December 31, 2020 based on the interbank market rate published by Reuters at 1:30 pm on the last business day of the period. Per share data in US$ is not in thousands.

 

6

(2)Except per share data, percentages and ratios, share numbers, employee numbers and branch numbers.

 

(3)Net income (expense) from financial operations and net foreign exchange gain.

 

(4)In 2019 Banco Santander sold its investments in Redbanc S.A., Transbank S.A. and Nexus S.A. in accordance with IFRS 5 and reclassified and presented these investments in Other Assets classified as held for sale separate from the rest of the investments in associates and presented the effects in the income statement as discontinued operations. See “Note 39- Non-current assets held for sale”.

 

(5)Total equity includes equity attributable to equity holders of the Bank plus non-controlling interests.

 

(6)Net interest income divided by average interest earning assets (as presented in “Item 5. Operating and Financial Review and Prospects— C. Selected Statistical Information”).

 

(7)Net income for the year divided by average total assets (as presented in “Item 5. Operating and Financial Review and Prospects— C. Selected Statistical Information”).

 

(8)Net income for the year divided by average equity (as presented in “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information”).

 

(9)This ratio is calculated using total average equity (as presented in “Item 5. Operating and Financial Review and Prospects— C. Selected Statistical Information”) including non-controlling interest.

 

(10)Total liabilities divided by equity.

 

(11)Non-performing loans include the aggregate unpaid principal and accrued but unpaid interest on all loans with at least one installment over 90 days past-due. Total loans in 2020, 2019 and 2018 corresponds to loans at amortized cost.

 

(12)Allowance for loan losses as of December 31, 2020, 2019 and 2018 corresponds to allowances for loans at fair value through other comprehensive income at amortized cost according to IFRS 9. Prior periods are in accordance with IAS 39.

 

(13)The efficiency ratio is equal to operating expenses over operating income. Operating expenses includes personnel salaries and expenses, administrative expenses, depreciation and amortization, impairment and other operating expenses. Operating income includes net interest income, net fee and commission income, net income from financial operations (net trading income), foreign exchange gain, net and other operating income.

 

(14)Based on information published by the Central Bank.

 

Dividends

 

Under the current General Banking Law, a Chilean bank may only pay a single dividend per year (i.e., interim dividends are not permitted). Santander-Chile’s annual dividend is proposed by its Board of Directors and is approved by the shareholders at the annual ordinary shareholders’ meeting held the year following that in which the dividend is generated. For example, the 2020 dividend must be proposed and approved during the first four months of 2021. Following shareholder approval, the proposed dividend is declared and paid. Historically, the dividend for a particular year has been declared and paid no later than one month following the shareholders’ meeting. Dividends are paid to shareholders of record on the fifth day preceding the date set for payment of the dividend. The applicable record dates for the payment of dividends to holders of ADSs will, to the extent practicable, be the same.

 

Under the General Banking Law, a bank must distribute cash dividends in respect of any fiscal year in an amount equal to at least 30% of its net income for that year, if the dividend does not result in the infringement of minimum capital requirements. The balances of our distributable net income are generally retained for use in our business (including for the maintenance of any required legal reserves). Although our Board of Directors currently intends to pay regular annual dividends, the amount of dividend payments will depend upon, among other factors, our current level of earnings, capital and legal reserve requirements, as well as market conditions, and there can be no assurance as to the amount or timing of future dividends.

 

Dividends payable to holders of ADSs are net of foreign currency conversion expenses of The Bank of New York Mellon, as depositary (the “Depositary”) and will be subject to the Chilean withholding tax currently at the rate of 35% (subject to credits in certain cases as described in “Item 10. Additional Information—E. Taxation—Material Tax Consequences of Owning Shares of Our Common Stock or ADSs”).

 

7

 

Under the Foreign Investment Contract (as defined herein), the Depositary, on behalf of ADS holders, is granted access to the Formal Exchange Market to convert cash dividends from Chilean pesos to U.S. dollars and to pay such U.S. dollars to ADS holders outside Chile, net of taxes, and no separate registration by ADS holders is required. In the past, Chilean law required that holders of shares of Chilean companies who were not residents of Chile to register as foreign investors under one of the foreign investment regimes contemplated by Chilean law in order to have dividends, sale proceeds or other amounts with respect to their shares remitted outside Chile through the Formal Exchange Market. On April 19, 2001, the Central Bank deregulated the Exchange Market and eliminated the need to obtain approval from the Central Bank in order to remit dividends, but at the same time this eliminated the possibility of accessing the Formal Exchange Market. These changes do not affect the current Foreign Investment Contract, which was signed prior to April 19, 2001, which grants access to the Formal Exchange Market with prior approval of the Central Bank. See “Item 10. Additional Information—D. Exchange Controls.”

 

The following table presents dividends declared and paid by us in nominal terms in the past four years: 

 

Year   Dividend
Ch$ millions
(1)
    Dividend
U.S.$ millions
(2)
    Per share
Ch$/share
(3)
    Per ADS U.S.$/ADS
(4)
    

% over
earnings

(5)

    

% over

earnings

(6)

 
2017    330,646    500.9    1.75    1.06    70    69 
2018    423,611    705.3    2.25    1.50    75    75 
2019    355,141    531.5    1.88    1.13    60    60 
2020 (7)    331,256    430.8    1.76    0.91    60    54 

____________________

(1)Millions of nominal pesos.

 

(2)Millions of U.S.$ using the observed exchange rate of the day the dividend was approved at the annual shareholders’ meeting.

 

(3)Calculated on the basis of 188,446 million shares.

 

(4)Dividend in U.S.$ million divided by the number of ADS, which was calculated on the basis of 400 shares per ADS.

 

(5)Calculated by dividing dividend paid in the year by net income attributable to the equity holders of the Bank for the previous year under Chilean Bank GAAP. This is the payment ratio determined by shareholders.

 

(6)Calculated by dividing dividend paid in the year by net income attributable to the equity holders of the Bank for the previous year under IFRS.

 

(7)In 2020, shareholders of the Bank approved the distribution of 30% of the 2019 net income attributable to shareholders under Chilean Bank GAAP on April 30, 2020. This amounted to Ch$ 165,627 million (US$ 198.0 million using the observed exchange rate of the day the dividend was approved at the annual shareholders’ meeting) or Ch$ 0.88 per share (US$ per ADR 0.49). In the Extraordinary Shareholders Meeting held on November 26, 2020, a further 30% of the 2019 earnings was approved.

 

B. Capitalization and Indebtedness

 

Not applicable.

 

C. Reasons for the Offer and Use of Proceeds

 

Not applicable.

 

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D. Risk Factors

 

You should carefully consider the following risk factors, which should be read in conjunction with all the other information presented in this Annual Report. The risks and uncertainties described below are not the only ones that we face. Additional risks and uncertainties that we do not know about or that we currently think are immaterial may also impair our business operations. Any of the following risks, if they actually occur, could materially and adversely affect our business, results of operations, prospects and financial condition. The following risk factors have been grouped as follows:

 

(a)Risk Factors in respect of Santander-Chile;

 

(b)Risk Factors in respect of Chile;

 

(c)Risk Factors in respect of our Controlling Shareholder and our ADSs; and

 

(d)General Risk Factors.

 

The risk factors in respect of Santander-Chile are presented in the following subcategories depending on their nature:

 

(a)Macro-economic Risks;

 

(b)Competitive Risks;

 

(c)Operational Risks;

 

(d)Financial Risks; and

 

(e)Legal and Regulatory Risks.

 

Summary of Key Risks

 

Our business is subject to numerous risks and uncertainties, discussed in more detail below. These risks include, among others, the following key risks:

 

·Our operations and results have been negatively impacted by the coronavirus outbreak.

 

·We are vulnerable to disruptions and volatility in the global financial markets.

 

·The growth rate of our loan portfolio may be affected by economic turmoil, which could also lead to a contraction in our loan portfolio.

 

·Our operations and results may be negatively affected by earthquakes due to the location of Chile in a highly seismic area.

 

·Climate change can create transition risks, physical risks, and other risks that could adversely affect us.

 

·Increased competition, including from non-traditional providers of banking services such as financial technology providers, and industry consolidation may adversely affect our results of operations.

 

·Our ability to maintain our competitive position depends, in part, on the success of new products and services we offer our clients.

 

·The growth of our loan portfolio may expose us to increased loan losses. Our exposure to individuals and small and mid-sized businesses could lead to higher levels of past due loans, allowances for loan losses and charge-offs.

 

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·Failure to successfully implement and continue to improve our risk management policies, procedures and methods, including our credit risk management system, could materially and adversely affect us, and we may be exposed to unidentified or unanticipated risks.

 

·Our loan and investment portfolios are subject to risk of prepayment, which could have a material adverse effect on us.

 

·Risks relating to cybersecurity, data collection, processing and storage systems and security are inherent in our business.

 

·Disclosure controls and procedures over financial reporting may not prevent or detect all errors or acts of fraud.

 

·We may not effectively manage risks associated with the replacement of benchmark indices.

 

·Market conditions have resulted, and could result, in material changes to the estimated fair values of our financial assets. Negative fair value adjustments could have a material adverse effect on our operating results, financial condition and prospects.

 

·Our financial results are constantly exposed to market risk. We are subject to fluctuations in inflation, interest rates and other market risks, which may materially and adversely affect us and our profitability.

 

·We are subject to counterparty risk in our banking business.

 

·Liquidity and funding risks are inherent in our business and could have a material adverse effect on our results, our costs of funds and our credit ratings.

 

·We are subject to regulatory capital and liquidity requirements that could limit our operations, and changes to these requirements may further limit and adversely affect our operating results, financial condition and prospects.

 

·We are subject to regulatory risk, or the risk of not being able to meet all of the applicable regulatory requirements and guidelines.

 

·Changes to the pension fund system may affect the funding mix of the Bank

 

·We may not be able to detect or prevent money laundering and other financial crime activities fully or on a timely basis, which could expose us to additional liability and could have a material adverse effect on us.

 

·We are exposed to risk of loss from legal and regulatory proceedings.

 

·Political, legal, regulatory and economic uncertainty arising from social unrest and the resulting social reforms, as well as the referendum on Chile’s constitution could adversely impact the Bank’s business

 

·Our growth, asset quality and profitability may be adversely affected by macroeconomic and political conditions in Chile.

 

·Currency fluctuations could adversely affect our financial condition and results of operations and the value of our securities.

 

·Our controlling shareholder has a great deal of influence over our business and its interests could conflict with yours.

 

·Our status as a controlled company and a foreign private issuer exempts us from certain of the corporate governance standards of the New York Stock Exchange (“NYSE”), limiting the protections afforded to investors.

 

·As a holder of ADSs you will have different shareholders’ rights than in the United States and certain other jurisdictions.

 

·Holders of ADSs may find it difficult to exercise voting rights at our shareholders’ meetings.

 

10

 

RISK FACTORS IN RESPECT OF SANTANDER-CHILE

 

Macro-Economic Risks

 

Our operations and results have been negatively impacted by the coronavirus outbreak, which we expect will have a continued and potentially material adverse effect on our business and results of operations for as long as the pandemic is ongoing.

 

Since December 2019, a novel strain of coronavirus (COVID-19) has spread around the world, including Chile. On March 18, 2020, the Chilean government declared a state of emergency and on March 19, 2020, the government ordered the suspension of all non-essential activities and a mandatory quarantine in neighborhoods with a high concentration of cases. Since that date different areas of Chile have come in and out of different levels of quarantine. These measures and similar measures have caused significant disruption of regional and global economic activity. These quarantines led to the closure of approximately 20% of our branches at the peak of the pandemic. As of December 31, 2020, 41 of our branches remained closed due to the pandemic. For the remaining of the open branches, we have instituted strict sanitary protocols and restrictions on the number of customers and personnel that can be in any individual branch at a time. As of December 31, 2020, 20% of the Bank’s central office workforce had returned to work at our headquarters, while the rest remain working remotely.

 

Preliminary economic figures for 2020 published by the Chilean Central Bank have shown a significant impact of the pandemic on economic activity. GDP is expected to fall by 5-6% in 2020 and as of December 2020 the unemployment rate was at 10.2%. We expect there to be an improvement in economic growth in 2021, but the risk of a second wave of the coronavirus will still be a threat in 2021.

 

In Chile, the industries and sectors that have been most impacted have been hotels, casinos, tourism, restaurants and airlines. As of December 31, 2020, our loan exposures to these industries totaled approximately 1.1% of its loan book. In addition, during this time, we have seen increased demand for commercial loans and an increase in the number of clients opting to defer loan payments as permitted by the terms of their loan agreements.

 

The Chilean government has also announced a series of measures to support lending. The largest measures were to provide an additional US$3 billion to the Guarantee Fund for Small Companies (Fogape), a state fund that guarantees loans, leases and other credits provided to small businesses, extend Fogape’s coverage to companies with annual sales of up to UF 1 million (US$34 million) and further amend the rules and regulations governing Fogape to encourage banks to provide lending to small businesses. Under Fogape’s new regulations, domestic banks, including us, may provide loans with preferential interest rates monetary policy rate (MPR) to the MPR plus 3% and terms of up to 48 months to eligible companies in an aggregate amount equal to up to 3 months of a company’s sales and receive a guarantee from Fogape of between 60% and 85% of each loan. Any recovery of all or a portion of a non-performing loan will first be used to satisfy the non-guaranteed portion of the principal amount of the loan as well as legal fees, followed by the amount of the guarantee provided by Fogape and lastly any accrued and unpaid interest and fees. In order to receive the guarantee from Fogape, such loans must have a 6-month grace period before a company must begin repaying the loan. In addition, companies that receive loans guaranteed by Fogape pursuant to these new regulations will be entitled to defer loan payments for a period of 6 months.

 

In February 2021, the government approved the FOGAPE 2.0 program. The maximum rate will be set at a monthly rate of TPM (overnight rate) plus 0.6%, implying an annual rate of 7.2%. The focus at this time will be to direct the loans for SMEs investments and not only for working capital needs.

 

Although we have received guarantees from Fogape for a portion of the Fogape loans we have granted, if our clients default on their payment obligations under these loans when they become due, or they otherwise fail to timely comply with their obligations under these loans, this will result in higher levels of non-performing loans in the future and require the recognition of additional allowances for loan losses. Moreover, we must share with Fogape a portion of any recovery made on non-performing loans guaranteed by Fogape. In addition, all other loans previously disbursed to a client from the same bank from which they receive the FOGAPE loan will also be granted

 

11

 

a 6-month grace period for repayment. If our clients default on their obligations under these loans, which are not guaranteed by Fogape, when such grace period ends, it could result in higher levels of non-performing loans in the future and require the recognition of additional allowances for loan losses.

 

As of December 31, 2020, we had approved Ch$2.1 trillion of Fogape loans to our SME and Middle-market clients. In December 2020 the first installments for approximately 50% of FOGAPE loans came due with an initial repayment rate of 99.6%. Despite these positive figures, we cannot assure that these repayment trends will continue in the future and a greater extension of the COVID-19 pandemic could signify a greater deterioration of the payment ability of our clients with a FOGAPE loan.

 

The FMC has also issued regulations regarding the granting of grace periods for mortgages, consumer loans and commercial loans that have been affected by the COVID-19 pandemic as follows:

 

Additionally, we provided grace periods for our consumer portfolio for up to 3 months, our mortgage portfolio for up to 6 months, and commercial loans up to 6 months to debtors who were 0-30 days overdue as of March 31,2020. As of December 31, 2020, we had provided a grace period according to the guidelines established by our regulator for Ch$9.1 trillion of our loans. Below is a breakdown of repayment behavior at the close of 2020:

 

Covid-19 measures As of December 31, 2020
MCh$
Payment holiday 9,098,028
Payment holiday – current 734,986
Payment holiday - expired 8,363,042

 

The Bank is closely monitoring payment behavior once payment holidays have expired. As of December 31, 2020, Ch$8,241,191 million corresponds to clients who are servicing their debt properly, and Ch$121,850 million defaulted or requested additional extensions.

 

Despite this favorable evolution of asset quality, there is still risk of an increase in the NPL ratio in 2021 as these grace periods continue to expire and as access to pension fund withdrawals is no longer available. In addition, the impact on allowance for loan losses is currently uncertain as it is highly dependent on the duration of the COVID-19 pandemic, the extent and length of the economic downturn and the rules and regulations put in place to combat the COVID-19 pandemic and its effects in the future.

 

Chile is currently rolling out a massive vaccination process, which officially began February 3, 2021, beginning with the riskiest segments such as health workers and the elderly. Each week it will include a broader segment of the population, trickling down to those that have close contact with people in their work. Chile has requested vaccines from all major laboratories. The target is to have 5 million people vaccinated by the end of March 2021, and 13 million by the end of June 2021, which accounts for 80% of the objective population.

 

The extent to which the COVID-19 pandemic impacts our results will depend on the duration of the pandemic and the level of continued disruption to Chilean, regional and global economic activity, which is impossible to predict at this time. Future developments with respect to the COVID-19 pandemic are highly uncertain and new information may emerge concerning the severity of the COVID-19 pandemic and the actions taken to contain it. Furthermore, there are no indications the Chilean government will continue providing loan support programs or other forms of relief or assistance for private sector entities such as us. If the pandemic continues and further government programs are not initiated, or the ones in place are not effective, this could have a material adverse effect on us.

 

Latam Airlines’ bankruptcy may have a material adverse effect on our business.

 

On May 26, 2020, Latam Airlines Group S.A. and its affiliates in Chile, Peru, Colombia, Ecuador and the United States filed for Chapter 11 bankruptcy in the United States. In Latam’s filings with bankruptcy court, we were identified as having one of Latam’s 40 largest unsecured claims. This claim is for the frequent flier mileage program we and Latam operate, through which holders of ours and Latam’s co-branded credit card accumulate airline miles with each spend on their credit card. The Bank’s balance sheet as of December 31, 2020, included a pre-paid expense for miles acquired under this program valued at Ch$372,544 billion (US$523 million) in Other Assets.

 

12

 

Latam and its affiliates will be able to continue flying during the pendency of its Chapter 11 bankruptcy case. In initial hearings held on May 28, 2020 under the Chapter 11 restructuring process, Latam’s motion to continue honoring its mileage program was approved. As of the date hereof, the Bank does not see the need to re-value or recognize an impairment for this pre-paid expense. However, such assets may become impaired in the future as a result of the bankruptcy proceedings and we cannot assure that at a future date the restructuring process being carried out by Latam Airlines will not have a material adverse effect on our business.

 

We are vulnerable to disruptions and volatility in the global financial markets.

 

Global economic conditions deteriorated significantly between 2007 and 2009, and some countries fell into recession. Some major financial institutions, including some of the world’s largest global commercial banks, investment banks, mortgage lenders, mortgage guarantors and insurance companies experienced, and some continue to experience, significant difficulties. Around the world, there were runs on deposits at several financial institutions, numerous institutions sought additional capital or were assisted by governments, and many lenders and institutional investors reduced or ceased providing funding to borrowers (including to other financial institutions).

 

In particular, we face, among others, the following risks related to an economic downturn:

 

·Reduced demand for our products and services.

 

·Increased regulation of our industry. Compliance with such regulation will continue to increase our costs and may affect the pricing for our products and services, increase our conduct and regulatory risks to non-compliance and limit our ability to pursue business opportunities.

 

·Inability of our borrowers to timely or fully comply with their existing obligations. Macroeconomic shocks may negatively impact the household income of our retail customers and may adversely affect the recoverability of our retail loans, resulting in increased loan losses.

 

·The process we use to estimate losses inherent in our credit exposure requires complex judgments, including forecasts of economic conditions and how these economic conditions might impair the ability of our borrowers to repay their loans. The degree of uncertainty concerning economic conditions may adversely affect the accuracy of our estimates, which may, in turn, impact the reliability of the process and the sufficiency of our loan loss allowances.

 

·The value and liquidity of the portfolio of investment securities that we hold may be adversely affected.

 

·Any worsening of global economic conditions may delay the recovery of the international financial industry and impact our financial condition and results of operations.

 

Despite the improvement of the global economy, uncertainty remains concerning the future economic environment. Such economic uncertainty could have a negative impact on our business and results of operations. A slowing or failing of the economic expansion would likely aggravate the adverse effects of these difficult economic and market conditions on us and on others in the financial services industry.

 

A return to volatile conditions in the global financial markets could have a material adverse effect on us, including on our ability to access capital and liquidity on financial terms acceptable to us, if at all. If capital markets financing ceases to become available, or becomes excessively expensive, we may be forced to raise the rates we pay on deposits to attract more customers and become unable to maintain certain liability maturities. Any such increase in capital markets funding availability or costs or in deposit rates could have a material adverse effect on our interest margins and liquidity.

 

Additionally, uncertainty in relation to the United States trade policy, especially with respect to China, has generated volatility in the global capital and currency markets.

 

If all or some of the foregoing risks were to materialize, this could have a material adverse effect on our financing availability and terms and, more generally, on our results, financial condition and prospects.

 

13

 

The growth rate of our loan portfolio may be affected by economic turmoil, which could also lead to a contraction in our loan portfolio.

 

There can be no assurance that our loan portfolio will continue to grow at similar rates to historical growth rates. A reversal of the rate of growth of the Chilean economy, a slowdown in the growth of customer demand, an increase in market competition or changes in governmental regulations could adversely affect the rate of growth of our loan portfolio and our risk index and, accordingly, increase our required allowances for loan losses. Economic turmoil could materially adversely affect the liquidity, businesses and financial condition of our customers as well as lead to a general decline in consumer spending and a rise in unemployment. All this could in turn lead to decreased demand for borrowings in general.

 

Climate change can create transition risks, physical risks, and other risks that could adversely affect us.

 

Climate change may imply three primary drivers of financial risk that could

 

adversely affect us:

 

·Transition risks associated with the move to a low-carbon economy, both at idiosyncratic and systemic levels, such as through policy, regulatory and technological changes.

 

·Physical risks related to extreme weather impacts and longer term trends, which could result in financial losses that could impair asset values and the creditworthiness of our customers.

 

·Liability risks derived from parties who may suffer losses from the effects of climate change and may seek compensation from those they hold responsible such as state entities, regulators, investors and lenders.

 

These primary drivers could materialize, among others, in the following financial risks, including the following:

 

·Credit risks: Physical climate change could lead to increased credit exposure and companies with business models not aligned with the transition to a low-carbon economy may face a higher risk of reduced corporate earnings and business disruption due to new regulations or market shifts. Central Chile is currently enduring the longest drought of its recent history.

 

·Market risks: Market changes in the most carbon-intensive sectors could affect energy and commodity prices, corporate bonds, equities and certain derivatives contracts. Increasing frequency of severe weather events could affect macroeconomic conditions, weakening fundamental factors such as economic growth, employment and inflation.

 

·Operational risks: Severe weather events could directly impact business continuity and operations both of customers and ours.

 

·Reputational risk could also arise from shifting sentiment among customers and increasing attention and scrutiny from other stakeholders (investors, regulators, etc.) on our response to climate change.

 

Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.

 

Competitive Risks

 

Increased competition, including from non-traditional providers of banking services such as financial technology providers, and industry consolidation may adversely affect our results of operations.

 

We face substantial competition in all parts of our business, including in payments, in originating loans and in attracting deposits. The competition in originating loans comes principally from other domestic and foreign banks, mortgage banking companies, consumer finance companies, insurance companies and other lenders and purchasers of loans.

 

The Chilean market for financial services is highly competitive. We compete with other private sector Chilean and non-Chilean banks, with Banco del Estado de Chile, the principal government-owned sector bank, with department

 

14

 

stores and with larger supermarket chains that make consumer loans and sell other financial products to a large portion of the Chilean population. The lower to middle-income segments of the Chilean population and the small- and mid- sized corporate segments have become the target markets of several banks and competition in these segments may increase. In addition, there has been a trend towards consolidation in the Chilean banking industry in recent years, which has created larger and stronger banks with which we must now compete. There can be no assurance that this increased competition will not adversely affect our growth prospects, and therefore our operations. We also face competition from non-bank (such as department stores, insurance companies, cajas de compensación and cooperativas) and non-finance competitors (principally department stores, auto-lenders and larger supermarket chains) with respect to some of our credit products, such as credit cards, consumer loans and insurance brokerage. In addition, we face competition from non-bank finance competitors, such as leasing, factoring, automobile finance and brokerage companies, with respect to department stores (for some credit products), and from mutual fund and pension fund management companies and insurance companies.

 

Non-traditional providers of banking services, such as Internet-based e-commerce providers, mobile telephone companies and Internet search engines may offer and/or increase their offerings of financial products and services directly to customers. These non-traditional providers of banking services currently have an advantage over traditional providers because they are not subject to banking regulation. Several of these competitors may have long operating histories, large customer bases, strong brand recognition and significant financial, marketing and other resources. They may adopt more aggressive pricing and rates and devote more resources to technology, infrastructure and marketing.

 

New competitors may enter the market or existing competitors may adjust their services with unique product or service offerings or approaches to providing banking services. If we are unable to successfully compete with current and new competitors, or if we are unable to anticipate and adapt our offerings to changing banking industry trends, including technological changes, our business may be adversely affected. In addition, our failure to effectively anticipate or adapt to emerging technologies or changes in customer behavior, including among younger customers, could delay or prevent our access to new digital-based markets, which would in turn have an adverse effect on our competitive position and business. Furthermore, the widespread adoption of new technologies, including distributed ledger, artificial intelligence and/or biometrics, to provide services such as cryptocurrencies and payments, could require substantial expenditures to modify or adapt our existing products and services as we continue to grow our Internet and mobile banking capabilities. Our customers may choose to conduct business or offer products in areas that may be considered speculative or risky. Such new technologies and mobile banking platforms in recent years could negatively impact the value of our investments in bank premises, equipment and personnel for our branch network.

 

The persistence or acceleration of this shift in demand towards Internet and mobile banking may necessitate changes to our retail distribution strategy, which may include closing and/or selling certain branches and restructuring our remaining branches and work force. These actions could lead to losses on these assets and may lead to increased expenditures to renovate, reconfigure or close a number of our remaining branches or to otherwise reform our retail distribution channel. Furthermore, our failure to swiftly and effectively implement such changes to our distribution strategy could have an adverse effect our competitive position.

 

In particular, we face the challenge to compete in an ecosystem where the relationship with the consumer is based on access to digital data and interactions. This access is increasingly dominated by digital platforms who are already eroding our results in very relevant markets such as payments. This privileged access to data can be used as a leverage to compete with us in other adjacent markets and may reduce our operations and margins in core businesses such as lending or wealth management. The alliances that our competitors are starting to build with Bigtechs can make it more difficult for us to successfully compete with them and could adversely affect us.

 

Increasing competition could also require that we increase our rates offered on deposits or lower the rates we charge on loans, which could also have a material adverse effect on us, including our profitability. It may also negatively affect our business results and prospects by, among other things, limiting our ability to increase our customer base and expand our operations and increasing competition for investment opportunities.

 

If our customer service levels were perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.

 

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Our ability to maintain our competitive position depends, in part, on the success of new products and services we offer our clients and our ability to offer products and services that meet the customers’ needs during the whole life cycle of the products or services, and we may not be able to manage various risks we face as we expand our range of products and services that could have a material adverse effect on us.

 

The success of our operations and our profitability depends, in part, on the success of new products and services we offer our clients and our ability to offer products and services that meet the customers’ needs during all their life cycle. However, our clients’ needs or desires may change over time, and such changes may render our products and services obsolete, outdated or unattractive and we may not be able to develop new products that meet our clients’ changing needs. Our success is also dependent on our ability to anticipate and leverage new and existing technologies that may have an impact on products and services in the banking industry. Technological changes may further intensify and complicate the competitive landscape and influence client behavior. If we cannot respond in a timely fashion to the changing needs of our clients, we may lose clients, which could in turn materially and adversely affect us. In addition, the cost of developing products is likely to affect our results of operations.

 

As we expand the range of our products and services, some of which may be at an early stage of development in the markets of certain regions where we operate, we will be exposed to new and potentially increasingly complex risks, such as the conduct risk in the relationship with customers, and development expenses. Our employees and our risk management systems, as well as our experience and that of our partners may not be sufficient to enable us to properly manage such risks. Any or all of these factors, individually or collectively, could have a material adverse effect on us.

 

Our strong position in the credit card market is in part due to our credit card co-branding agreement with Chile’s largest airline. This agreement was renewed in January 2019 for seven more years. Once this agreement expires, no assurance can be given that it will be renewed, which may materially and adversely affect our results of operations and financial condition in the credit card business.

 

While we have successfully increased our customer service levels in recent years, should these levels ever be perceived by the market to be materially below those of our competitor financial institutions, we could lose existing and potential business. If we are not successful in retaining and strengthening customer relationships, we may lose market share, incur losses on some or all of our activities or fail to attract new deposits or retain existing deposits, which could have a material adverse effect on our operating results, financial condition and prospects.

 

Operational Risks

 

The financial problems faced by our customers could adversely affect us.

 

Market turmoil and economic recession could materially and adversely affect the liquidity, credit ratings, businesses and/or financial conditions of our borrowers, which could in turn increase our non-performing loan ratios, impair our loan and other financial assets and result in decreased demand for borrowings in general. In addition, our customers may further significantly decrease their risk tolerance to non-deposit investments such as stocks, bonds and mutual funds, which would adversely affect our fee and commission income. Any of the conditions described above could have a material adverse effect on our business, financial condition and results of operations.

 

We may generate lower revenues from fee and commission based businesses.

 

The fees and commissions that we earn from the different banking and other financial services that we provide represent a significant source of our revenues. Regulatory changes that modify the fees we may charge could adversely affect our fee and commission income.

 

A portion of the Bank’s fee income is derived from brokerage of mutual funds, stocks and bonds and a market downturn could result in significantly lower fees from these sources. Banco Santander Chile sold its asset management business in 2013 and signed a management service agreement for a 10 year-period with the acquirer of this business in which we sell asset management funds on their behalf. Therefore, even in the absence of a market downturn, below-market performance by the mutual funds of the firm we broker for may result in a reduction in revenue we receive from selling asset management funds and adversely affect our results of operations.

 

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The growth of our loan portfolio may expose us to increased loan losses. Our exposure to individuals and small and mid-sized businesses could lead to higher levels of past due loans, allowances for loan losses and charge-offs.

 

The further expansion of our loan portfolio (particularly in the consumer, small- and mid-sized companies and real estate segments) can be expected to expose us to a higher level of loan losses and require us to establish higher levels of provisions for loan losses. See “Note 9—Loans and Account Receivable at Amortized Cost – under IFRS 9” and “Note 10—Loans and Account Receivable at Fair Value through Other Comprehensive Income – under IFRS 9” in our Audited Consolidated Financial Statements for a description and presentation of our loan portfolio as well as “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Loan Portfolio.”

 

Retail customers represent 70.5% of the value of the total loan portfolio at amortized cost as of December 31, 2020. As part of our business strategy, we seek to increase lending and other services to retail clients, which are more likely to be adversely affected by downturns in the Chilean economy. In addition, as of December 31, 2020, our residential mortgage loan portfolio totaled Ch$12,411,825 million, representing 36.1% of our total loans. See “Note 9— Loans and Account Receivable at Amortized Cost –under IFRS 9” in our Audited Consolidated Financial Statements for a description and presentation of our residential mortgage loan portfolio. If the economy and real estate market in Chile experience a significant downturn, this could materially adversely affect the liquidity, businesses and financial conditions of our customers, which may in turn cause us to experience higher levels of past-due loans, thereby resulting in higher provisions for loan losses and subsequent charge-offs. This may materially and adversely affect our asset quality, results of operations and financial condition.

 

Failure to successfully implement and continue to improve our risk management policies, procedures and methods, including our credit risk management system, could materially and adversely affect us, and we may be exposed to unidentified or unanticipated risks.

 

The management of risk is an integral part of our activities. We seek to monitor and manage our risk exposure through a variety of separate but complementary financial, credit, market, operational, compliance and legal reporting systems, among others. While we employ a broad and diversified set of risk monitoring and risk mitigation techniques, such techniques and strategies may not be fully effective in mitigating our risk exposure in all economic market environments or against all types of risk, including risks that we may fail to identify or anticipate.

 

Some of our qualitative tools and metrics for managing risk are based upon our use of observed historical market behavior. We apply statistical and other tools to these observations to arrive at quantifications of our risk exposures. These qualitative tools and metrics may fail to predict future risk exposures. These risk exposures could, for example, arise from factors we did not anticipate or correctly evaluate in our statistical models. This would limit our ability to manage our risks. Our losses thus could be significantly greater than the historical measures indicate. In addition, our quantified modeling does not take all risks into account.

 

Our more qualitative approach to managing those risks could prove insufficient, exposing us to material unanticipated losses. We could face adverse consequences as a result of decisions, which may lead to actions by management, based on models that are poorly developed, implemented or used, or as a result of the modelled outcome being misunderstood or the use of such information for purposes for which it was not designed. If existing or potential customers or counterparties believe our risk management is inadequate, they could take their business elsewhere or seek to limit their transactions with us. Any of these factors could have a material adverse effect on our reputation, operating results, financial condition and prospects.

 

As a retail bank, one of the main types of risks inherent in our business is credit risk. For example, an important feature of our credit risk management system is to employ an internal credit rating system to assess the particular risk profile of a customer. As this process involves detailed analyses of the customer, taking into account both quantitative and qualitative factors, it is subject to human or IT systems errors. In exercising their judgement on current or future credit risk behavior of our customers, our employees may not always be able to assign an accurate credit rating, which may result in our exposure to higher credit risks than indicated by our risk rating system.

 

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Some of the models and other analytical and judgement-based estimations we use in managing risks are subject to review by, and require the approval of, our regulators. If models do not comply with all their expectations, our regulators may require us to make changes to such models, may approve them with additional capital requirements or we may be precluded from using them. Any of these possible situations could limit our ability to expand our businesses or have a material impact on our financial results.

 

Failure to effectively implement, consistently monitor or continuously refine our credit risk management system may result in an increase in the level of non-performing loans and a higher risk exposure for us, which could have a material adverse effect on us.

 

The effectiveness of our credit risk management is affected by the quality and scope of information available in Chile.

 

In assessing customers’ creditworthiness, we rely largely on the credit information available from our own internal databases, the FMC, the Directorio de Información Comercial (Dicom), a Chilean nationwide credit bureau, and other sources. Due to limitations in the availability of information and the developing information infrastructure in Chile, our assessment of credit risk associated with a particular customer may not be based on complete, accurate or reliable information. In addition, although we have been improving our credit scoring systems to better assess borrowers’ credit risk profiles, we cannot assure you that our credit scoring systems will collect complete or accurate information reflecting the actual behavior of customers or that their credit risk can be assessed correctly. Without complete, accurate and reliable information, we will have to rely on other publicly available resources and our internal resources, which may not be effective. As a result, our ability to effectively manage our credit risk and subsequently our loan loss allowances may be materially adversely affected.

 

Our loan and investment portfolios are subject to risk of prepayment, which could have a material adverse effect on us.

 

Our fixed rate loan and investment portfolios are subject to prepayment risk, which results from the ability of a borrower or issuer to pay a debt obligation prior to maturity. Generally, in a declining interest rate environment, prepayment activity increases, which reduces the weighted average lives of our earning assets and could have a material adverse effect on us. We would also be required to amortize net premiums into income over a shorter period of time, thereby reducing the corresponding asset yield and net interest income. Prepayment risk also has a significant adverse impact on credit card and collateralized mortgage loans, since prepayments could shorten the weighted average life of these assets, which may result in a mismatch in our funding obligations and reinvestment at lower yields. Prepayment risk is inherent to our commercial activity and an increase in prepayments or a reduction in prepayment fees could have a material adverse effect on us. The Chilean government is presently analyzing an initiative to reduce or limit prepayment fees and the Bank does not yet have an estimate of the potential impact of such initiatives. We cannot assure you that this change or any future regulatory changes related to prepayment fees will not have a material impact on our business.

 

Teleworking may cause disruptions to our business.

 

On March 24, 2020, Law No. 21,220 (the “Teleworking Law”), which regulates the employment conditions of remote workers and teleworkers, became effective in Chile. The Teleworking Law creates a number of obligations for employers with regards to remote workers and teleworkers that may have an impact on those companies where employees are permitted to work from home or from a place other than such company’s offices.

 

For companies permitting remote or teleworking, the company and the employee must sign a teleworking or distance working agreement at the beginning of the employee’s working relationship with the company or at any time during the employee’s employment when remote or teleworking options are provided to such employee. The Teleworking Law also establishes a certain flexibility regarding working hours for teleworkers, providing the possibility for the parties to establish total weekly working hours, which can be distributed by the employee according to his or her convenience, when by the nature of his or her services he or she must be subject to working hours. In addition, the Teleworking Law provides employees that have signed a distance working agreement with a disconnection right, according to which the employee has the right to disconnect from work and not receive communications from the employer for a period of 12 hours in a 24-hour period.

 

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According to the Teleworking Law, employers also have additional obligations, such as (i) to provide employees with the necessary working tools to carry out their functions at a distance, (ii) to pay the costs of operation, functioning, maintenance and repair of the elements necessary for the provision of the services remotely, which includes internet and electricity, and (iii) in the case of employees subject to working hours, to implement an attendance register system authorized by the Labor Board (Dirección del Trabajo), compatible with teleworking.

 

As of December 31, 2020, 2,015 employees were working under the terms of the Teleworking Law. The new obligations set out in the Teleworking Law may lead to a material increase in our labor costs. Moreover, we cannot assure you that this change or any future regulatory changes related to telework or working conditions will not have a material impact on its business.

 

If we are unable to manage the growth of our operations or to integrate successfully our inorganic growth, this could have an adverse impact on our profitability.

 

We allocate management and planning resources to develop strategic plans for organic growth, and to identify possible acquisitions and disposals and areas for restructuring our businesses. From time to time, we evaluate acquisition and partnership opportunities that we believe offer additional value to our shareholders and are consistent with our business strategy such as our acquisition of 51% of Santander Consumer S.A. in 2019. However, we may not be able to identify suitable acquisition or partnership candidates, and our ability to benefit from any such acquisitions and partnerships will depend in part on our successful integration of those businesses. Any such integration entails significant risks such as unforeseen difficulties in integrating operations and systems, unexpected liabilities or contingencies relating to the acquired businesses, including legal claims and delivery and execution risks. We can give no assurances that our expectations with regards to integration and synergies will materialize. We also cannot provide assurance that we will, in all cases, be able to manage our growth effectively or deliver our strategic growth objectives. Challenges that may result from our strategic growth decisions include our ability to:

 

·manage efficiently the operations and employees of expanding businesses;

 

·maintain or grow our existing customer base;

 

·assess the value, strengths and weaknesses of investment or acquisition candidates, including local regulation that can reduce or eliminate expected synergies;

 

·finance strategic investments or acquisitions;

 

·align our current information technology systems adequately with those of an enlarged group;

 

·apply our risk management policy effectively to an enlarged group; and

 

·manage a growing number of entities without over-committing management or losing key personnel.

 

Any failure to manage growth effectively could have a material adverse effect on our operating results, financial condition and prospects.

 

In addition, any acquisition or venture could result in the loss of key employees and inconsistencies in standards, controls, procedures and policies.

 

Moreover, the success of the acquisition or venture will at least in part be subject to a number of political, economic and other factors that are beyond our control. Any of these factors, individually or collectively, could have a material adverse effect on us.

 

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Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely manner or any failure to successfully implement new cybersecurity and data privacy regulations could have a material adverse effect on us.

 

Our ability to remain competitive depends in part on our ability to upgrade our information technology on a timely and cost-effective basis. We must continually make significant investments in and improvements to our information technology infrastructure in order to meet the needs of our customers. We cannot assure you that in the

future we will be able to maintain the level of capital expenditures necessary to support the continuous improvement and upgrading of our information technology infrastructure. To the extent we are dependent on any particular technology or technological solution, we may be harmed if such technology or technological solution becomes non-compliant with existing industry standards, fails to meet or exceeds the capabilities of our competitors’ equivalent technologies or technological solutions, becomes increasingly expensive to service, retain and update, becomes subject to third party claims of intellectual property infringement, misappropriation or other violation, or malfunctions or functions in a way we did not anticipate. Additionally, new technologies and technological solutions are continually being released. As such, it is difficult to predict the problems we may encounter in improving our technologies’ functionality. There is no assurance that we will be able to successfully adopt new technology as critical systems and applications become obsolete and better ones become available. Any failure to effectively improve or upgrade our information technology infrastructure and management information systems in a timely and cost-efficient manner could have a material adverse effect on us.

 

In addition, several new and proposed laws, directives and regulations are defining how to manage cybersecurity and data protection risks, including with respect to the data breach reporting requirements and supervisory processes, among others. These regulations are quite fragmented in terms of definitions, scope and applicability. A failure to successfully implement all or some of these new local, state, national and international regulations, which in some cases have severe sanctions regimes, could have a material adverse effect on us.

 

Risks relating to data collection, processing and storage systems and security are inherent in our business.

 

Like other financial institutions, we receive, manage, process, hold and transmit proprietary and sensitive or confidential information, including personal information of customers and employees in the conduct of our banking operations, as well as a large number of assets. Accordingly, our business depends on our ability to process a large number of transactions efficiently and accurately, and on our ability to rely on our digital technologies, computer and email services, software and networks, as well as on the secure processing, storage and transmission of confidential or sensitive personal data and other information using our computer systems and networks or those of our third party vendors. The proper and secure functioning of our financial controls, accounting and other data collection and processing systems is critical to our business and to our ability to compete effectively.

 

Cybersecurity incidents and data losses can result from inadequate personnel, inadequate or failed internal control processes and systems, or from external events or actors that interrupt normal business operations. We also face the risk that the design of our cybersecurity controls and procedures prove to be inadequate or are circumvented such that our data and/or client records are incomplete, not recoverable or not securely stored. Any material disruption or slowdown of our systems could cause information, including data related to customer requests, to be lost or to be delivered to our clients with delays or errors, which could reduce demand for our services and products, could produce customer claims and could materially and adversely affect us.

 

Although we work with our clients, vendors, service providers, counterparties and other third parties to develop secure data and information processing, storage and transmission capabilities to prevent against information security risk, we routinely manage personal, confidential and proprietary information by electronic means, and we may be the target of attempted cyber-attacks or subject to other information security incidents or breaches. This is especially applicable in the current response to the COVID-19 pandemic and the shift we have experienced in having a significant part of our employees working from their homes for the time being, as our employees access our secure networks through their home networks. If we cannot maintain an effective and secure electronic data and information, management and processing systems or if we fail to maintain complete physical and electronic records, this could result in disruptions to our operations, claims from customers, regulators, employees and other parties, violations of applicable privacy and other laws, regulatory sanctions and serious reputational and financial harm to us.

 

We take protective measures and continuously monitor and develop our systems to protect our technology infrastructure, data and information from misappropriation or corruption, but our and our third-party vendors’ systems, software and networks nevertheless may be vulnerable to disruptions and failures caused by unauthorized access or misuse, computer viruses, disability devices, phishing attacks or other malicious code, fire, power loss, telecommunications failures, employee misconduct, human error, computer hackers, and other events that could have a security impact on us. An interception loss, misuse or mishandling of personal, confidential or proprietary information sent to or received from a client, employee, vendor, service provider, counterparty or other third party could result in legal liability, regulatory action, reputational harm and financial loss. There can be no absolute assurance that we will not suffer material losses from operational risks in the future, including those relating to any security breaches.

 

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We have seen in recent years computer systems of companies and organizations being increasingly targeted, and the techniques used to obtain unauthorized, improper or illegal access to information technology systems have become increasingly complex and sophisticated. Furthermore, such techniques change frequently and are often not recognized or detected until after they have been launched and can originate from a wide variety of sources, including not only cyber criminals, but also activists and rogue states. We have been and continue to be subject to a range of cyber-attacks, such as denial of service, malware and phishing. Cyber-attacks could give rise to the loss of significant amounts of customer data and other sensitive information, as well as significant levels of liquid assets (including cash). In addition, cyber-attacks could disrupt our electronic systems used to service our customers. As attempted attacks continue to evolve in scope and sophistication, we may incur significant costs in order to modify or enhance our protective measures against such attacks, or to investigate or remediate any vulnerability or resulting breach, or in communicating cyber-attacks to our customers or other affected individuals. If we fail to effectively manage our cybersecurity risk by failing to update our systems and processes in response to new threats, this could harm our reputation and adversely affect our operating results, financial condition and prospects, including through the payment of customer compensation or other damages, litigation expenses, regulatory penalties and fines and/or through the loss of assets. In addition, we may also be impacted by cyber-attacks against national critical infrastructures of the countries where we operate, such as the telecommunications networks. Our information technology systems are dependent on such national critical infrastructure and any cyber-attack against such critical infrastructure could negatively affect our ability to service our customers. As we do not operate such national critical infrastructure, we have limited ability to protect our information technology systems from the adverse effects of such a cyber-attack. For further information, see “Item 11. Quantitative and Qualitative Disclosures about Market Risk—2. Non-financial risks—Cyber-security and data security plans.”

 

Although we have procedures and controls in place to safeguard personal and other confidential or sensitive information in our possession, unauthorized access or disclosures could subject us to legal actions and administrative sanctions as well as damages and reputational harm that could materially and adversely affect our operating results, financial condition and prospects. Further, our business is exposed to risk from employees’ potential non-compliance with policies, misconduct, negligence or fraud, which could result in regulatory sanctions and serious reputational and financial harm. It is not always possible to deter or prevent employee misconduct, and the precautions we take to detect and prevent this activity may not always be effective. In addition, we may be required to report events related to information security issues, events where customer information may be compromised, unauthorized access to our systems and other security breaches, to the relevant regulatory authorities.

 

Modifications to Law 20,009 were passed in 2020 that modified the scope of responsibility for users and issuers when a client’s cards and/or online payment or transfer user information are lost, stolen or fraudulently used (including through hacking and cloning). Cardholders are obligated to notify the bank through an easily accessible channel when their cards have been lost, stolen, or fraudulently used. For those transactions realized prior to the notice of loss or theft of a credit card, the cardholder must also notify the issuer of all of the unauthorized transactions in the same notice or up to five business days following the original notification. In cases of fraud, the user will not be responsible for the transactions that they did not authorize, and which were made prior to the fraud notification within the 30 calendar days following the issuance of said notice. In these cases, issuers are responsible for assuming these costs or must demonstrate that the transaction was in fact authorized by the owner or user of the credit card. The law also considers increasing fines and jail time for those committing theft or fraud with credit cards, which must be legally pursued by the card issuer.

 

In light of these developments, we are trying to limit the exposure of our clients to credit card fraud through education, insurance coverage, marketing campaigns, daily transfer amount limits, chip technology, improved ATM software, and other technological improvements, but we cannot assure that this law will not increase the financial costs related to cybercrime and credit card fraud.

 

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We rely on third parties and affiliates for important products and services.

 

Third party vendors and certain affiliated companies provide key components of our business infrastructure such as loan and deposit servicing systems, back office and business process support, information technology production and support, Internet connections and network access. Relying on these third parties and affiliated companies can be a source of operational and regulatory risk to us, including with respect to security breaches affecting such parties. We are also subject to risk with respect to security breaches affecting the vendors and other parties that interact with these service providers. As our interconnectivity with these third parties and affiliated companies increases, we increasingly face the risk of operational failure with respect to their systems. We may be required to take steps to protect the integrity of our operational systems, thereby increasing our operational costs and potentially decreasing customer satisfaction. In addition, any problems caused by these third parties or affiliated companies, including as a result of them not providing us their services for any reason, or performing their services poorly, could adversely affect our ability to deliver products and services to customers and otherwise conduct our business, which could lead to reputational damage and regulatory investigations and intervention. Replacing these third party vendors could also entail significant delays and expense. Further, the operational and regulatory risk we face as a result of these arrangements may be increased to the extent that we restructure such arrangements. Any restructuring could involve significant expense to us and entail significant delivery and execution risks, which could have a material adverse effect on our business, operations and financial condition.

 

Damage to our reputation could cause harm to our business prospects.

 

Maintaining a positive reputation is critical to protect our brand, attract and retain customers, investors and employees and conduct business transactions with counterparties. Damage to our reputation can therefore cause significant harm to our business and prospects. Harm to our reputation can arise from numerous sources, including, among others, employee misconduct, including the possibility of fraud perpetrated by our employees, litigation or regulatory enforcement, failure to deliver minimum standards of service and quality, dealing with sectors that are not well perceived by the public (weapons industries or embargoed countries, for example), dealing with customers in sanctions lists, rating downgrades, significant variations in our share price throughout the year, compliance failures, unethical behavior, and the activities of customers and counterparties, including activities that negatively affect the environment. Further, negative publicity regarding us may result in harm to our prospects.

 

Actions by the financial services industry generally or by certain members of, or individuals in, the industry can also affect our reputation. For example, the role played by financial services firms in the financial crisis and the seeming shift toward increasing regulatory supervision and enforcement has caused public perception of us and others in the financial services industry to decline.

 

We could suffer significant reputational harm if we fail to identify and manage potential conflicts of interest properly. The failure, or perceived failure, to adequately address conflicts of interest could affect the willingness of clients to deal with us, or give rise to litigation or enforcement actions against us. Therefore, there can be no assurance that conflicts of interest will not arise in the future that could cause material harm to us.

 

We may be the subject of misinformation and misrepresentations deliberately propagated to harm our reputation or for other deceitful purposes, or by profiteering short sellers seeking to gain an illegal market advantage by spreading false information about us. There can be no assurance that we will effectively neutralize and contain a false information that may be propagated regarding the business, which could have an adverse effect on our operating results, financial condition and prospects.

 

Financial Risks

 

We may not effectively manage risks associated with the replacement or reform of benchmark indices.

 

Interest rate, equity, foreign exchange rate and other types of indices which are deemed to be “benchmarks,” including those in widespread and long-standing use, have been the subject of ongoing international, national and other regulatory scrutiny and initiatives and proposals for reform. Some of these reforms are already effective while others are still to be implemented or are under consideration. These reforms may cause benchmarks to perform differently than in the past, or to disappear entirely, or have other consequences, which cannot be fully anticipated.

 

Any of the benchmark reforms that have been proposed or implemented, or the general increased regulatory scrutiny of benchmarks, could also increase the costs and risks of administering or otherwise participating in the setting of benchmarks and complying with regulations or requirements relating to benchmarks. Such factors may have the effect of discouraging market participants from continuing to administer or contribute to certain benchmarks, trigger changes in the rules or methodologies used in certain benchmarks or lead to the disappearance of certain benchmarks.

 

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Any of these developments, and any future initiatives to regulate, reform or change the administration of benchmarks, could result in adverse consequences to the return on, value of and market for loans, mortgages, securities, derivatives and other financial instruments whose returns are linked to any such benchmark, including those issued, funded or held by Banco Santander.

 

Various regulators, industry bodies and other market participants in the U.S. and other countries have worked to develop, introduce and encourage the use of alternative rates to replace certain benchmarks. A transition away from the widespread use of certain benchmarks to alternative rates has begun and will continue over the course of the next few years. There is no assurance that these new rates will be accepted or widely used by market participants, or that the characteristics of any of these new rates will be similar to, or produce the economic equivalent of, the benchmarks that they seek to replace. If a particular benchmark were to be discontinued and an alternative rate has not been successfully introduced to replace that benchmark, this could result in widespread dislocation in the financial markets, engender volatility in the pricing of securities, derivatives and other instruments, and suppress capital markets activities, all of which could have adverse effects on Banco Santander’s results of operations. In addition, the transition of a particular benchmark to a replacement rate could affect hedge accounting relationships between financial instruments linked to that benchmark and any related derivatives, which could adversely affect Banco Santander’s results.

 

In December 2020, the ICB Benchmark Administration Limited (IBA) published a consultation about its intention to stop publishing LIBOR rates in currencies other than USD since December 31, 2021, and all other LIBOR in USD since June 30, 2023.

 

The Bank is working in a “transition program” focused mainly in:

 

i.Identifying the risks associated with the transition and defining mitigation actions

 

ii.Developing products referenced to the proposed replacement rates

 

iii.Developing a transition process, through the renegotiation of existing contracts referenced to LIBOR

 

At December 31, 2020, the exposures of financial assets and liabilities impacted by the IBOR reform are presented below:

 

Loans and advances Deposits Debt instruments

Financial derivative contracts

(Assets) 

Financial derivative contracts

(Liabilities) 

Ch$mn Ch$mn Ch$mn Ch$mn Ch$mn
362,331 582,979 200,301 614,035 483,789

 

Furthermore, the European Money Market Institute (EMMI) announced the discontinuation of the EONIA after January 3, 2022 and that from October 2, 2019 until its total discontinuation it will be replaced by the €STR plus a spread of 8.5 basis points. Many unresolved issues remain, such as the timing of the successor benchmarks, introduction and the transition of a particular benchmark to a replacement rate, which could result in wide spread dislocation in the financial markets, engender volatility in the pricing of securities, derivatives and other instruments, and suppress capital markets activities. These and other reforms may cause benchmarks to perform differently than in the past, or to disappear entirely, or have other consequences which cannot be fully anticipated which introduces a number of risks for the Group. These risks include (i) legal risks arising from potential changes required to documentation for new and existing transactions; (ii) risk management, financial and accounting risks arising from market risk models and from valuation, hedging, discontinuation and recognition of financial instruments linked to benchmark rates; (iii) business risk of a decrease in revenues of products linked to indices that will be replaced; (iv) pricing risks arising from how changes to benchmark indices could impact pricing mechanisms on some instruments; (v) operational risks arising from the potential requirement to adapt IT systems, trade reporting infrastructure and operational processes; (vi) conduct risks arising from the potential impact of communication with customers and engagement during the transition period, and (vii) litigation risks regarding our existing products and services, which could adversely impact our profitability. The replacement benchmarks and their transition path have been defined, but the mechanisms for implementation are under development. Accordingly, it is not currently possible to determine whether, or to what extent, any such changes would affect us. However, the implementation of alternative benchmark rates may have a material adverse effect on our business, results of operations, financial condition and prospects. We may also be adversely affected if the change restricts our ability to provide products and services or if it necessitates the development of additional information technology systems.

 

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Credit, market and liquidity risk may have an adverse effect on our credit ratings and our cost of funds. Any downgrade in Chile’s, our controlling shareholders or our credit rating would likely increase our cost of funding, require us to post additional collateral or take other actions under some of our derivative and other contracts and adversely affect our interest margins and results of operations.

 

Credit ratings affect the cost and other terms upon which we are able to obtain funding. Rating agencies regularly evaluate us, and their ratings of our debt are based on a number of factors, including our financial strength and conditions affecting the financial services industry. In addition, due to the methodology of the main rating agencies, our credit rating is affected by the rating of Chile’s sovereign debt. If Chile’s sovereign debt is downgraded, our credit rating would also likely be downgraded by an equivalent amount. In addition, our ratings may be adversely affected by any downgrade in the ratings of our parent company, Santander Spain.

 

During 2020, as a result of the social unrest in Chile and the COVID-19 pandemic, Standard and Poor’s Ratings Services (“S&P”) and Moody’s revised the Republic of Chile and Bank’s credit ratings to a negative outlook.

 

Any downgrade in our debt credit ratings would likely increase our borrowing costs and require us to post additional collateral or take other actions under some of our derivative and other contracts, and could limit our access to capital markets and adversely affect our commercial business. For example, a ratings downgrade could adversely affect our ability to sell or market some of our products, engage in certain longer-term and derivatives transactions and retain our customers, particularly customers who need a minimum rating threshold in order to invest. In addition, under the terms of certain of our derivative contracts and other financial commitments, we may be required to maintain a minimum credit rating or terminate such contracts or require the posting of collateral. Any of these results of a ratings downgrade could reduce our liquidity and have an adverse effect on us, including our operating results and financial condition.

 

While certain potential impacts of these downgrades are contractual and quantifiable, the full consequences of a credit rating downgrade are inherently uncertain, as they depend upon numerous dynamic, complex and inter-related factors and assumptions, including market conditions at the time of any downgrade, whether any downgrade of our long-term credit rating precipitates downgrades to our short-term credit rating, and assumptions about the potential behaviors of various customers, investors and counterparties. Actual outflows could be higher or lower than the preceding hypothetical examples, depending upon certain factors including which credit rating agency downgrades our credit rating, any management or restructuring actions that could be taken to reduce cash outflows and the potential liquidity impact from loss of unsecured funding (such as from money market funds) or loss of secured funding capacity. Although unsecured and secured funding stresses are included in our stress testing scenarios and a portion of our total liquid assets is held against these risks, a credit rating downgrade could still have a material adverse effect on us.

 

In addition, if we were required to cancel our derivatives contracts with certain counterparties and were unable to replace such contracts, our market risk profile could be altered.

 

There can be no assurance that the rating agencies will maintain the current ratings or outlooks. In general, the future evolution of Santander’s ratings will be linked, to a large extent, to the impact of the COVID-19 pandemic (including, for example, a second wave, new lockdowns, etc.) on the macro outlook of our asset quality, profitability and capital. Failure to maintain favorable ratings and outlooks could increase our cost of funding and adversely affect interest margins, which could have a material adverse effect on us.

 

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Market conditions have resulted, and could result, in material changes to the estimated fair values of our financial assets. Negative fair value adjustments could have a material adverse effect on our operating results, financial condition and prospects.

 

In the past, financial markets have been subject to significant stress resulting in steep falls in perceived or actual financial asset values, particularly due to volatility in global financial markets and the resulting widening of credit spreads, including as a result of the COVID-19 pandemic. We have material exposures to securities, loans and other investments that are recorded at fair value and are therefore exposed to potential negative fair value adjustments. Asset valuations in future periods, reflecting then-prevailing market conditions, may result in negative changes in the fair values of our financial assets and these may also translate into increased impairments. In addition, the value ultimately realized by us on disposal may be lower than the current fair value. Any of these factors could require us to record negative fair value adjustments, which may have a material adverse effect on our operating results, financial condition or prospects.

 

In addition, to the extent that fair values are determined using financial valuation models, such values may be inaccurate or subject to change, as the data used by such models may not be available or may become unavailable due to changes in market conditions, particularly for illiquid assets, and particularly in times of economic instability. In such circumstances, our valuation methodologies require us to make assumptions, judgements and estimates in order to establish fair value, and reliable assumptions are difficult to make and are inherently uncertain and valuation models are complex, making them inherently imperfect predictors of actual results. Any consequential impairments or write-downs could have a material adverse effect on our operating results, financial condition and prospects.

 

The value of the collateral securing our loans may not be sufficient, and we may be unable to realize the full value of the collateral securing our loan portfolio.

 

The value of the collateral securing our loan portfolio may fluctuate or decline due to factors beyond our control, including as a result of the COVID-19 pandemic and macroeconomic factors affecting Chile’s economy. The value of the collateral securing our loan portfolio may be adversely affected by force majeure events, such as natural disasters, particularly in locations where a significant portion of our loan portfolio is composed of real estate loans. Natural disasters such as earthquakes and floods may cause widespread damage, which could impair the asset quality of our loan portfolio and could have an adverse impact on Chile’s economy. The real estate market is particularly vulnerable in the current economic climate and this may affect us, as real estate represents a significant portion of the collateral securing our residential mortgage loan portfolio. We may also not have sufficiently recent information on the value of collateral, which may result in an inaccurate assessment for impairment losses of our loans secured by such collateral. If any of the above were to occur, we may need to make additional provisions to cover actual impairment losses of our loans, which may materially and adversely affect our results of operations and financial condition.

 

At December 31, 2020, 44% of our loans and advances to customers have property collateral while 21% have other types of collateral (securities, pledges and others).

 

In addition, auto industry technology changes, accelerated by environmental rules, could affect our auto consumer business in Chile, particularly residual values of leased vehicles, which could have a material adverse effect on our operating results, financial condition and prospects.

 

The credit quality of our loan portfolio may deteriorate, and our loan loss reserves could be insufficient to cover our loan losses, which could have a material adverse effect on us.

 

Risks arising from changes in credit quality and the recoverability of loans and amounts due from counterparties are inherent to a wide range of our businesses. Non-performing or low credit quality loans have in the past negatively impacted our results of operations and could do so in the future. In particular, the amount of our reported non-performing loans may increase in the future as a result of growth in our total loan portfolio, including as a result of loan portfolios that we may acquire in the future (the credit quality of which may turn out to be worse than we had anticipated), or factors beyond our control, such as adverse changes in the credit quality of our borrowers and counterparties or a general deterioration in economic conditions in Chile or in global economic and political conditions, including as a result of the COVID-19 pandemic. In response to the COVID-19 pandemic, with the purpose of helping our customers from the credit perspective and foster their economic resilience, we have

 

25

 

implemented several actions, including (i) providing liquidity and credit facilities to customers facing hardship; (ii) granting BBpayment deferrals in outstanding loans under the EBA Guidelines on moratoria; (iii) focus credit risk management on those economic sectors more affected by the pandemic; (iv) focus on the collections & recoveries readiness across the Group; and (v) quantifying the provisions overlay on the expected credit losses as a result of the macroeconomic shock. If we were unable to control the level of our non-performing or poor credit quality loans, this could have a material adverse effect on us.

 

As of December 31, 2020, our non-performing loans were Ch$486,435 million, and the ratio of our non-performing loans to total loans was 1.4%. As of December 31, 2020, our allowance for loan losses was Ch$1,036,793 million, and the ratio of our allowance for loan losses to total loans was 3.0%. For additional information on our asset quality, see “Item 5. Operating and Financial Review and Prospects—C. Selected Statistical Information—Classification of Loan Portfolio Based on the Borrower’s Payment Performance.”

 

Our loan loss reserves are based on our current assessment of and expectations concerning various factors affecting the quality of our loan portfolio. These factors include, among other things, our borrowers’ financial condition, repayment abilities and repayment intentions, the realizable value of any collateral, the prospects for support from any guarantor, Chile’s economy, government macroeconomic policies, interest rates and the legal and regulatory environment. Because many of these factors are beyond our control and there is no infallible method for predicting loan and credit losses, we cannot assure you that our current or future loan loss and reserves will be sufficient to cover actual losses. If our assessment of and expectations concerning the above-mentioned factors differ from actual developments, if the quality of our total loan portfolio deteriorates, for any reason, or if the future actual losses exceed our estimates of expected losses, we may be required to increase our loan loss reserves, which may adversely affect us. Additionally, in calculating our loan loss reserves, we employ qualitative tools and statistical models which may not be reliable in all circumstances and which are dependent upon data that may not be complete.

 

Our financial results are constantly exposed to market risk. We are subject to fluctuations in interest rates and other market risks, which may materially and adversely affect us and our profitability.

 

The COVID-19 pandemic has caused high market volatility, which may materially and adversely affect us and our trading and banking book.

 

Market risk refers to the probability of variations in our interest income / (charge) or in the market value of our assets and liabilities due to volatility of interest rate, inflation, exchange rate or equity price. Changes in interest rates affect the following areas, among others, of our business:

 

·interest income / (charges);

 

·the volume of loans originated;

 

·credit spreads;

 

·the market value of our securities holdings;

 

·the value of our loans and deposits; and

 

·the value of our derivatives transactions.

 

Interest rates are sensitive to many factors beyond our control, including increased regulation of the financial sector, the reserve policies of the Central Bank, deregulation of the financial sector in Chile, monetary policies and domestic and international economic and political conditions. Variations in interest rates could affect the interest earned on our assets and the interest paid on our borrowings, thereby affecting our interest income / (charges), which comprises the majority of our revenue, reducing our growth rate and potentially resulting in losses. In addition, costs we incur as we implement strategies to reduce interest rate exposure could increase in the future (which, in turn, will impact our results).

 

Increases in interest rates may reduce the volume of loans we originate. Sustained high interest rates have historically discouraged customers from borrowing and have resulted in increased delinquencies in outstanding loans and deterioration in the quality of assets. Increases in interest rates may reduce the value of our financial assets and may reduce gains or require us to record losses on sales of our loans or securities.

 

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While it would likely decrease funding costs, if interest rates decrease, the income we receive from our investments in securities and loans with similar maturities could be adversely affected. In addition, we may also experience increased delinquencies in a low interest rate environment when such an environment is accompanied by high unemployment and recessionary conditions. “See Item 11. Quantitative and Qualitative Disclosure About Market Risks—E. Market Risks—Impact of Interest Rates.”

 

The market value of a security with a fixed interest rate generally decreases when the prevailing interest rates rise, which may have an adverse effect on our earnings and financial condition. In addition, we may incur costs as we implement strategies to reduce interest rate exposure in the future (which, in turn, will impact our results). The market value of an obligation with a floating interest rate can be adversely affected when interest rates increase, due to a lag in the implementation of repricing terms or an inability to refinance at lower rates.

 

High levels of inflation in Chile could adversely affect the Chilean economy and our business, financial condition and results of operations. Any change in the methodology of how the CPI index or the UF are calculated could also adversely affect our business, financial condition and results of operations. Extended periods of deflation could also have an adverse effect on our business, financial condition and results of operations. The UF is revalued in monthly cycles. On each day in the period beginning on the tenth day of any given month through the ninth day of the succeeding month, the nominal peso value of the UF is indexed up (or down in the event of deflation) in order to reflect a proportionate amount of the change in the Chilean Consumer Price Index during the prior calendar month. For more information regarding the UF, see “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Impact of Inflation.” Although we benefit from inflation in Chile due to the current structure of our assets and liabilities (i.e., a significant portion of our loans are indexed to the inflation rate, but there are no corresponding features in deposits, or other funding sources that would increase the size of our funding base), there can be no assurance that our business, financial condition and result of operations in the future will not be adversely affected by changing levels of inflation, including from extended periods of inflation that adversely affect economic growth or periods of deflation. “See Item 11. Quantitative and Qualitative Disclosure About Market Risks—E. Market Risks—Impact of Inflation,”

 

We are also exposed to foreign exchange rate risk as a result of mismatches between assets and liabilities denominated in different currencies. Fluctuations in the exchange rate between currencies may negatively affect our earnings and value of our assets and securities. Therefore, while the Bank seeks to avoid significant mismatches between assets and liabilities due to foreign currency exposure, from time to time, we may have mismatches. The Chilean peso has been subject to large devaluations and appreciations in the past and could be subject to significant fluctuations in the future. Our results of operations may be affected by fluctuations in the exchange rates between the peso and the dollar despite our policy and Chilean regulations relating to the general avoidance of material exchange rate exposure. In order to avoid material exchange rate exposure, we enter into forward exchange transactions. We may decide to change our policy regarding exchange rate exposure. Regulations that limit such exposures may also be amended or eliminated. Greater exchange rate risk will increase our exposure to the devaluation of the peso, and any such devaluation may impair our capacity to service foreign currency obligations and may, therefore, materially and adversely affect our financial condition and results of operations. Notwithstanding the existence of general policies and regulations that limit material exchange rate exposures, the economic policies of the Chilean government, new foreign currency regulations by the Central Bank and any future fluctuations of the peso against the dollar could affect our financial condition and results of operations. “See Item 11. Quantitative and Qualitative Disclosure About Market Risks—E. Market Risks—Foreign exchange fluctuations.”

 

If any of these risks were to materialize, our interest income / (charges) or the market value of our assets and liabilities could suffer a material adverse impact.

 

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We are subject to market, operational and other related risks associated with our derivative transactions that could have a material adverse effect on us.

 

We enter into derivative transactions for trading purposes as well as for hedging purposes. We are subject to market, credit and operational risks associated with these transactions, including basis risk (the risk of loss associated with variations in the spread between the asset yield and the funding and/or hedge cost) and credit or default risk (the risk of insolvency or other inability of the counterparty to a particular transaction to perform its obligations thereunder, including providing sufficient collateral).

 

Market practices and documentation for derivative transactions in Chile may differ from those in other countries. For example, documentation may not incorporate terms and conditions of derivatives transactions as commonly understood in other countries. In addition, the execution and performance of these transactions depend on our ability to maintain adequate control and administration systems. Moreover, our ability to adequately monitor, analyze and report derivative transactions continues to depend, largely, on our information technology systems. These factors further increase the risks associated with these transactions and could have a material adverse effect on us.

 

At December 31, 2020, the notional value of the trading derivatives in our books amounted to Ch$377,131,597 million (with a market value of Ch$8,148,608 million of debit balance and Ch$7,390,654 million of credit balance).

 

At December 31, 2020, the nominal value of the hedging derivatives in our books within our financial risk management strategy and with the aim of reducing asymmetries in the accounting treatment of our operations amounted to Ch$363,668,609 million (with market value of Ch$9,032,085 million in assets and Ch$9,018,660 million in liabilities).

 

We are subject to counterparty risk in our banking business.

 

We are exposed to counterparty risk in addition to credit risks associated with lending activities. Counterparty risk may arise from, for example, investing in securities of third parties, entering into derivative contracts under which counterparties have obligations to make payments to us or executing securities, futures, currency or commodity trades from proprietary trading activities that fail to settle at the required time due to non-delivery by the counterparty or systems failure by clearing agents, clearing houses or other financial intermediaries.

 

We routinely transact with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks, mutual funds, hedge funds and other institutional clients. Defaults by, and even rumors or questions about the solvency of, certain financial institutions and the financial services industry generally have led to market-wide liquidity problems and could lead to losses or defaults by other institutions. Many of the routine transactions we enter into expose us to significant credit risk in the event of default by one of our significant counterparties.

 

Liquidity and funding risks are inherent in our business and could have a material adverse effect on us.

 

Liquidity risk is the risk that we either do not have available sufficient financial resources to meet our obligations as they fall due or can secure them only at excessive cost. This risk is inherent in any retail and commercial banking business and can be heightened by a number of enterprise-specific factors, including over-reliance on a particular source of funding, changes in credit ratings or market-wide phenomena such as market dislocation, including as a result of the COVID-19 pandemic. While we have in place liquidity management processes to seek to mitigate and control these risks, unforeseen systemic market factors make it difficult to eliminate completely these risks. Constraints in the supply of liquidity, including in inter-bank lending, could materially and adversely affect the cost of funding of our business, and extreme liquidity constraints may affect our current operations and our ability to fulfill regulatory liquidity requirements, as well as limit growth possibilities.

 

Our cost of obtaining funding is directly related to prevailing interest rates and to our credit spreads. Increases in interest rates and/or in our credit spreads can significantly increase the cost of our funding. Credit spreads variations are market-driven and may be influenced by market perceptions of our creditworthiness. Changes to interest rates and our credit spreads occur continuously and may be unpredictable and highly volatile.

 

We rely, and will continue to rely, primarily on retail deposits to fund lending activities. The ongoing availability of this type of funding is sensitive to a variety of factors beyond our control, such as general economic conditions and the confidence of retail depositors in the economy and in the financial services industry, and the availability and extent of deposit guarantees, as well as competition for deposits between banks or with other products, such as mutual funds. Any of these factors could significantly increase the amount of retail deposit withdrawals in a short period of time, thereby reducing our ability to access retail deposit funding on appropriate terms, or at all, in the future. If these circumstances were to arise, this could have a material adverse effect on our operating results, financial condition and prospects.

 

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We anticipate that our customers will continue, in the near future, to make short-term deposits (particularly demand deposits and short-term time deposits), and we intend to maintain our emphasis on the use of banking deposits as a source of funds. As of December 31, 2020, 99.1% of our customer deposits had remaining maturities of one year or less or were payable on demand. A significant portion of our assets have longer maturities, resulting in a mismatch between the maturities of liabilities and the maturities of assets. Historically, one of our principal sources of funds has been time deposits. Time deposits represented 19.0% and 28.0% of our total liabilities and equity as of December 31, 2020 and 2019, respectively. The Chilean time deposit market is concentrated given the importance in size of various large institutional investors such as pension funds and corporations relative to the total size of the economy. As of December 31, 2020, the Bank’s top 20 time deposits represented 25.1% of total time deposits, or 4.8% of total liabilities and equity, and totaled U.S.$3.7 billion. No assurance can be given that future economic stability in the Chilean market will not negatively affect our ability to continue funding our business or to maintain our current levels of funding without incurring increased funding costs, a reduction in the term of funding instruments or the liquidation of certain assets. If this were to happen, we could be materially adversely affected.

 

The short-term nature of this funding source could cause liquidity problems for us in the future if deposits are not made in the volumes we expect or are not renewed. If a substantial number of our depositors withdraw their demand deposits or do not roll over their time deposits upon maturity, we may be materially and adversely affected.

 

Central banks have taken extraordinary measures to increase liquidity in the financial markets as a response to the financial crisis and the COVID-19 pandemic. If current facilities were rapidly removed or significantly reduced, this could have an adverse effect on our ability to access liquidity and on our funding costs.

 

In response to the COVID-19 pandemic, the Chilean Central Bank has made available two lines of credit to banks to reinforce their liquidity. These lines of credit bear interest at the Central Bank’s MPR, which was 0.5% as of December 31, 2020. Pursuant to these lines of credit, a bank may borrow up to 3% of the aggregate amount of its consumer and commercial loan portfolios as of February 29, 2020 and may borrow up to an additional 12% if it uses the funds to provide loans to companies and individuals. The first line of credit is a facility available conditionally on loan growth (the “FCIC”) to ensure that banks continue to finance households and businesses in Chile. Loans provided by this line of credit may have maturities of up to 4 years and must be secured by government bonds, corporate bonds or highly rated large commercial loans as collateral. In stages 1 and 2, the Board of the Central Bank had allocated a total of US$ 40 billion to this facility, of which approximately US$30 billion has been disbursed. The Central Bank in its Monetary Policy Meeting held on January 27, 2021 announced the beginning of a third stage of this instrument (FCIC3) commencing on March 1, 20201. Loans provided under the second line of credit, the LCL, are unsecured and may have maturities of up to 2 years. In addition, borrowings by a bank under the LCL are limited to the aggregate amount of the liquidity reserve requirements of such bank. Ultimately, these lines of credit are intended to ensure banks have ample liquidity to enable them to continue financing companies and individuals. As of December 31, 2020, we had borrowed Ch$4,959,260 billion (US$7 billion) under both these lines of credit.

 

Additionally, our activities could be adversely impacted by liquidity tensions arising from generalized drawdowns of committed credit lines to our customers.

 

We cannot assure that in the event of a sudden or unexpected shortage of funds in the banking system, we will be able to maintain levels of funding without incurring high funding costs, a reduction in the term of funding instruments or the liquidation of certain assets. If this were to happen, we could be materially adversely affected.

 

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Changes to the pension fund system may affect our liquidity levels and/or funding costs

 

The current pension fund system dates from the 1980s when pensions went from being state-funded to privately-funded, which requires Chilean employees to set aside 10% of their wages. As of December 31, 2020, the Chilean pension fund management companies (Administradora de Fondos de Pensión, or “AFPs”) had U.S.$5 billion invested in the Bank via equity, deposits and fixed income. The demographics of Chilean society have changed, resulting in a need to modify the system. In January 2020, the Chilean government presented a proposal for pension reform to Congress for discussion. These changes include increasing minimum pensions and introducing a social insurance scheme for events such as longevity. The amount each worker must set aside is also expected to increase from the current 10% of wages to 16%. The additional 6% would be gradually introduced over 12 years and would be a cost of the employer, thus potentially raising personnel expenses. The additional 6% would not be managed by the AFPs, but by a new government pension entity. Although the bill is currently being discussed and widely expected to be approved, we are unable to predict the final content of the law. The potential adverse effect of the proposed law on our financial condition and results of operations cannot yet be ascertained.

 

Moreover, in 2020, and as a result of the COVID-19 pandemic, two extraordinary withdrawals were permitted from pension funds. In total, at year-end 2020, US$31.3 billion had been withdrawn from the pension fund system. In order to avoid strong swings in asset prices, the Central Bank introduced a series of measures to ensure healthy liquidity levels including the direct purchase of bank instruments and the acquisition of government bonds in the secondary market supported by the FCIC and LCL lines available to banks as described above. The potential adverse effect of these and future withdrawals on our financial condition, liquidity levels, the ability to obtain funding from the AFPs and results of our operations cannot yet be ascertained.

 

Chilean regulations also impose a series of restrictions on how Chilean AFPs may allocate their assets. In the particular case of financial issuers’ there are three restrictions, each involving different assets and different limits determined by the amount of assets in each fund and the market and book value of the issuer’s equity. As a consequence, limits vary within funds of AFPs and issuers. According to our estimates in December 2020, the AFPs still had the possibility of being able to invest another U.S.$8.8 billion in the Bank via equity, deposits and fixed income. If the exposure of any AFP to Santander-Chile exceeds the regulatory limits, if the regulatory limits are reduced or the amount of funds available in the pension funds falls significantly, we would need to seek alternative sources of funding, which could be more expensive and, as a consequence, may have a material adverse effect on our financial condition and results of operations.

 

Legal and Regulatory Risks

 

We are subject to regulatory capital requirements that could limit our operations, and changes to these requirements may further limit and adversely affect our operating results, financial condition and prospects.

 

Chilean banks are required by the General Banking Law to maintain regulatory capital of at least 8% of risk-weighted assets, net of required loan loss allowance and deductions, and paid-in capital and reserves (“core capital”) of at least 3% of total assets, net of required loan loss allowances. As we are the result of the merger between two predecessors with a relevant market share in the Chilean market, we are currently required to maintain a minimum regulatory capital to risk-weighted assets ratio of 11%. As of December 31, 2020, the ratio of our regulatory capital to risk-weighted assets, net of loan loss allowance and deductions, was 15.4% and our core capital ratio was 10.7%. Certain developments could affect our ability to continue to satisfy the current capital adequacy requirements applicable to us, including:

 

·the increase of risk-weighted assets as a result of the expansion of our business or regulatory changes;

 

·the failure to increase our capital correspondingly;

 

·losses resulting from a deterioration in our asset quality;

 

·declines in the value of our investment instrument portfolio;

 

·changes in accounting standards;

 

·changes in provisioning guidelines that are charged directly against our equity or net income; and

 

·changes in the guidelines regarding the calculation of the capital adequacy ratios of banks in Chile.

 

On January 19, 2019, the Chilean government passed a law that amends, among others, the General Banking Law (the General Banking Law, as amended, is referred to herein as the “New General Banking Law”) and established new capital regulation for banks in Chile in line with Basel III standards and the merger of the banking regulator with the FMC, transferring all SBIF attributions to the FMC. The FMC was created by Law 21,000 in 2017 and started operations December 14, 2017 (eliminating the Superintendency of Securities and Insurance as of January 15, 2018). As of June 1, 2019, the SBIF merged into the FMC.

 

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Therefore, the FMC has become the sole supervisor for the Chilean financial system overseeing insurance companies, companies with publicly traded securities, credit unions, credit card and prepaid card issuers, and banks. This Commission is responsible for the proper functioning, development and stability of the financial market, facilitating the participation of market agents and defending public faith in the financial markets. To do so, it must maintain a general and systemic vision of the market, considering the interests of investors and policyholders. It is also responsible for ensuring that the persons or entities audited, from their initiation until the end of their liquidation, comply with the laws, regulations, statutes and other provisions that govern them.

 

The Commission is in charge of a Council, which is composed of five members, who are appointed and are subject to the following rules:

 

·A Commissioner appointed by the President of Chile, of recognized professional or academic prestige in matters related to the financial system, which will have the character of President of the Commission.

 

·Four commissioners appointed by the President of Chile, from among persons of recognized professional or academic prestige in matters related to the financial system, by supreme decree issued through the Ministry of Finance, after ratification of the Senate by the four sevenths of its members in exercise, in session specially convened for that purpose.

 

The Council’s responsibilities include regulation, sanctioning and the definition of general supervision policies. In addition, there is a prosecutor in charge of investigations and the Chairman is responsible for supervision. The FMC acts in coordination with the Chilean Central Bank.

 

On October 9, 2020, the FMC published the final new regulations on regulatory capital to comply with effective net worth rules in accordance with Basel III and the New General Banking Law. The new regulation will be effective on December 1, 2021 and will be gradually implemented and adjusted to be fully effective by December 1, 2025. Pursuant to the proposed regulation, there will be three levels of capital: ordinary capital level 1 or CET1 (basic capital), additional capital level 1 or AT1 (perpetual bonds and preferred stock) and capital level 2 or T2 (subordinated bonds and voluntary provisions). Regulatory capital will be composed of the sum of CET1, AT and T2 after making some deductions, mainly for intangible assets, hybrid securities issued by foreign subsidiaries, partial deduction for deferred taxes and some reserve and profit accounts.

 

Under the New General Banking Law, minimum capital requirements have increased in terms of amount and quality. Total Regulatory Capital remains at 8% of risk-weighted assets which includes credit, market and operational risk. Minimum Tier 1 capital increased from 4.5% to 6% of risk-weighted assets, of which up to 1.5% may be Additional Tier 1 (AT1), either in the form of preferred shares or perpetual bonds, both of which may be convertible to common equity. The FMC also establishes the conditions and requirements for the issuance of perpetual bonds and preferred equity. Tier 2 capital is now set at 2% of risk-weighted assets.

 

Additional capital demands are incorporated through a Conservation Buffer of 2.5% of risk-weighted assets. The Central Bank may set an additional Counter Cyclical Buffer of up to 2.5% of risk-weighted assets in agreement with the FMC. Both buffers must be comprised of core capital.

 

On November 2, 2020 the FMC publishing the final guidelines regarding the identification and core capital charge for those banks considered Systemically Important Banks (“SIB”). The FMC, in with agreement from the Central Bank, also imposed additional capital requirements for SIBs of between 1-3.5% of risk-weighted assets. This additional capital requirement will be gradually phased in by 25% each year beginning on December 2021 until December 2025. With the implementation of additional capital requirements for SIBs, the requirement imposed on Banco Santander Chile to have a minimum regulatory capital ratio of 11% compared to the 8% limit for most other banks in Chile will be gradually phased out and replaced by the new regulatory requirements for a SIB.

 

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There is a total of four factors that are then weighted to reach a market share:

 

1.Size (weighted at 30%): Includes total assets consolidated in the domestic market.

 

2.Domestic interconnection (weighted at 30%): Includes assets and liabilities with financial institutions (banks and non-banks) and assets in circulation in the Chilean financial market (equity and fixed income).

 

3.Domestic substitution (weighted at 20%): Includes the share in local payments, assets in custody, deposits and loans.

 

4.Complexity (weighted at 20%): Includes factors that could lead to greater difficulties regarding costs and/ or time for the orderly resolution of the Bank. These include the notional amount of OTC derivatives, inter-jurisdictional assets and liabilities and available-for-sale assets.

 

The minimum amount of the sum of the factors to be considered systemic is 1000 bp, equivalent to a weighted participation of 10% of all four factors. The core capital additional charge depends on the size of the total factor, as set out in the table below:

 

Systemic Level Range (bp) Core capital additional charge (% of risk-weighted assets)
I 1000-1300 1.0%-1.25%
II 1300-1800 1.25%-1.75%
III 1800-2000 1.75%-2.5%
IV >=2000 2.5%-3.5%

 

The Central Bank may also require for a SIB: (1) the addition of up to 2% to the core capital to a bank’s total assets ratios; (2) a reduction in the technical reserve requirement trigger from 2.5 times the regulatory capital to 1.5 times the regulatory capital; and/or (3) a reduction in the interbank loan limit to 20% of the regulatory capital of any SIB.

 

The first calculation of which level a SIB will be included in will be published in March 2021 using a bank’s balance sheet figures as of year-end 2020. Given our size and market share, it is likely that we will be classified as a SIB either in Level II or III.

 

The New General Banking Law also incorporates Pillar II capital requirements with the objective of assuring an adequate management of risk. The objective of this pillar is to ensure that banks maintain capital levels that are consistent with their risk profile and business model and encourages the development and use of appropriate processes to monitor and manage their risks. Pillar 2 also established an attribution for regulators to impose greater capital requirements as a result of deficient evaluations of a bank’s internal capital adequacy assessment process (ICAAP), which should consider a bank’s risk profile and a strategy to sustain adequate level of capital, even under stress scenarios. Pillar 2 also focuses on risks not considered in Pillar 1 such as reputational risks, concentration risks, liquidity risks and interest rate risk of the banking book. The FMC, with at least four votes from the Council of the FMC, will have the power to impose additional regulatory capital demands of up to 4% of risk-weighted assets, either Tier I or Tier II, if it determines that the previous capital levels and buffers are not enough for a particular financial institution.

 

The following table sets forth a comparison between the regulatory capital demands under the previous law, and those under the New General Banking Law:

 

Minimum capital requirements: Basel III, previous GBL and new requirements

Capital categories

 

Previous Law

 

New General Banking Law

(% over risk weighted assets)
(1) Shareholders’ Equity   4.5   4.5
(2) Additional Tier 1 Capital (AT1)     1.5
(3) Total Tier 1 Capital (1+2)   4.5   6
(4) Tier 2 Capital   3.5   2
(5) Total Regulatory Capital (3+4)  

8

 

8

(6) Conservation Buffer       2.5 CET1
(7) Total Equity Requirement (5+6)  

8

 

10.5 

(8) Counter Cyclical Buffer     up to 2.5 CET1
(9) SIB* Requirement  

Up to 6% in case of a merger

  Between 1 - 3.5 CET1
(10) Pillar 2  

2% over regulatory capital in order to be classified in Category A solvency.

  Up to 4% CET1 or Tier 2

 

____________________

* Systemically Important Banks

 

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We believe our current capital levels are adequate, but we cannot rule out having to raise additional capital in the future in order to maintain our capital adequacy ratios above the minimum required by the FMC. Our ability to raise additional capital may be limited by numerous factors, including: our future financial condition, results of operations and cash flows; any necessary government regulatory approvals; our credit ratings; general market conditions for capital raising activities by commercial banks and other financial institutions; and domestic and international economic, political and other conditions. If we require additional capital in the future, we cannot assure you that we will be able to obtain such capital on favorable terms, in a timely manner or at all. Furthermore, the FMC may increase the minimum capital adequacy requirements applicable to us. Accordingly, although we currently meet the applicable capital adequacy requirements, we may face difficulties in meeting these requirements in the future. If we fail to meet the capital adequacy requirements, we may be required to take corrective actions. These measures could materially and adversely affect our business reputation, financial condition and results of operations. In addition, if we are unable to raise enough capital in a timely manner, the growth of our loan portfolio and other risk-weighted assets may be restricted, and we may face significant challenges in implementing our business strategy. As a result, our prospects, results of operations and financial condition could be materially and adversely affected.

 

We are subject to liquidity requirements that could limit our operations, and changes to these requirements may further limit and adversely affect our operating results, financial condition and prospects.

 

The SBIF (now the FMC) and the Central Bank published new liquidity standards in 2015 and ratios that must be implemented and calculated by all banks. These new liquidity standards are in line with those established in Basel III. The most important liquidity ratios that have been adopted by Chilean banks are:

 

·Liquidity coverage ratio (LCR), which measures the percentage of liquid assets over net cash outflows. The new guidelines also define liquid assets and the formulas for calculating net cash outflows.

 

·Net Stable Funding Ratio (NSFR) which will measure a bank’s available stable funding relative to its required stable funding. Both concepts are also defined in the new regulations.

 

The implementation of internationally accepted liquidity ratios might require changes in business practices that affect our profitability. The LCR is a liquidity standard that measures if banks have enough high-quality liquid assets to cover expected net cash outflows over a 30-day liquidity stress period. At December 31, 2020, our LCR ratio was 142% under Chilean regulations, which is above the 80% minimum requirement for 2020. The net stable funding ratio (NSFR) provides a sustainable maturity structure of assets and liabilities such that banks maintain a stable funding profile in relation to their activities. The Chilean regulator has not yet defined a calendar of implementation for the local NSFR. This could materially increase the liquidity we are required to maintain on our balance sheet.

 

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We are subject to regulatory risk, or the risk of not being able to meet all of the applicable regulatory requirements and guidelines.

 

As a financial institution, we are subject to extensive regulation, inspections, examinations, inquiries, audits and other regulatory requirements by Chilean regulatory authorities, which materially affect our businesses. We cannot assure you that we will be able to meet all of the applicable regulatory requirements and guidelines, or that we will not be subject to sanctions, fines, restrictions on our business or other penalties in the future as a result of noncompliance. If sanctions, fines, restrictions on our business or other penalties are imposed on us for failure to comply with applicable requirements, guidelines or regulations, our business, financial condition, results of operations and our reputation and ability to engage in business may be materially and adversely affected.

 

In their supervisory roles, the regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening the protection of customers and the financial system. The supervisors’ continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of prudential returns, reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, these regulators have a more outcome-focused regulatory approach that involves more proactive enforcement and more punitive penalties for infringement. As a result, we face increased supervisory scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines.

 

Changes in regulations may also cause us to face increased compliance costs and limitations on our ability to pursue certain business opportunities and provide certain products and services. As some of the banking laws and regulations have been recently adopted, the way those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, to the extent these recently adopted regulations are implemented inconsistently in the various jurisdictions in which we operate, we may face higher compliance costs.

 

A draft bill currently in Congress, (the “Market Agents Bill”) proposes, among other initiatives, to regulate the banks’ ability to sell insurance tied to loans related to contingencies such as fire, earthquake, unemployment insurance etc. This bill would require financial institutions to pay half of the insurance premiums associated with loans. Additionally, it would prohibit banks from selling insurance policies underwritten by a related party. This initiative after being approved in the Chamber of Deputies, was rejected in a Mixed Congressional Committee. In its place members of Congress introduced a bill to prohibit the charging of interest over interest on overdue loans. We currently, cannot estimate an impact of these bills, if ever approved, could have on our business, but no assurance can be given that they will not have a material impact on future income.

 

Another bill currently in Congress proposes to regulate prepayment commissions. This bill eliminates the prepayment fee for all interest-bearing loans, permitting the debtor to pay off capital and the interests accrued at any moment during the duration of the loan, unless otherwise expressly specified in the contract. This bill would also prohibits grace periods to accrue interest. This bill is still in the early phases of congressional discussion so we cannot estimate an impact, bur no assurance can be given that this will not have a material impact on future income.

 

No assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have a material adverse effect on our business and results of operations.

 

Modifications to reserve requirements may affect our business.

 

Deposits are subject to a reserve requirement of 9.0% for demand deposits and 3.6% for time deposits (with terms of less than one year). The Central Bank has statutory authority to require banks to maintain reserves of up to an average of 40.0% for demand deposits and up to 20.0% for time deposits (irrespective, in each case, of the currency in which these deposits are denominated) to implement monetary policy. In addition, to the extent that the aggregate amount of the following types of liabilities exceeds 2.5 times the amount of a bank’s regulatory capital, a bank must maintain a 100% reserve against them: demand deposits, deposits in checking accounts, obligations payable on sight incurred in the ordinary course of business and, in general, all deposits unconditionally payable immediately. The New General Banking Law also states that the FMC, with the approval from the Central Bank, may lower this threshold from 2.5 times to 1.5 times a bank’s regulatory capital for a bank considered to be a SIB. This could lead to lower loan growth and have a negative effect on our business.

 

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We may not be able to detect or prevent money laundering and other financial crime activities fully or on a timely basis, which could expose us to additional liability and could have a material adverse effect on us.

 

We are required to comply with applicable anti-money laundering (“AML”), anti-terrorism, anti-bribery and corruption, sanctions and other laws and regulations applicable to us. These laws and regulations require us, among other things, to conduct full customer due diligence (including sanctions and politically-exposed person screening), keep our customer, account and transaction information up to date and have implemented financial crime policies and procedures detailing what is required from those responsible. We are also required to conduct AML training for our employees and to report suspicious transactions and activity to appropriate law enforcement following full investigation by our AML team.

 

Financial crime has become the subject of enhanced regulatory scrutiny and supervision by regulators globally. AML, anti-bribery and corruption and sanctions laws and regulations are increasingly complex and detailed. The Basel Committee is now introducing guidelines to strengthen the interaction and cooperation between prudential and AML/CFT supervisors. Compliance with these laws and regulations requires automated systems, sophisticated monitoring and skilled compliance personnel.

 

We maintain updated policies and procedures aimed at detecting and preventing the use of our banking network for money laundering and other financial crime related activities. However, emerging technologies, such as cryptocurrencies and blockchain, could limit our ability to track the movement of funds. Our ability to comply with the legal requirements depends on our ability to improve detection and reporting capabilities and reduce variation in control processes and oversight accountability. These require implementation and embedding within our business effective controls and monitoring, which in turn requires on-going changes to systems and operational activities. Financial crime is continually evolving and is subject to increasingly stringent regulatory oversight and focus. This requires proactive and adaptable responses from us so that we are able to deter threats and criminality effectively. Even known threats can never be fully eliminated, and there will be instances where we may be used by other parties to engage in money laundering and other illegal or improper activities. In addition, we rely heavily on our employees to assist us by spotting such activities and reporting them, and our employees have varying degrees of experience in recognizing criminal tactics and understanding the level of sophistication of criminal organizations. Where we outsource any of our customer due diligence, customer screening or anti financial crime operations, we remain responsible and accountable for full compliance and any breaches. If we are unable to apply the necessary scrutiny and oversight of third parties to whom we outsource certain tasks and processes, there remains a risk of regulatory breach.

 

If we are unable to fully comply with applicable laws, regulations and expectations, our regulators and relevant law enforcement agencies have the ability and authority to impose significant fines and other penalties on us, including requiring a complete review of our business systems, day-to-day supervision by external consultants and ultimately the revocation of our banking license.

 

The reputational damage to our business and global brand would be severe if we were found to have breached AML, anti-bribery and corruption or sanctions requirements. Our reputation could also suffer if we are unable to protect our customers’ bank products and services from being used by criminals for illegal or improper purposes.

 

In addition, while we review our relevant counterparties’ internal policies and procedures with respect to such matters, we, to a large degree, rely upon our relevant counterparties to maintain and properly apply their own appropriate compliance procedures and internal policies. Such measures, procedures and internal policies may not be completely effective in preventing third parties from using our (and our relevant counterparties’) services as a conduit for illicit purposes (including illegal cash operations) without our (and our relevant counterparties’) knowledge. If we are associated with, or even accused of being associated with, breaches of AML, anti-terrorism or sanctions requirements, our reputation could suffer and/or we could become subject to fines, sanctions and/or legal enforcement (including being added to “black lists” that would prohibit certain parties from engaging in transactions with us), any one of which could have a material adverse effect on our operating results, financial condition and prospects.

 

Any such risks could have a material adverse effect on our operating results, financial condition and prospects.

 

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We are subject to extensive regulation and regulatory and governmental oversight which could adversely affect our business, operations and financial condition.

 

As a financial institution, we are subject to extensive regulation, inspections, examinations, inquiries, audits and other regulatory requirements by Chilean regulatory authorities, which materially affect our businesses. We cannot assure you that we will be able to meet all of the applicable regulatory requirements and guidelines, or that we will not be subject to sanctions, fines, restrictions on our business or other penalties in the future as a result of noncompliance. If sanctions, fines, restrictions on our business, higher capital requirement or other penalties are imposed on us for failure to comply with applicable requirements, guidelines or regulations, our business, financial condition, results of operations and our reputation and ability to engage in business may be materially and adversely affected.

 

In their supervisory roles, the regulators seek to maintain the safety and soundness of financial institutions with the aim of strengthening the protection of customers and the financial system. The supervisors’ continuing supervision of financial institutions is conducted through a variety of regulatory tools, including the collection of information by way of prudential returns, reports obtained from skilled persons, visits to firms and regular meetings with management to discuss issues such as performance, risk management and strategy. In general, these regulators have a more outcome-focused regulatory approach that involves more proactive enforcement and more punitive penalties for infringement. As a result, we face increased supervisory scrutiny (resulting in increasing internal compliance costs and supervision fees), and in the event of a breach of our regulatory obligations we are likely to face more stringent regulatory fines.

 

Changes in regulations may also cause us to face increased compliance costs and limitations on our ability to pursue certain business opportunities and provide certain products and services. As some of the banking laws and regulations have been recently adopted, the manner in which those laws and related regulations are applied to the operations of financial institutions is still evolving. Moreover, to the extent these recently adopted regulations are implemented inconsistently in the various jurisdictions in which we operate, we may face higher compliance costs. No assurance can be given generally that laws or regulations will be adopted, enforced or interpreted in a manner that will not have a material adverse effect on our business and results of operations.

 

The main regulations and regulatory and governmental oversight that can adversely impact us include but are not limited to the following (see more details on “Item 4. Information on the Company—B. Business Overview—Regulation and Supervision”):

 

We are subject to regulation by the FMC and by the Central Bank with regard to certain matters, including reserve requirements, interest rates, foreign exchange mismatches and market risks. Chilean laws, regulations, policies and interpretations of laws relating to the banking sector and financial institutions are continually evolving and changing. Any new reforms could result in increased competition in the industry and thus may have a material adverse effect on our financial condition and results of operations.

 

Pursuant to the New General Banking Law, all Chilean banks may, subject to the approval of the FMC, engage in certain businesses other than commercial banking depending on the risk associated with such business and their financial strength. Such additional businesses include securities brokerage, mutual fund management, securitization, insurance brokerage, leasing, factoring, financial advisory, custody and transportation of securities, loan collection and financial services. The New General Banking Law also applies to the Chilean banking system a modified version of the capital adequacy guidelines issued by the Basel Committee on Banking Regulation and Supervisory Practices and limits the discretion of the FMC to deny new banking licenses. There can be no assurance that regulators will not in the future impose more restrictive limitations on the activities of banks, including us. Any such change could have a material adverse effect on our financial condition or results of operations.

 

Historically, Chilean banks have not paid interest on amounts deposited in checking accounts. We have begun to pay interest on some checking accounts under certain conditions. If competition or other factors lead us to pay higher interest rates on checking accounts, to relax the conditions under which we pay interest or to increase the number of checking accounts on which we pay interest, any such change could have a material adverse effect on our financial condition or results of operations.

 

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The changes in the way banking institutions with economic difficulties should be treated shifts the focus from solving to anticipating potential adverse situations that may affect a bank or the banking system or that implies the dissolution and liquidation of a bank. To that extent banks will be obliged to inform the FMC whenever they are in any of a certain number of situations specified in the proposed bill and present an Early Regularization Plan for approval by the FMC. Banks in such situations will be able to undertake a preventive capital increase or receive a three-year term loan from another bank, which will be considered as capital. The creditors agreement considered in the current banking law is eliminated. In case the Regularization Plan fails or is not presented by the bank, the FMC will appoint a delegated inspector or eventually a Provisional Administrator. We cannot assure you that we will not incur in such situations in the future, which could have a material adverse impact on you.

 

We are exposed to risk of loss from legal and regulatory proceedings.

 

We face risk of loss from legal and regulatory proceedings, including tax proceedings, that could subject us to monetary judgements, regulatory enforcement actions, fines and penalties. The current regulatory and tax enforcement environment in the jurisdictions in which we operate reflects an increased supervisory focus on enforcement, combined with uncertainty about the evolution of the regulatory regime, and may lead to material operational and compliance costs.

 

We are from time to time subject to regulatory investigations and civil and tax claims, and party to certain legal proceedings incidental to the normal course of our business, including in connection with conflicts of interest, lending securities and derivatives activities, relationships with our employees and other commercial or tax matters. In view of the inherent difficulty of predicting the outcome of legal matters, particularly where the claimants seek very large or indeterminate damages, or where the cases present novel legal theories, involve a large number of parties or are in the early stages of investigation or discovery, we cannot state with certainty what the eventual outcome of these pending matters will be or what the eventual loss, fines or penalties related to each pending matter may be.

 

The amount of our reserves in respect of these matters is substantially less than the total amount of the claims asserted against us, and, in light of the uncertainties involved in such claims and proceedings, there is no assurance that the ultimate resolution of these matters will not significantly exceed the reserves currently accrued by us. As a result, the outcome of a particular matter may be material to our operating results for a particular period. At December 31, 2020, we had provisions for legal contingencies of Ch$1,024 million.

 

RISK FACTORS IN RESPECT OF CHILE

 

Political, legal, regulatory and economic uncertainty arising from social unrest and the resulting social reforms, as well as the referendum on Chile’s constitution could adversely impact the Bank’s business

 

During October 2019, growing public concern over perceived social inequality led to a rise in social unrest. There are numerous demands by the population, related to more economic inclusion and fairer social relationships. Important political and social actors claim that the social unrest reflects the desire of a new constitution, as Chile’s current constitution dates back to 1980. When the government announced the possibility of enacting a new constitution, there was increased volatility in the Chilean stock market and exchange rate fluctuations that resulted in a weakening of the Chilean peso against the U.S. dollar. The share prices on local banks and bond spreads, including Santander Chile, suffered significant declines in the market as social protests continued in the country. Seventy of the Bank’s branches suffered different levels of damages during this period but most of these costs were covered by insurance. There was also a rise in early non-performance levels among SMEs, mortgage and consumer loans due to reduced working hours in the economy.

 

In November 2020, a referendum was held to vote on two matters: (i) whether a new constitution should be enacted and (ii) if so, whether a constituent convention should be comprised of an elected mixed assembly of current Congress members and newly elected persons or entirely comprised of newly-elected citizens. This referendum resulted in ample support for convening a fully elected Constitutional Convention to draft Chile’s new constitution. The election of the members of this convention will be held in April 2021. Each new article of the Constitution would have to be approved by two thirds of the convention. The Constitutional Convention will have approximately one year, starting in April 2021, to complete the draft of the constitution. An exit referendum with compulsory participation will then be held to ratify the new constitution.

 

News of the referendum calmed markets and unrest levels have improved since then. The long-term effects of this social unrest are hard to predict, but could include slower economic growth, which could adversely affect the Bank’s profitability and prospects.

 

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Our growth, asset quality and profitability may be adversely affected by macroeconomic and political conditions in Chile.

 

A substantial number of our loans are to borrowers doing business in Chile. Chile’s economy has experienced significant volatility in recent decades, characterized, in some cases, by slow or regressive growth and declining investment. This volatility resulted in fluctuations in the levels of deposits and in the relative economic strength of various segments of the economies to which we lend. The Chilean economy may not continue to grow at similar rates as in the past or future developments may negatively affect Chile’s overall levels of economic activity.

 

Negative and fluctuating economic conditions, such as slowing or negative growth and a changing interest rate and inflationary environment, impact our profitability by causing lending margins to decrease and credit quality to decline and leading to decreased demand for higher margin products and services. Negative and fluctuating economic conditions in Chile could also result in government defaults on public debt. This could affect us in two ways: directly, through portfolio losses, and indirectly, through instabilities that a default in public debt could cause to the banking system as a whole, particularly since commercial banks’ exposure to government debt is high in Chile.

 

Our revenues are also subject to risk of loss from unfavorable political and diplomatic developments, social instability, and changes in governmental policies, including expropriation, nationalization, international ownership legislation, interest-rate caps and tax policies.

 

Any future fluctuation in oil prices may give rise to volatility in the global financial markets and further economic instability in oil-dependent regions, such as Chile. In addition, the ability of borrowers in or exposed to the oil sector has been and may be further adversely affected by such price fluctuations.

 

Our growth, asset quality and profitability may be adversely affected by volatile macroeconomic and political conditions in Chile.

 

Any material change to United States trade policy with respect to Chile could have a material adverse effect on the economy, which could in turn materially harm our financial condition and results of operations.

 

Portions of our loan portfolio are subject to risks relating to force majeure events and any such event could materially adversely affect our operating results.

 

Chile lies on the Nazca tectonic plate, making it one of the world’s most seismically active regions. Our financial and operating performance may be adversely affected by force majeure events, such as natural disasters, particularly in locations where a significant portion of our loan portfolio is composed of real estate loans. Natural disasters such as earthquakes and floods may cause widespread damage which could impair the asset quality of our loan portfolio and could have an adverse impact on the economy of the affected region.

 

Changes in taxes, including the corporate tax rate, in Chile may have an adverse effect on us and our clients.

 

The Chilean Government enacted various tax reforms in 2014, 2016 and 2020 in order to finance greater social expenditures. The most relevant change was the rise of the corporate tax rate to 27% in 2018. There is currently discussion of another tax reform to finance the growing deficit. We cannot predict at this time if these reforms will have a material impact on our business or clients or if further tax reforms will be implemented in the future. Banco Santander Chile’s effective corporate tax rate could rise in the future, which may have an adverse impact on our results of operations. Please see “Item 10—Additional information—E. Taxation” for more information regarding the impacts of this tax reform on ADR holders.

 

Developments in other countries may affect us, including the prices for our securities.

 

The prices of securities issued by Chilean companies, including banks, are influenced to varying degrees by economic and market considerations in other countries. We cannot assure you that future developments in or affecting the Chilean economy, including consequences of economic difficulties in other markets, will not materially and adversely affect our business, financial condition or results of operations.

 

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We are exposed to risks related to the weakness and volatility of the economic and political situation in Asia, the United States, Europe (including Spain, where Santander Spain, our controlling shareholder, is based), Brazil, Argentina and other nations. Although economic conditions in Europe and the United States may differ significantly from economic conditions in Chile, investors’ reactions to developments in these other countries may have an adverse effect on the market value of securities of Chilean issuers. In particular, investor perceptions of the risks associated with our securities may be affected by perception of risk conditions in Spain.

 

If these, or other nations’ economic conditions deteriorate, the economy in Chile, as both a neighboring country and a trading partner, could also be affected and could experience slower growth than in recent years, with possible adverse impact on our borrowers and counterparties. If this were to occur, we would potentially need to increase our allowances for loan losses, thus affecting our financial results, our results of operations and the price of our securities As of December 31, 2020, the Bank’s foreign exposure, including counterparty risk in the derivative instruments’ portfolio, was US$ 2,309 million or 3.7% of our total assets. There can be no assurance that the ongoing effects of a global financial crisis will not negatively impact growth, consumption, unemployment, investment and the price of exports in Chile. Crises and political uncertainties in other Latin American countries could also have an adverse effect on Chile, the price of our securities or our business.

 

Chile has considerable economic ties with China, the United States and Europe. In 2020, approximately 37.2% of Chile’s exports went to China, mainly copper. China’s economy has grown at a strong pace in recent times, but a slowdown in economic activity in China may affect Chile’s GDP and export growth as well as the price of copper, which is Chile’s main export. Chile exported approximately 14.0% of total exports to the United States and 8.8% to Europe in 2020.

 

Chile was recently involved in international litigation with Bolivia regarding maritime borders. We cannot assure you that crises and political uncertainty in other Latin American countries will not have an adverse effect on Chile, the price of our securities or our business.

 

A change in labor laws in Chile or a worsening of labor relations in the Bank could impact our business.

 

As of December 31, 2020 on a consolidated basis, we had 10,470 employees, of which 73.4% were unionized. In February 2021, a new collective bargaining agreement was signed with the main unions ahead of schedule, which will be effective on September 1, 2021 and expires on December 31, 2024.

 

There is currently a new labor reform being discussed in Congress, which, among other items, shortens the work week from 45 hours to 40 hours, excluding the lunch break. There is also discussion to increase minimum wage currently set at Ch$301,000/month (US$415/month) by up to 50%. At Santander Chile, the weekly working hours agreed under the collective bargaining agreement are 40 hours, excluding lunch, and our minimum wage is set above the legal minimum. Despite this, we cannot assure at this time that the new labor reform will not have material impact on our expenses.

 

These and any additional legislative or regulatory actions in Chile, Spain, the European Union, the United States or other countries, and any required changes to our business operations resulting from such legislation and regulations, could result in reduced capital availability, significant loss of revenue, limit our ability to continue organic growth (including increased lending), pursue business opportunities in which we might otherwise consider engaging and provide certain products and services, affect the value of assets that we hold, require us to increase our prices and therefore reduce demand for our products, impose additional costs on us or otherwise adversely affect our businesses. Accordingly, we cannot provide assurance that any such new legislation or regulations would not have an adverse effect on our business, results of operations or financial condition in the future.

 

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Our corporate disclosure may differ from disclosure regularly published by issuers of securities in other countries, including the United States.

 

Issuers of securities in Chile are required to make public disclosures that are different from, and that may be reported under presentations that are not consistent with, disclosures required in other countries, including the United States. In particular, as a Chilean regulated financial institution, we are required to submit to the FMC on a monthly basis unaudited consolidated balance sheets and income statements, excluding any note disclosure, prepared in accordance with Chilean Bank GAAP as issued by the FMC. This disclosure differs in a number of significant respects from generally accepted accounting principles in the United States and information generally available in the United States with respect to U.S. financial institutions or IFRS. In addition, as a foreign private issuer, we are not subject to the same disclosure requirements in the United States as a domestic U.S. registrant under the Exchange Act, including the requirements to prepare and issue quarterly reports, the proxy rules applicable to domestic U.S. registrants under Section 14 of the Exchange Act or the insider reporting and short-swing profit rules under Section 16 of the Exchange Act. Accordingly, the information about us available to you will not be the same as the information available to shareholders of a U.S. company and may be reported in a manner that you are not familiar with.

 

Risks FACTORS IN RESPECT OF Our Controlling Shareholder and our ADSs

 

Investors may find it difficult to enforce civil liabilities against us or our directors, officers and controlling persons.

 

We are a Chilean corporation. None of our directors are residents of the United States and most of our executive officers reside outside of the United States. In addition, all or a substantial portion of our assets and the assets of our directors and executive officers are located outside of the United States. Although we have appointed an agent for service of process in any action against us in the United States with respect to our ADSs, none of our directors, officers or controlling persons has consented to service of process in the United States or to the jurisdiction of any United States court. As a result, it may be difficult for investors to effect service of process within the United States on such persons.

 

It may also be difficult for ADS holders to enforce in the United States or in Chilean courts money judgments obtained in United States courts against us or our directors and executive officers based on civil liability provisions of the U.S. federal securities laws. If a U.S. court grants a final money judgment in an action based on the civil liability provisions of the federal securities laws of the United States, enforceability of this money judgment in Chile will be subject to the obtaining of the relevant “exequatur” (i.e., recognition and enforcement of the foreign judgment) according to Chilean civil procedure law currently in force, and consequently, subject to the satisfaction of certain factors. The most important of these factors are the existence of reciprocity, the absence of a conflicting judgment by a Chilean court relating to the same parties and arising from the same facts and circumstances and the Chilean courts’ determination that the U.S. courts had jurisdiction, that process was appropriately served on the defendant and that enforcement would not violate Chilean public policy. Failure to satisfy any of such requirements may result in non-enforcement of your rights.

 

Our controlling shareholder has a great deal of influence over our business and its interests could conflict with yours.

 

Santander Spain controls Santander-Chile through its holdings in Teatinos Siglo XXI Inversiones S.A. and Santander Chile Holding S.A., which are controlled subsidiaries. Santander Spain has control over 67.18% of our shares and actual participation, excluding non-controlling shareholders that participate in Santander Chile Holding, S.A. of 67.12%.

 

Due to its share ownership, our controlling shareholder has the ability to control us and our subsidiaries, including the ability to:

 

·elect the majority of the directors and exercise control over our company and subsidiaries;

 

·cause the appointment of our principal officers;

 

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·declare the payment of any dividends;

 

·agree to sell or otherwise transfer its controlling stake in us; and

 

·determine the outcome of substantially all actions requiring shareholder approval, including amendments of our by-laws, transactions with related parties, corporate reorganizations, acquisitions and disposals of assets and issuance of additional equity securities, if any.

 

We operate as a stand-alone subsidiary within the Santander Group. Our controlling shareholder has no liability for our banking operations, except for the amount of its holdings of our capital stock. The interests of Santander Spain may differ from the interests of our other shareholders, and the concentration of control in Santander Spain may differ from the interests of our other shareholders, and the concentration of control in Santander Spain will limit other shareholders’ ability to influence corporate matters. As a result, we may take actions that our other shareholders do not view as beneficial.

 

Our status as a controlled company and a foreign private issuer exempts us from certain of the corporate governance standards of the New York Stock Exchange (“NYSE”), limiting the protections afforded to investors.

 

We are a “controlled company” and a “foreign private issuer” within the meaning of the NYSE corporate governance standards. Under the NYSE rules, a controlled company is exempt from certain NYSE corporate governance requirements. In addition, a foreign private issuer may elect to comply with the practice of its home country and not to comply with certain NYSE corporate governance requirements, including the requirements that (1) a majority of the board of directors consist of independent directors, (2) a nominating and corporate governance committee be established that is composed entirely of independent directors and has a written charter addressing the committee’s purpose and responsibilities, (3) a compensation committee be established that is composed entirely of independent directors and has a written charter addressing the committee’s purpose and responsibilities and (4) an annual performance evaluation of the nominating and corporate governance and compensation committees be undertaken. Although we have similar practices, they do not entirely conform to the NYSE requirements for U.S. issuers; therefore, we currently use these exemptions and intend to continue using them. Accordingly, you will not have the same protections afforded to shareholders of companies that are subject to all NYSE corporate governance requirements.

 

There may be a lack of liquidity and market for our shares and ADSs.

 

Our ADSs are listed and traded on the NYSE (under the ticker “BSAC”). Our common stock is listed and traded on the Santiago Stock Exchange (under the ticker “BSANTANDER”), which we refer to as the Chilean Stock Exchange, although the trading market for the common stock is small by international standards. At December 31, 2020, we had 188,446,126,794 shares of common stock outstanding. The Chilean securities markets are substantially smaller, less liquid and more volatile than major securities markets in the United States. According to Article 14 of the Ley de Mercado de Valores, Ley No. 18,045, or the Chilean Securities Market Law, FMC may suspend the offer, quotation or trading of shares of any company listed on one or more Chilean stock exchanges for up to 30 days if, in its opinion, such suspension is necessary to protect investors or is justified for reasons of public interest. Such suspension may be extended for up to 120 days. If, at the expiration of the extension, the circumstances giving rise to the original suspension have not changed, the FMC will then cancel the relevant listing in the registry of securities. In addition, the Santiago Stock Exchange may inquire as to any movement in the price of any securities in excess of 10% and suspend trading in such securities for a day if it deems necessary.

 

Although our common stock is traded on the Chilean Stock Exchange, there can be no assurance that a liquid trading market for our common stock will continue to exist. Approximately 33.0% of our outstanding common stock is held by the public (i.e., shareholders other than Santander Spain and its affiliates), including our shares that are represented by ADSs trading on the NYSE. A limited trading market in general and our concentrated ownership in particular may impair the ability of an ADS holder to sell in the Chilean market shares of common stock obtained upon withdrawal of such shares from the ADR facility in the amount and at the price and time such holder desires, and could increase the volatility of the price of the ADSs.

 

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Chile imposes controls on foreign investment and repatriation of investments that may affect your investment in, and earnings from, our ADSs.

 

Equity investments in Chile by persons who are not Chilean residents have generally been subject to various exchange control regulations, which restrict the repatriation of the investments and earnings therefrom. In April 2001, the Central Bank eliminated the regulations that affected foreign investors, except that investors are still required to provide the Central Bank with information relating to equity investments and conduct such operations within Chile’s Formal Exchange Market. The ADSs are subject to a contract, dated May 17, 1994, among the Depositary, us and the Central Bank (the “Foreign Investment Contract”) that remains in full force and effect. The ADSs continue to be governed by the provisions of the Foreign Investment Contract subject to the regulations in existence prior to April 2001. The Foreign Investment Contract grants the Depositary and the holders of the ADSs access to the Formal Exchange Market, which permits the Depositary to remit dividends it receives from us to the holders of the ADSs. The Foreign Investment Contract also permits ADS holders to repatriate the proceeds from the sale of shares of our common stock withdrawn from the ADR facility, or that have been received free of payment as a consequence of spin offs, mergers, capital increases, wind ups, share dividends or preemptive rights transfers, enabling them to acquire the foreign currency necessary to repatriate earnings from such investments. Pursuant to Chilean law, the Foreign Investment Contract cannot be amended unilaterally by the Central Bank, and there are judicial precedents (although not binding with respect to future judicial decisions) indicating that contracts of this type may not be abrogated by future legislative changes or resolutions of the Advisory Council of the Central Bank. Holders of shares of our common stock, except for shares of our common stock withdrawn from the ADS facility or received in the manner described above, are not entitled to the benefits of the Foreign Investment Contract, may not have access to the Formal Exchange Market, and may have restrictions on their ability to repatriate investments in shares of our common stock and earnings therefrom.

 

Holders of ADSs are entitled to receive dividends on the underlying shares to the same extent as the holders of shares. Dividends received by holders of ADSs will be paid net of foreign currency exchange fees and expenses of the Depositary and will be subject to Chilean withholding tax, currently imposed at a rate of 35.0% (subject to credits in certain cases). If for any reason, including changes in Chilean law, the Depositary were unable to convert Chilean pesos to U.S. dollars, investors would receive dividends and other distributions, if any, in Chilean pesos.

 

We cannot assure you that additional Chilean restrictions applicable to holders of our ADSs, the disposition of the shares underlying them or the repatriation of the proceeds from such disposition or the payment of dividends will not be imposed in the future, nor can we advise you as to the duration or impact of such restrictions if imposed.

 

You may be unable to exercise preemptive rights.

 

The Ley Sobre Sociedades Anónimas, Ley No. 18,046 and the Reglamento de Sociedades Anónimas, which we refer to collectively as the Chilean Companies Law, and applicable regulations require that whenever we issue new common stock for cash, we grant preemptive rights to all of our shareholders (including holders of ADSs), giving them the right to purchase a sufficient number of shares to maintain their existing ownership percentage. Such an offering would not be possible in the United States unless a registration statement under the U.S. Securities Act of 1933 (“Securities Act”), as amended, were effective with respect to such rights and common stock or an exemption from the registration requirements thereunder were available.

 

Since we are not obligated to make a registration statement available with respect to such rights and the common stock, you may not be able to exercise your preemptive rights in the United States. If a registration statement is not filed or an applicable exemption is not available under U.S. securities law, the Depositary will sell such holders’ preemptive rights and distribute the proceeds thereof if a premium can be recognized over the cost of any such sale.

 

As a holder of ADSs you will have different shareholders’ rights than in the United States and certain other jurisdictions.

 

Our corporate affairs are governed by our estatutos, or by-laws, and the laws of Chile, which may differ from the legal principles that would apply if we were incorporated in a jurisdiction in the United States or in certain other jurisdictions outside Chile. Under Chilean corporate law, you may have fewer and less well-defined rights to protect your interests than under the laws of other jurisdictions outside Chile. For example, under legislation applicable to Chilean banks, our shareholders would not be entitled to appraisal rights in the event of a merger or other business combination undertaken by us.

 

Although Chilean corporate law imposes restrictions on insider trading and price manipulation, the form of these regulations and the manner of their enforcement may differ from that in the U.S. securities markets or markets in certain other jurisdictions. In addition, in Chile, self-dealing and the preservation of shareholder interests may be regulated differently, which could potentially disadvantage you as a holder of the shares underlying ADSs.

 

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Holders of ADSs may find it difficult to exercise voting rights at our shareholders’ meetings.

 

Holders of ADSs will not be our direct shareholders and will be unable to enforce directly the rights of shareholders under our by-laws and the laws of Chile. Holders of ADSs may exercise voting rights with respect to the common stock represented by ADSs only in accordance with the deposit agreement governing the ADSs. Holders of ADSs will face practical limitations in exercising their voting rights because of the additional steps involved in our communications with ADS holders. Holders of our common stock will be able to exercise their voting rights by attending a shareholders’ meeting in person or voting by proxy. By contrast, holders of ADSs will receive notice of a shareholders’ meeting by mail from the Depositary following our notice to the Depositary requesting the Depository to do so. To exercise their voting rights, holders of ADSs must instruct the Depositary on a timely basis on how they wish to vote. This voting process necessarily will take longer for holders of ADSs than for holders of our common stock. If the Depositary fails to receive timely voting instructions for all or part of the ADSs, the Depositary will assume that the holders of those ADSs are instructing it to give a discretionary proxy to a person designated by us to vote their ADSs, except in limited circumstances.

 

Holders of ADSs also may not receive the voting materials in time to instruct the Depositary to vote the common stock underlying their ADSs. In addition, the Depositary and its agents are not responsible for failing to carry out voting instructions of the holders of ADSs or for the manner of carrying out those voting instructions. Accordingly, holders of ADSs may not be able to exercise voting rights, and they will have little, if any, recourse if the common stocks underlying their ADSs are not voted as requested.

 

ADS holders may be subject to additional risks related to holding ADSs rather than shares.

 

Because ADS holders do not hold their shares directly, they are subject to the following additional risks, among others:

 

·as an ADS holder, you may not be able to exercise the same shareholder rights as a direct holder of ordinary shares;

 

·we and the Depositary may amend or terminate the deposit agreement without the ADS holders’ consent in a manner that could prejudice ADS holders or that could affect the ability of ADS holders to transfer ADSs; and

 

·the Depositary may take or be required to take actions under the Deposit Agreement that may have adverse consequences for some ADS holders in their particular circumstances.

 

GENERAL RISK FACTORS

 

Disclosure controls and procedures over financial reporting may not prevent or detect all errors or acts of fraud.

 

Disclosure controls and procedures, including internal controls, over financial reporting are designed to provide reasonable assurance that information required to be disclosed by the company in reports filed or submitted under the Securities Exchange Act of 1934 (the “Exchange Act”) is accumulated and communicated to management, and recorded, processed, summarized and reported within the time periods specified in the SEC’s US Securities and Exchange Commission’s rules and forms.

 

These disclosure controls and procedures have inherent limitations, which include the possibility that judgements in decision-making can be faulty and that breakdowns can occur because of errors or mistakes. Additionally, controls can be circumvented by any unauthorized override of the controls. Consequently, our businesses are exposed to risk from potential non-compliance with policies, employee misconduct or negligence and fraud, which could result in regulatory sanctions, civil claims and serious reputational or financial harm. In recent years, a number of multinational financial institutions have suffered material losses due to the actions of ‘rogue traders’ or other employees. It is not always possible to deter employee misconduct and the precautions we take to prevent and detect this activity may not always be effective. Accordingly, because of the inherent limitations in the control system, misstatements due to error or fraud may occur and not be detected.

 

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Our financial statements are based in part on assumptions and estimates which, if inaccurate, could cause material misstatement of the results of our operations and financial position.

 

The preparation of financial statements requires management to make judgements, estimates and assumptions that affect the reported amounts of assets, liabilities, income and expenses. Due to the inherent uncertainty in making estimates, actual results reported in future periods may be based upon amounts which differ from those estimates. Estimates, judgements and assumptions are continually evaluated and are based on historical experience and other factors, including expectations of future events that are believed to be reasonable under the circumstances. Revisions to accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected. The accounting policies deemed critical to our results and financial position, based upon materiality and significant judgements and estimates, include impairment of loans and advances, good will impairment, valuation of financial instruments, deferred tax assets –provisions and pension obligations for liabilities.

 

If the judgement, estimates and assumptions we use in preparing our consolidated financial statements are subsequently found to be incorrect, there could be a material effect on our results of operations and a corresponding effect on our funding requirements and capital ratios.

 

Changes in accounting standards could impact reported earnings.

 

The accounting standard setters and other regulatory bodies periodically change the financial accounting and reporting standards that govern the preparation of our consolidated financial statements. For example, IFRS 9 was adopted as of January 1, 2018, establishing a new impairment model of expected loss and make changes to the classification and measurement requirements for financial assets and liabilities. In addition, the Bank adopted IFRS 16 as of January 1, 2019, requiring new standards for recognition, measurement, presentation and disclosure of leases. This led to approximately Ch$154,284 million of assets for the right of use and lease liabilities for the same amount as of the date of adoption of IFRS 16. Changes made to accounting standards can materially impact how we record and report our financial condition and results of operations, as well as affect the calculation of our capital ratios. In some cases, we could be required to apply a new or revised standard retroactively, resulting in the restatement of prior period financial statements. Various amendments were made to financial and accounting standards in 2020 for implementation in future periods without an impact in 2020. The Bank’s management is still evaluating the potential impact of these new standards. For further information about developments in financial accounting and reporting standards, see Note 1 to our Audited Consolidated Financial Statements.

 

We rely on recruiting, retaining and developing appropriate senior management and skilled personnel.

 

Our continued success depends in part on the continued service of key members of our senior executive team and other key employees. The ability to continue to attract, train, motivate and retain highly qualified and talented professionals is a key element of our strategy. The successful implementation of our strategy and culture depends on the availability of skilled and appropriate management, both at our head office and in each of our business units. If we or one of our business units or other functions fails to staff its operations appropriately, or loses one or more of its key senior executives or other key employees and fails to replace them in a satisfactory and timely manner, our business, financial condition and results of operations, including control and operational risks, may be adversely affected.

 

In addition, the financial industry has and may continue to experience more stringent regulation of employee compensation, which could have an adverse effect on our ability to hire or retain the most qualified employees. If we fail or are unable to attract and appropriately train, motivate and retain qualified professionals, our business may also be adversely affected.

 

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Our business could be affected if its capital is not managed effectively or if changes limiting our ability to manage our capital position are adopted.

 

Effective management of our capital position is important to our ability to operate our business, to continue to grow organically and to pursue our business strategy. However, in response to the global financial crisis, a number of changes to the regulatory capital framework have been adopted or continue to be considered. As these and other changes are implemented or future changes are considered or adopted that limit our ability to manage our balance sheet and capital resources effectively or to access funding on commercially acceptable terms, we may experience a material adverse effect on our financial condition and regulatory capital position.

 

We are subject to review by tax authorities, and an incorrect interpretation by us of tax laws and regulations may have a material adverse effect on us.

 

The preparation of our tax returns requires the use of estimates and interpretations of complex tax laws and regulations and is subject to review by tax authorities.

 

We are subject to the income tax laws of Chile and certain foreign countries. These tax laws are complex and subject to different interpretations by the taxpayer and relevant governmental tax authorities, which are sometimes subject to prolonged evaluation periods until a final resolution is reached. In establishing a provision for income tax expense and filing returns, we must make judgements and interpretations about the application of these inherently complex tax laws.

 

If the judgement, estimates and assumptions we use in preparing our tax returns are subsequently found to be incorrect, there could be a material adverse effect on our results of operations. In some jurisdictions, the interpretations of the tax authorities are unpredictable and frequently involve litigation, which introduces further uncertainty and risk as to tax expense.

 

We engage in transactions with related parties that others may not consider to be on an arm’s-length basis.

 

We and our affiliates have entered into a number of services agreements pursuant to which we render services, such as administrative, accounting, finance, treasury, legal services and others.

 

Chilean law applicable to public companies and financial groups and institutions and our by-laws provide for several procedures designed to ensure that the transactions entered into with or among our financial subsidiaries and/or affiliates do not deviate from prevailing market conditions for those types of transactions, including the requirement that our board of directors approve such transactions. Furthermore, all significant related party transactions must be approved by the Audit Committee and the Board. These significant transactions are also reported in our annual shareholders meeting. Please see Note 36 of our Audited Consolidated Financial Statements and “Item 7. Major Shareholders and Related Party Transactions.”

 

We are likely to continue to engage in transactions with our affiliates. Future conflicts of interests between us and any of affiliates, or among our affiliates, may arise, which conflicts are not required to be and may not be resolved in our favor.

 

ITEM 4. INFORMATION ON THE COMPANY

 

A. History and Development of the Company

 

Overview

 

We are the largest bank in the Chilean market in terms of loans (excluding loans held by subsidiaries of Chilean banks abroad) and the second largest bank in terms of total deposits (excluding deposits held by subsidiaries of Chilean banks aboard). As of December 31, 2020, we had total assets of Ch$55,703,223 million (U.S.$ 78,183 million), outstanding loans at amortized cost, net of allowances for loan losses of Ch$ 33,303,100 million (U.S.$ 46,743 million), total deposits of Ch$ 25,142,684 million (U.S.$ 35,289 million) and shareholders’ equity of Ch$ 3,620,091 million (U.S.$ 5,081 million). As of December 31, 2020, we employed 10,470 people. We have a leading presence in all the major business segments in Chile, and a large distribution network with national coverage spanning across all the country. We offer unique transaction capabilities to clients through our 358 branches and 1,199 ATMs. Our headquarters are in Santiago and we operate in every major region of Chile.

 

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We provide a broad range of commercial and retail banking services to our customers, including Chilean peso and foreign currency denominated loans to finance a variety of commercial transactions, trade, foreign currency forward contracts and credit lines and a variety of retail banking services, including mortgage financing. We seek to offer our customers a wide range of products while providing high levels of service. In addition to our traditional banking operations, we offer a variety of financial services, including financial leasing, financial advisory services, mutual fund management, securities brokerage, insurance brokerage and investment management.

 

The legal predecessor of Santander-Chile was Banco Santiago (“Santiago”). Old Santander-Chile was established as a subsidiary of Santander Spain in 1978. On August 1, 2002, Santiago and Old Santander Chile merged, whereby the latter ceased to exist and Santander-Chile (formerly known as Santiago) being the surviving entity.

 

Our principal executive offices are located at Bandera 140, 20th floor, Santiago, Chile. Our telephone number is +562-320-2000 and our website is www.santander.cl. None of the information contained on our website is incorporated by reference into, or forms part of, this Annual Report. Our agent for service of process in the United States is Puglisi & Associates, 850 Library Ave., Suite 204, Newark, DE 19711. The SEC maintains a website on the Internet at http://www.sec.gov that contains reports and information statements and other information about us. The reports (including this annual report) and information statements and other information about us can be downloaded from the SEC’s website www.sec.gov website or our investor relations website www.santandercl.gcs-web.com. None of the information contained on our website, or any website referred to in this Annual Report, is incorporated by reference into, or forms part of, this Annual Report.

 

Relationship with Grupo Santander

 

We believe that our relationship with our controlling shareholder, Santander Spain, offers us a significant competitive advantage over our peer Chilean banks. Grupo Santander, our parent company, is one of the largest financial groups in Brazil and the rest of Latin America, in terms of total assets measured on a regional basis. It is the largest financial group in Spain and is a major player elsewhere in Europe, including the United Kingdom, Poland and Portugal. Through Santander Consumer, it also operates a leading consumer finance franchise in the United States, as well as in Germany, Italy, Spain, and several other European countries.

 

Our relationship with Santander Spain provides us with access to the group’s client base, while its multinational focus allows us to offer international solutions to our clients’ financial needs. We also have the benefit of selectively borrowing from Santander Spain’s product offerings in other countries, as well as of its know-how in systems management. We believe that our relationship with Santander Spain will also enhance our ability to manage credit and market risks by adopting policies and knowledge developed by Santander Spain. In addition, our internal auditing function has been strengthened as a result of the addition of an internal auditing department that concurrently reports directly to our Audit Committee and the audit committee of Santander Spain. We believe that this structure leads to improved monitoring and control of our exposure to operational risks.

 

Grupo Santander’s support of Santander-Chile includes the assignment of managerial personnel to key supervisory areas of Santander-Chile, such as risks, auditing, accounting and financial control. Santander-Chile does not pay any management fees to Santander Spain in connection with these support services.

 

B. Business Overview

 

We have 358 branches, 220 of which are operated under the Santander brand name, with the remaining branches under certain specialty brand names, including 19 under the Select brand name, 32 specialized branches for the Middle Market and 28 as auxiliary and payment centers. During 2020, we also opened 6 Santander Workcafés, reaching a total of 59 Workcafés across all regions of Chile. We provide a full range of financial services to corporate and individual customers. We divide our clients into the following groups: (i) Retail banking, (ii) Middle-market, (iii) Corporate Investment Banking and (iv) Corporate Activities (“Other”).

 

The Bank has the reportable segments noted below (see “Segmentation Criteria” for further information):

 

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Retail Banking

 

This segment consists of individuals and small to medium-sized entities (SMEs) with annual sales less than Ch$2,000 million (U.S.$2.8 million). This segment gives customers a variety of services, including consumer loans, credit cards, auto loans, commercial loans, foreign exchange, mortgage loans, debit cards, checking accounts, savings products, mutual funds, stock brokerage, and insurance brokerage. Additionally, the SME clients are offered government-guaranteed loans, foreign trade services, leasing and factoring.

 

Middle-market

 

This segment serves companies and large corporations with annual sales exceeding Ch$2,000 million (U.S.$2.8 million). It also serves institutions such as universities, government entities, local and regional governments and companies engaged in the real estate industry who carry out projects to sell properties to third parties and annual sales exceeding Ch$800 million (U.S.$1.1 million) with no upper limit. The companies within this segment have access to many products including commercial loans, leasing, factoring, foreign trade, credit cards, mortgage loans, checking accounts, transactional services, treasury services, financial consulting, savings products, mutual funds, and insurance brokerage. Also, companies in the real estate industry are offered specialized services to finance projects, chiefly residential, with the aim of expanding sales of mortgage loans.

 

Corporate Investment Banking

 

This segment consists of foreign and domestic multinational companies with sales over Ch$10,000 million (U.S.$14.0 million). The companies within this segment have access to many products including commercial loans, leasing, factoring, foreign trade, project finance, credit cards, mortgage loans, checking accounts, transactional services, treasury services, financial consulting, investments, savings products, mutual funds and insurance brokerage.

 

This segment also consists of a Treasury Division which provides sophisticated financial products, mainly to companies in the Middle-market segment and Corporate Investment Banking. These include products such as short-term financing and fund raising, brokerage services, foreign exchange services, derivatives, securitization and other tailor-made products. The Treasury Division may act as broker to transactions and manages the Bank’s trading fixed income portfolio.

 

Corporate Activities (“Other”)

 

This segment mainly includes our Financial Management Division, which develops global management functions, including managing inflation rate risk, foreign currency gaps, interest rate risk and liquidity risk. Liquidity risk is managed mainly through wholesale deposits, debt issuances and the Bank’s available-for-sale portfolio. This segment also manages capital allocation by unit. These activities, with the exception of our inflation gap, usually result in a negative contribution to income.

 

In addition, this segment encompasses all the intra-segment income and all the activities not assigned to a given segment or product with customers.

 

The segments’ accounting policies are those described in the summary of accounting policies. The Bank earns most of its income in the form of interest income, fee and commission income and income from financial operations. To evaluate a segment’s financial performance and make decisions regarding the resources to be assigned to segments, the Chief Operating Decision Maker (CODM) bases his or her assessment on the segment’s interest income, fee and commission income, and expenses.

 

The tables below show the Bank’s results by reporting segment for the year ended December 31, 2020, in addition to the corresponding balances of loans and accounts receivable from customers:

 

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   For the year ended December 31, 2020
   Loans and accounts receivable at amortized cost (1)  Net interest income  Net fee and commission income  Financial transactions, net (2)  Provision for loan losses  Support expenses (3)  Segment’s net contribution
   (in millions of Ch$)
                      
Retail Banking    24,279,248    1,049,543    213,431    28,577    (317,050)   (596,464)   378,038 
Middle-market    8,136,402    346,225    38,335    21,859    (109,999)   (91,132)   205,287 
Corporate Investment Banking    1,635,217    114,229    23,180    82,303    (51,097)   (72,715)   95,900 
Other    289,026    83,851    (7,668)   17,058    (118)   (8,235)   84,888 
Total    34,339,893    1,593,848    267,278    149,797    (478,264)   (768,546)   764,113 
Other operating income                                  8,206 
Other operating expenses and impairment                                  (78,444)
Income from investments in associates and other companies                                  1,388 
Income tax expense                                  (142,533)
Result of continuous operations                                 552,730 
Result of discontinued operations                                 - 
Net income for the year                                  552,730 

____________________

(1)Corresponds to loans and accounts receivable at amortized cost under IFRS 9, without deducting their allowances for loan losses.

 

(2)Corresponds to the sum of the net income from financial operations and the foreign exchange profit or loss.

 

(3)Corresponds to the sum of personnel salaries and expenses, administrative expenses, depreciation and amortization.

 

Operations through Subsidiaries

 

The New General Banking Law permits us to directly provide the leasing and financial advisory services that we could formerly offer only through our subsidiaries, to offer investment advisory services outside of Chile and to undertake activities that we could not formerly offer directly or through subsidiaries, such as factoring, securitization, foreign investment funds, custody and transport of securities and insurance brokerage services. For the twelve–month period ended December 31, 2020, our subsidiaries collectively accounted for 1.9% of our total consolidated assets.

 

     

Percent ownership share as of December 31,

     

2020

 

2019

 

2018

Name of the Subsidiary

 

Main activity

 

Direct

 

Indirect

 

Total

 

Direct

 

Indirect

 

Total

 

Direct

 

Indirect

 

Total

      (in %)
Santander Corredora de Seguros Limitada   Insurance brokerage   99.75    0.01    99.76    99.75    0.01    99.76    99.75    0.01    99.76 
Santander Corredores de Bolsa Limitada   Financial instruments brokerage   50.59    0.41    51.00    50.59    0.41    51.00    50.59    0.41    51.00 
Santander Asesorias Financieras Limitada   Financial advisory   99.03        99.03    99.03        99.03    99.03        99.03 
Santander S.A. Sociedad Securitizadora   Purchase of credits and issuance of debt instruments   99.64        99.64    99.64        99.64    99.64        99.64 
Klare Corredora de Seguros S.A.  Insurance brokerage   50.10        50.10    50.10        50.10             
Santander Consumer Chile S.A.  Financing   51.00        51.00    51.00        51.00             
Sociedad operadora de Tarjetas de Pago Santander Getnet Chile S.A.  Card operator   99.99    0.01    100.00                         

  

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On July 6, 2020, we registered “Sociedad Operadora de Tarjeta de Pago Santander Getnet Chile S.A” as a new subsidiary and support company. On January 7, 2021, at the Extraordinary Shareholders’ Meeting of the “Sociedad Operadora de Tarjetas de Pago Santander Getnet Chile S.A.” the members agreed to pay total the subscribed and unpaid capital. Accordingly, “Santander Asesorías Financieras Limitada” will pay Ch$0,8 milllion in cash and Banco Santander Chile should pay Ch$37 million in cash plus assets whose appraisal determined by the Board were Ch$3,689 million, thus the shareholders will have paid 100% of the company’s capital. On January 29, 2021, the FMC through Resolution Exempt N°704 authorized the operation of “Sociedad Operadora de Tarjetas de Pago Santander Getnet Chile S.A.” as a banking support company and its registration in the Payment Card Operator Registry, thus authorizing its commercial activities.

 

As of December 18, 2019, changes were made to the company name and objective of Santander Agente de Valores Limitada, becoming Santander Asesorias Financieras Limitada.

 

As of October 19, 2019 Klare Corredores de Seguros S.A. was established as a digital insurance brokerage and is a banking subsidiary subject to banking regulations. The Bank owns 50.1% of the company’s capital share.

 

As of November 15, 2019 the FMC approved the acquisition of 51% of Santander Consumer Chile S.A. by the Bank. This acquisition had been previously approved in the extraordinary shareholders’ meeting held on July 20, 2019 where it was agreed that the Bank would acquire the ownership held by SK Bergé Financiamiento S.A. and a further 2% held by the Santander Group. The total payment for the total 51% was Ch$62,136 million.

 

The following companies have been consolidated based on the determination that they are controlled by the Bank, in accordance with IFRS 10 Consolidated Financial Statements:

 

·Santander Gestión de Recaudación y Cobranza Limitada (collection services)

 

·Bansa Santander S.A. (management of repossessed assets and leasing of properties)

 

·Multiplica SpA (management of co-branding agreements)

 

As of December 2019 the Bank no longer directly consolidates Bansa Santander S.A., however it is indirectly consolidated through Santander Consumer Chile S.A. Bansa has developed a new line of business, therefore, based on IFRS 10 Consolidated Financial Statement, the Bank has ceased to exercise control, since the Bank is not exposed, or has rights, to variable returns from its involvement with the investee.

 

On October 4, 2019 the company Multiplica SpA was created as a banking business support company. In accordance with IFRS 10 Consolidated Financial Statement, the Bank controls the entity, since the relevant activities are addressed by the Bank, and the Bank is exposed, or has rights, to variable returns from its involvement with the investee.

 

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The Bank also has significant influence over the following entities:

 

         Percentage of ownership share as of December 31,
         2020  2019  2018
Associates  Main activity  Place of Incorporation and operation  (in %)
Centro de Compensación Automatizado   Electronic fund transfer and compensation services  Santiago, Chile   33.33    33.33    33.33 
Sociedad Interbancaria de Depósito de Valores S.A.   Delivery of securities on public offer  Santiago, Chile   29.29    29.29    29.29 
Cámara Compensación de Alto Valor S.A.   Payments clearing  Santiago, Chile   15.00    15.00    15.00 
Administrador Financiero del Transantiago S.A.   Administration of boarding passes for public transportation  Santiago, Chile   20.00    20.00    20.00 
Servicios de Infraestructura de Mercado OTC S.A.   Administration of the infrastructure for the financial market of derivative instruments  Santiago, Chile   12.48    12.48    12.48 

 

In the case of Cámara Compensación de Pagos Alto Valor S.A., Banco Santander-Chile has a representative on the Board of Directors. As per the definition of associates, the Bank has concluded that it exerts significant influence over this entity.

 

In the case of Servicios de Infraestructura de Mercado OTC S.A., the Bank actively participates, through its executives, in the administration and in the process of organization, which is why the Administration has concluded that it exerts significant influence over it.

 

The Bank classifies the following entities as Assets Held for Sale and Discontinued Operations:

 

         Percentage of ownership share as of
December 31,
         2020  2019  2018
Associates  Main activity  Place of Incorporation and operation  (in %)
Sociedad Nexus S.A.   Credit card processor  Santiago, Chile       1.94    12.90 
Redbanc S.A.   ATM services  Santiago, Chile       33.43    33.43 
Transbank S.A.   Debit and credit card services  Santiago, Chile       25.00    25.00 

 

As of December 31, 2020, the Bank is in process to sell its share participation on Redbanc S.A. and Transbank S.A. therefore it has been classified in accordance to IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations” as investment available for sale. Given the facts and circumstances arising from the social contingency in Chile and the COVID-19 pandemic (situations beyond the control of the Bank), the process of sale of the shares has taken a longer time than initially estimated. However, the Bank continues committed to the sale plan for these assets, actively seeking for potential buyers and continuing its plans to develop its own acquiring network, as evidenced by the recent creation of a payment card operating company. The Bank sold its stake in Sociedad Nexus S.A. in October 2019 and January 2020. See Note 38 of our Audited Consolidated Financial Statements.

 

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Competition

 

Overview

 

The Chilean financial services market consists of a variety of largely distinct sectors. The most important sector, commercial banking, includes a number of privately-owned banks and one public-sector bank, Banco del Estado de Chile (which operates within the same legal and regulatory framework as the private sector banks). The private-sector banks include local banks and a number of foreign-owned banks operating in Chile. The Chilean banking system is comprised of 18 banks, including one public-sector bank. The six largest banks accounted for 87.2% of all outstanding loans by Chilean financial institutions as of December 31, 2020 (excluding assets held abroad by Chilean banks). In July 2018, Scotiabank Chile acquired BBVA Chile, becoming the third largest bank in terms of loans in the Chilean market. Furthermore, in the last quarter of 2018, BCI acquired the credit card financing business of Walmart Chile and the credit card of CMR Falabella was integrated into Banco Falabella. This represented an increase of total credit cards in the banking system of approximately 6%.

 

The Chilean banking system has experienced increased competition in recent years, largely due to consolidation in the industry and new legislation. We also face competition from non-bank and non-finance competitors, principally department stores, credit unions and cajas de compensación (private, non-profitable corporations whose aim is to administer social welfare benefits, including payroll loans, to their members) with respect to some of our credit products, such as credit cards, consumer loans and insurance brokerage. In addition, we face competition from non-bank finance competitors, such as leasing, factoring and automobile finance companies, with respect to credit products, and mutual funds, pension funds and insurance companies, with respect to savings products. Currently, banks continue to be the main suppliers of leasing, factoring and mutual funds, and the insurance sales business has grown rapidly.

 

All the competition data in the following sections is based on Chilean Bank GAAP.

 

The following tables set out certain statistics comparing our market position to that of our peer group, defined as the six largest banks in Chile in terms of total loans as of December 31, 2020 (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2020, unless otherwise noted
   Market Share  Rank
Commercial loans    16.5%   2 
Consumer loans    21.6%   1 
Residential mortgage loans    21.5%   1 
Total loans    18.6%   1 
Deposits    17.4%   2 
Credit card usage(1)    25.0%   1 
Checking accounts(2)    25.3%   1 
Branches(2)    19.0%   2 

____________________ 

Source: FMC

 

(1)As of October 2020, according to the latest publicly available information

(2)As of November 2020, according to the latest publicly available information

 

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Loans

 

As of December 31, 2020, our loan portfolio was the largest among Chilean banks. Our loan portfolio, including interbank loans, represented 18.6% of the market for loans in the Chilean financial system as of such date. The following table sets forth our and our peer group’s market shares in terms of loans (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2020 (Chilean Bank GAAP)
Loans  Ch$ million  U.S.$ million  Market Share
Santander-Chile    34,409,170    48,296    18.6%
Banco de Chile    31,496,591    44,208    17.0%
Banco de Crédito e Inversiones    26,451,150    37,126    14.3%
Banco del Estado de Chile    25,936,163    36,403    14.0%
Scotiabank Chile    25,430,916    35,694    13.7%
Itaú Corpbanca    17,625,148    24,738    9.5%
Others    23,742,744    33,325    12.8%
Chilean financial system    185,091,882    259,789    100.0%

____________________ 

Source: FMC.

 

Deposits

 

We had a 17.4% market share in deposits, ranking second among banks in Chile as of December 31, 2020. Deposit market share is based on total time and demand deposits as of the respective dates. The following table sets forth our and our peer group’s market shares in terms of deposits (excluding assets held by Chilean banks abroad).

 

   As of December 31, 2020 (Chilean Bank GAAP)
Deposits  Ch$ million  U.S.$ million  Market Share
Banco del Estado de Chile    30,696,893    43,085    21.3%
Santander-Chile    25,142,684    35,289    17.4%
Banco de Chile    24,066,770    33,779    16.7%
Banco de Crédito e Inversiones    18,671,533    26,207    12.9%
Scotiabank Chile    15,645,249    21,959    10.8%
Itaú Corpbanca    12,489,172    17,529    8.6%
Others    17,709,952    24,857    12.3%
Chilean financial system    144,422,253    202,706    100.0%

____________________ 

Source: FMC.

 

Total Equity

 

With Ch$3,567,916 million (U.S.$ 5,008 million) in equity in Chilean Bank GAAP as of December 31, 2020, we were the third largest commercial bank in Chile in terms of shareholders’ equity. The following table sets forth our and our peer group’s shareholders’ equity.

 

   As of December 31, 2020 (Chilean Bank GAAP)
Total Equity  Ch$ million  U.S.$ million  Market Share
Banco de Crédito e Inversiones    3,893,620    5,465    17.9%
Banco de Chile    3,726,267    5,230    17.2%
Santander-Chile    3,567,916    5,008    16.4%
Scotiabank Chile    2,398,357    3,366    11.0%
Itaú Corpbanca    2,315,411    3,250    10.7%
Banco del Estado de Chile    2,011,964    2,824    9.3%
Others    17,382,019    24,397    80.1%
Chilean financial system    21,709,394    30,471    100.0%

____________________ 

Source: FMC.

 

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Efficiency

 

As of December 31, 2020, we were the most efficient bank in our peer group. The following table sets forth our and our peer group’s efficiency ratio (defined as operating expenses as a percentage of operating revenue, which is the aggregate of net interest income, fees and income from services (net), net gains from mark-to-market and trading, exchange differences (net) and other operating income (net)) in each case under Chilean Bank GAAP.

 

Efficiency ratio as defined by the FMC  As of
December 31, 2020 (Chilean Bank GAAP)
Santander-Chile    42.0%
Banco de Chile    45.3%
Scotiabank Chile    45.7%
Banco de Crédito e Inversiones    50.9%
Banco del Estado de Chile    57.8%
Itaú Corpbanca    155.1%
Chilean financial system    57.1%

____________________ 

Source: FMC.

 

Net Income for the Period Attributable to Equity Holders

 

In 2020, we were the largest bank in Chile in terms of net income attributable to shareholders, which was equivalent to Ch$517,447 million (U.S.$ 726 million) measured under Chilean Bank GAAP. The following table sets forth our and our peer group’s net income.

 

   As of December 31, 2020 (Chilean Bank GAAP)
Net income attributable to equity holders  Ch$ million  U.S.$ million  Market Share
Santander-Chile    517,447    726    43.9%
Banco de Chile    463,108    650    39.3%
Banco de Crédito e Inversiones    317,454    446    26.9%
Scotiabank Chile    275,419    387    23.4%
Banco del Estado de Chile    142,595    200    12.1%
Itaú Corpbanca    (925,479)   (1,299)   - 
Others    388,771    546    33.0%
Chilean financial system    1,179,315    1,655    100.0%

____________________ 

Source: FMC.

 

Return on equity

 

As of December 31, 2020, we were the most profitable bank in our peer group (as measured by return on period-end equity under Chilean Bank GAAP) and the second most capitalized bank as measured by the Chilean BIS ratio. The following table sets forth our and our peer group’s return on average equity and BIS ratio.

 

   Return on period-end equity as of December 31, 2020 (Chilean Bank GAAP)  BIS Ratio as of November 30, 2020(Chilean Bank GAAP)
Santander-Chile    14.3%   14.7%
Banco de Chile    12.4%   15.6%
Scotiabank Chile    11.4%   12.9%
Banco de Crédito e Inversiones    8.2%   13.1%
Banco del Estado de Chile    7.7%   12.7%
Itaú Corpbanca    -38.9%   13.3%
Chilean financial system    5.6%   14.3%

____________________ 

Source: FMC.

 

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Asset Quality

 

As of December 31, 2020, we had the third lowest non-performing loan to loan ratio in our peer group. The following table sets forth our and our peer group’s non-performing loan ratio as defined by the FMC as of December 31, 2020.

 

   Non-performing loans / total loans(1) as of December 31, 2020(Chilean Bank GAAP)
Banco de Chile    1.0%
Banco de Crédito e Inversiones    1.2%
Santander-Chile    1.4%
Scotiabank Chile    1.4%
Itaú Corpbanca    2.3%
Banco del Estado de Chile    2.8%
Chilean financial system    1.6%

____________________ 

Source: FMC

 

(1)Excluding interbank loans.

 

Regulation and Supervision

 

General

 

In Chile, only banks may maintain checking accounts for their customers, conduct foreign trade operations, and, together with non-banking financial institutions, accept time deposits. The principal authorities that regulate financial institutions in Chile are the FMC and the Central Bank. Chilean banks are primarily subject to the General Banking Law, and secondarily subject, to the extent not inconsistent with this statute, to the provisions of the Chilean Companies Law governing public corporations, except for certain provisions which that expressly excluded.

 

The modern Chilean banking system dates from 1925 and has been characterized by periods of substantial regulation and state intervention, as well as periods of deregulation. The most recent period of deregulation commenced in 1975 and culminated in the adoption of a series of amendments to General Banking Law. That law was amended in 2001 to grant additional powers to banks, including general underwriting powers for new issues of certain debt and equity securities and the power to create subsidiaries to engage in activities related to banking, such as brokerage, investment advisory and mutual fund services, administration of investment funds, factoring, securitization products and financial leasing services. The most recent amendment to the General Banking Law was introduced by law 21,130, passed in January 2019, which modernizes Chile’s banking legislation by adopting capital and resolution standards in line with the requirements of the Basel Committee.

 

The Central Bank

 

The Central Bank is an autonomous legal entity created by the Chilean Constitution. It is subject to the Chilean Constitution and its own ley orgánica constitucional, or organic constitutional law. To the extent not inconsistent with the Chilean Constitution or the Central Bank’s organic constitutional law, the Central Bank is also subject to private sector laws (but in no event is it subject to the laws applicable to the public sector). It is directed and administered by a Board of Directors composed of five members designated by the President of Chile, subject to the approval of the Chilean Senate.

 

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The legal purpose of the Central Bank is to maintain the stability of the Chilean peso and the orderly functioning of Chile’s internal and external payment systems. The Central Bank’s powers include setting reserve requirements, regulating the amount of money and credit in circulation, establishing regulations and guidelines regarding finance companies, foreign exchange (including the Formal Exchange Market) and banks’ deposit-taking activities.

 

Financial Market Commission

 

In 2017, Law 21,000 created the Comisión para el Mercado Financiero or Financial Market Commission (FMC). This law became a Law of the Republic in January 2018. The FMC is the sole supervisor for the Chilean financial system overseeing insurance companies, companies with publicly traded securities, credit unions, credit card and prepaid card issuers, and, as of June 1, 2019, banks. It is the responsibility of this commission to ensure the proper functioning, development and stability of the financial market, facilitating the participation of market agents and defending public faith in the financial markets. To do so, it must maintain a general and systemic vision of the market, considering the interests of investors and policyholders. Likewise, it shall be responsible for ensuring that the persons or entities audited, from their initiation until the end of their liquidation, comply with the laws, regulations, statutes and other provisions that govern them.

 

The Commission is in charge of a Council, which is composed of five members, who are appointed and are subject to the following rules:

 

·A commissioner appointed by the President of Chile, of recognized professional or academic prestige in matters related to the financial system, which will have the character of president of the FMC.

 

·Four commissioners appointed by the President of Chile, from among persons of recognized professional or academic prestige in matters related to the financial system, by supreme decree issued through the Ministry of Finance, after ratification of the Senate by the four sevenths of its members in exercise, in session specially convened for that purpose.

 

The Council’s responsibilities include regulation, sanctioning and the definition of general supervision policies. In addition, there will be a prosecutor in charge of investigations and the Chairman will be responsible for supervision. The FMC will act in coordination with the Chilean Central Bank (BCCh).

 

The date of entry into operation of the Commission for the Financial Market was December 14, 2017. The Superintendency of Securities and Insurance was eliminated on January 15, 2018 and all functions of this Superintendency were absorbed by the FMC.

 

In January 2019, Law 21,130, which modernized the banking legislation contained in the General Banking Law and amended Law 21,000 (among others), was published in the Official Gazette. The law modernizes Chilean banking regulation in order to comply with Basel III practices and provisions. The law provides for stronger banking capital and reserves requirements in accordance with Basel III guidelines. The law also modernizes the corporate governance function of the FMC and, importantly, transfers the SBIF functions to the domain of the FMC. The FMC now has the faculty to determine the risk weighting of assets through a standardized model to be approved by the FMC or banks can implement their own methodology, subject to approval by the FMC. The law also imposes limitations on dividend distributions and puts in place intervention mechanisms in the event of insolvency.

 

The regulator examines all banks from time to time, generally at least once a year. Banks are also required to submit their financial statements monthly to the FMC, and the banks’ financial statements are published at least four times a year in a newspaper with countrywide coverage. In addition, banks are required to provide extensive information regarding their operations at various periodic intervals to the FMC. A bank’s annual financial statements and the opinion of its independent auditors must also be submitted to the FMC.

 

Any person wishing to acquire, directly or indirectly, 10.0% or more of the share capital of a bank must obtain the prior approval of the FMC. Absent such approval, the acquirer of shares so acquired will not have the right to vote. The FMC may only refuse to grant its approval, based on specific grounds set forth in the General Banking Law.

 

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According to Article 35bis of the New General Banking Law, the prior authorization of the regulator is required for:

 

·the merger of two or more banks;

 

·the acquisition of all or a substantial portion of a bank’s assets and liabilities by another bank;

 

·the control by the same person, or controlling group, of two or more banks; or

 

·a substantial increase in the existing control of a bank by a controlling shareholder of that bank.

 

The intended purchase, merger or expansion may be denied by the regulator with an accompanying resolution recording the specific reasons for denial and with agreement of a majority of the Board of Directors of the Central Bank.

 

Pursuant to the regulations of the FMC, the following ownership disclosures are required:

 

·a bank is required to inform the FMC of the identity of any person owning, directly or indirectly, 5.0% or more of such banks’ shares;

 

·holders of ADSs must disclose to the Depositary the identity of beneficial owners of ADSs registered under such holders’ names;

 

·the Depositary is required to notify the bank as to the identity of beneficial owners of ADSs which such Depositary has registered and the bank, in turn, is required to notify the FMC as to the identity of the beneficial owners of the ADSs representing 5.0% or more of such banks’ shares; and

 

·bank shareholders who individually hold 10.0% or more of a bank’s capital stock and who are controlling shareholders must periodically inform the FMC of their financial condition.

 

Limitations on Types of Activities

 

Chilean banks can only conduct those activities allowed by the General Banking Law: making loans, accepting deposits and, subject to limitations, making investments and performing financial services. Investments are restricted to real estate for the bank’s own use, gold, foreign exchange and debt securities. Through subsidiaries, banks may also engage in other specific financial service activities such as securities brokerage services, equity investments, securities, mutual fund management, investment fund management, financial advisory and leasing activities. Subject to specific limitations and the prior approval of the FMC and the Central Bank, Chilean banks may own majority or non-controlling interests in foreign banks.

 

Deposit Insurance

 

The Chilean government guarantees certain time and demand deposits and savings accounts held by natural persons with a maximum value of UF400 per person (Ch$ 11,628,132 or U.S.$ 16,349 as of December 31, 2020) per calendar year in the entire financial system and a maximum of UF200 per person per bank.

 

Reserve Requirements

 

Deposits are subject to a reserve requirement of 9.0% for demand deposits and 3.6% for time deposits (with terms of less than one year). For purposes of calculating the reserve obligation, banks are authorized to deduct daily from their foreign currency denominated liabilities, the balance in foreign currency of certain loans and financial investments held outside of Chile, the most relevant of which include:

 

·cash clearance account, which should be deducted from demand deposit for calculating reserve requirement;

 

·certain payment orders issued by pension providers; and

 

·the amount set aside for “technical reserve” (as described below), which can be deducted from reserve requirement.

 

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The Central Bank has statutory authority to require banks to maintain reserves of up to an average of 40.0% for demand deposits and up to 20.0% for time deposits (irrespective, in each case, of the currency in which they are denominated) to implement monetary policy. In addition, to the extent that the aggregate amount of the following types of liabilities exceeds 2.5 times the amount of a bank’s regulatory capital, a bank must maintain a 100.0% “technical reserve” against them: demand deposits, deposits in checking accounts, or obligations payable on sight incurred in the ordinary course of business, and in general all deposits unconditionally payable immediately but excluding interbank demand deposits.

 

Minimum Capital

 

Capital Adequacy Requirements under BIS I

 

Under the General Banking Law, a bank is required to have a minimum of UF800,000 (approximately Ch$23,256 million or U.S.$.32.7 million as of December 31, 2020) of paid-in capital and reserves, calculated in accordance with Chilean Bank GAAP, regulatory capital of at least 8.0% of its risk weighted assets, net of required allowances, and paid in capital and reserves of at least 3.0% of its total assets, net of required allowances, as calculated in accordance with Chilean Bank GAAP.

 

Regulatory capital is defined as the aggregate of:

 

·a bank’s paid-in capital and reserves, excluding capital attributable to subsidiaries and foreign branches or capital básico;

 

·its subordinated bonds, valued at their placement price (but decreasing by 20.0% for each year during the period commencing six years prior to maturity), for an amount up to 50.0% of its core capital; and

 

·its voluntary allowances for loan losses for an amount of up to 1.25% of risk weighted-assets.

 

Capital Adequacy Requirements

 

According to the General Banking Law, a bank is required to have regulatory capital of at least 8.0% of its risk-weighted assets, net of required loan loss allowances, and paid-in capital and reserves (i.e., core capital) of at least 3.0% of its total assets, net of required loan loss allowances. For these purposes, the regulatory capital of a bank is the sum of: (1) the bank’s core capital; (2) subordinated bonds issued by the bank valued at their placement price for an amount up to 50.0% of its core capital, provided that the value of the bonds is required to be decreased by 20.0% for each year that elapses during the period commencing six years prior to their maturity; and (3) its voluntary allowances for loan losses, for an amount of up to 1.25% of its risk-weighted assets. Santander-Chile does not have goodwill, but if it did, this value would be required to be deducted from regulatory capital. When calculating risk weighted assets, we also include off-balance sheet contingent loans. The merger of Old Santander Chile and Santiago on August 1, 2002 required a special regulatory pre-approval of the SBIF (predecessor of the FMC), which was granted on May 16, 2002. The resolution granting this pre-approval imposed a regulatory capital to risk weighted assets ratio of 12.0% for the merged bank. This requirement was reduced to 11.0% by the SBIF (now the FMC) effective January 1, 2005. For purposes of weighing the risk of a bank’s assets, the General Banking Law considers five different categories of assets, based on the nature of the issuer, the availability of funds, and the nature of the assets and the existence of collateral securing such assets.

 

As of December 31, 2020 our ratio of regulatory capital to risk weighted assets was 15.4%.

 

New Capital Adequacy Requirements under the New Banking Law

 

On October 9, 2020, the FMC published the final regulations on regulatory capital to comply with effective net worth rules in accordance with Basel III and the New General Banking Law. The new regulation will become effective on December 1, 2021 and will be gradually implemented and adjusted to be fully in place by December 1, 2025. Pursuant to the proposed regulation, there will be three levels of capital: ordinary capital level 1 or CET1 (basic capital), additional capital level 1 or AT1 (perpetual bonds and preferred stock) and capital level 2 or T2 (subordinated bonds and voluntary provisions). Regulatory capital will be composed of the sum of CET1, AT and T2 after making some deductions, mainly for intangible assets, hybrid securities issued by foreign subsidiaries, partial deduction for deferred taxes and some reserve and profit accounts.

 

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Under the New General Banking Law, minimum capital requirements have increased in terms of amount and quality. Total Regulatory Capital remains at 8% of risk-weighted assets which includes credit, market and operational risk. Minimum Tier 1 capital increased from 4.5% to 6% of risk-weighted assets, of which up to 1.5% may be Additional Tier 1 (AT1), either in the form of preferred shares or perpetual bonds, both of which may be convertible to common equity. The FMC also establishes the conditions and requirements for the issuance of perpetual bonds and preferred equity. Tier 2 capital is now set at 2% of risk-weighted assets.

 

Additional capital demands are incorporated through a Conservation Buffer of 2.5% of risk-weighted assets. The Central Bank may set an additional Counter Cyclical Buffer of up to 2.5% of risk-weighted assets in agreement with the FMC. Both buffers must be comprised of core capital.

 

On November 2, 2020 the FMC published the final guidelines regarding the identification and core capital charge for banks considered SIBs. The FMC, agreement with the Central Bank, also imposed additional capital requirements for SIBs of between 1-3.5% of risk-weighted assets. This additional capital requirement will be gradually phased in by 25% beginning on December 2021 until December 2025. With the implementation of additional capital requirements for SIBs, the requirement imposed on Banco Santander Chile to have a minimum regulatory capital ratio of 11% compared to the 8% limit for most other banks in Chile will be gradually phased out and replaced by the new regulatory requirements for a SIB.

 

There are a total of four factors that are weighted to reach a market share:

 

5.Size (weighted at 30%): Includes total assets consolidated in the domestic market.

 

6.Domestic interconnection (weighted at 30%): Includes assets and liabilities with financial institutions (banks and non-banks) and assets in circulation in the Chilean financial market (equity and fixed income).

 

7.Domestic substitution (weighted at 20%): Includes the share in local payments, assets in custody, deposits and loans.

 

8.Complexity (weighted at 20%): Includes factors that could lead to greater difficulties regarding costs and/ or time for the orderly resolution of the Bank. These include the notional amount of OTC derivatives, inter-jurisdictional assets and liabilities and available-for-sale assets.

 

The minimum amount of the sum of the factors to be considered systemic is 1000 bp, equivalent to a weighted participation of 10% of all four factors. The core capital additional charge depends on the size of the total factor, as set out in the table below:

 

Systemic Level Range (bp) Core capital additional charge (% of risk-weighted assets)
I 1000-1300 1.0%-1.25%
II 1300-1800 1.25%-1.75%
III 1800-2000 1.75%-2.5%
IV >=2000 2.5%-3.5%

 

The Central Bank may also require for a SIB: (1) the addition of up to 2% to the core capital to a bank’s total assets ratios; (2) a reduction in the technical reserve requirement trigger from 2.5 times regulatory capital to 1.5 times regulatory capital; and/or (3) a reduction in the interbank loan limit to 20% of regulatory capital of any SIB.

 

The initial systemic level calculation for Chilean banks will be published in March 2021 using a bank’s balance sheet figures as of year-end 2020. Given our size and market share, it is likely that we will be classified as level II or III SIB.

 

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The New General Banking Law also incorporates Pillar II capital requirements with the objective of assuring an adequate management of risk. The objective of this pillar is to ensure that banks maintain capital levels that are consistent with their risk profile and business model and encourages the development and use of appropriate processes to monitor and manage their risks. Pillar 2 also granted the regulators the power to impose greater capital requirements as a result of deficient evaluations of a bank’s internal capital adequacy assessment process (ICAAP), which should consider a bank’s risk profile and a strategy to sustain adequate levels of capital, even under stress scenarios. Pillar 2 also focuses on risks not considered in Pillar 1 such as reputational risks, concentration risks, liquidity risks and interest rate risks. The FMC, with at least four votes from the Council of the FMC, will have the power to impose additional regulatory capital demands of up to 4% of risk-weighted assets, either Tier I or Tier II, if it determines that the previous capital levels and buffers are not enough for a particular financial institution.

 

The following table sets forth a comparison between the regulatory capital demands under the previous law, and those under the New General Banking Law:

 

Minimum capital requirements: Basel III, previous GBL and new requirements

Capital categories

 

Previous Law

 

New General Banking Law

(% over risk weighted assets)
(1) Shareholders’ Equity   4.5   4.5
(2) Additional Tier 1 Capital (AT1)     1.5
(3) Total Tier 1 Capital (1+2)   4.5   6
(4) Tier 2 Capital   3.5   2
(5) Total Regulatory Capital (3+4)  

8

 

(6) Conservation Buffer       2.5 CET1
(7) Total Equity Requirement (5+6)  

 

10.5 

(8) Counter Cyclical Buffer     up to 2.5 CET1
(9) SIB* Requirement  

Up to 6% in case of a merger

  Between 1 - 3.5 CET1
(10) Pillar 2  

2% over regulatory capital in order to be classified in Category A solvency.

  Up to 4% CET1 or Tier 2

____________________

* Systemically Important Banks

 

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Risk Weightings

 

On December 1, 2020 the FMC published the final regulations to establishing risk weightings for calculating capital adequacy ratios under the New Banking Law.

 

The Basel Committee on Banking Supervision (BCBS) defines credit risk (CR) as the risk that a debtor or bank counterparty does not meet its obligations in accordance with the agreed terms. Credit risk is the most relevant in the Chilean banking industry. The mechanism in force today estimates Risk Weighted Assets by Credit Risk (RWCR) using a methodology based on the Basel I standard. The proposed standard method with Basel III standards is more advanced, since it has categories that depend on the type of counterparty and different risk factors. These categories are not based on accounting criteria, but rather on the underlying risk. Thus, all exposures that have mortgage guarantees, for example mortgage loans for housing, have a different treatment from those exposures not guaranteed by a mortgage. Additionally, in the case of mortgage-backed exposures, there will be different types of treatment depending on the type of real estate and whether the obligations are paid with income generated by the property itself. The new framework will also allow the use of internal methodologies, subject to compliance with minimum requirements. The standard in consultation includes the possibility of reducing RWCR when considering credit risk mitigators, such as compensation agreements, guarantees and other compensations.

 

The Basel Committee on Banking Supervision (BCBS) defines operational risk (OR) as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. This definition includes legal risk but excludes strategic and reputational that a debtor or bank counterparty does not meet its obligations in accordance with the agreed terms. In order to estimate the operational risk coefficient, two factors are considered:

 

1.The business indicator component (BIC): A component that considers interest income, interest earning assets, dividend income, financial transactions, fees, and other operational income and expenses. These are then multiplied by a marginal coefficient.

 

2.Internal Loss Multiplier (ILM): This component is based on 10 years of historical operational losses, or at least five years in some special cases.

 

BCBS defines market risk (MR) as the risk of losses arising from movements in market prices. The risks subject to market risk capital requirements mainly includes: interest rate risk, credit spread risk, equity risk, foreign exchange (FX) risk and commodities risk for trading book instruments; and FX risk and commodities risk for banking book instruments. The FMC will not permit banks to use internal models for calculating MRWA and instead has published standardized models that all banks must use.

 

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The regulations for calculating RWA under the new guidelines must be implemented by December 1, 2021. We believe our current capital levels are adequate, but we cannot rule out having to raise additional capital in the future in order to maintain our capital adequacy ratios above the minimum required by the FMC.

 

Lending Limits

 

Under the General Banking Law, Chilean banks are subject to certain lending limits, including the following material limits:

 

·A bank may not extend to any entity or individual (or any one group of related entities), except for another financial institution, directly or indirectly, unsecured credit in an amount that exceeds 10.0% of the bank’s regulatory capital, or in an amount that exceeds 30.0% of its regulatory capital if the excess over 10.0% is secured by certain assets with a value equal to or higher than such excess. In the case of financing infrastructure projects built by government concession, the 10.0% ceiling for unsecured credits is raised to 15.0% if secured by a pledge over the concession, or if granted by two or more banks or finance companies which have executed a credit agreement with the builder or holder of the concession in the case of export loans in foreign currency the ceiling is raised to 30%;

 

·a bank may not extend loans to another financial institution subject to the General Banking Law in an aggregate amount exceeding 30.0% of its regulatory capital;

 

·a bank may not grant loans to a single business group, as defined in Title XV of Law 18.045, that exceeds 30% of the Bank’s regulatory capital. This limit excludes interbank loans.

 

·if a bank originates a loan in excess of these limits, a fine equivalent to 10% of the excess will be applied to the bank.

 

·a bank may not directly or indirectly grant a loan whose purpose is to allow an individual or entity to acquire shares of the lender bank;

 

·a bank may not lend, directly or indirectly, to a director or any other person who has the power to act on behalf of the bank; and

 

·a bank may not grant loans to related parties (including holders of more than 1.0% of its shares) on more favorable terms than those generally offered to non-related parties. Loans granted to related parties are subject to the limitations described in the first bullet point above. In addition, the aggregate amount of loans to related parties may not exceed a bank’s regulatory capital.

 

In addition, the General Banking Law limits the aggregate amount of loans that a bank may grant to its employees to 1.5% of its regulatory capital, and provides that no individual employee may receive loans in excess of 10.0% of this 1.5% limit. Notwithstanding these limitations, a bank may grant to each of its employees a single residential mortgage loan for personal use during such employee’s term of employment.

 

Allowance for Loan Losses under Chilean Bank GAAP

 

Chilean banks are required to provide to the FMC detailed information regarding their loan portfolio on a monthly basis. The FMC examines and evaluates each financial institution’s credit management process, including its compliance with the loan classification guidelines. Banks are classified into four categories: 1, 2, 3 and 4. Each bank’s category depends on the models and methods used by the bank to classify its loan portfolio, as determined by the FMC. Category 1 banks are those banks whose methods and models are satisfactory to the FMC. Category 1 banks will be entitled to continue using the same methods and models they currently have in place. A bank classified as a category 2 bank will have to maintain the minimum levels of reserves established by the FMC while its Board of Directors will be made aware of the problems detected by the FMC and required to take steps to correct them. Banks classified as categories 3 and 4 will have to maintain the minimum levels of reserves established by the FMC until they are authorized by the FMC to do otherwise. Santander-Chile is categorized as a “Category 1” bank.

 

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Differences between IFRS and Chilean Bank GAAP

 

Chilean Bank GAAP, as prescribed by the Compendium of Accounting Standards (the “Compendium”), differs in certain respects from IFRS. The main differences that should be considered by an investor are the following:

 

Suspension of Income Recognition on Accrual Basis

 

In accordance with the Compendium, financial institutions must suspend recognition of income on an accrual basis in their statements of income for certain loans included in the impaired portfolio. IFRS 9 and IAS 39 did not allow the suspension of accrual of interest on financial assets for which an impairment loss has been determined. As of January 1, 2018, the Bank adopted IFRS 9. Under IFRS 9, interest income is calculated by applying the effective interest rate to the gross carrying amount of financial assets, except for financial assets that have subsequently become credit-impaired (or “Stage 3”), for which interest revenue is calculated by applying the effective interest rate to their amortized cost (i.e., net of ECL provision). Off-balance interests are recorded as interest income only if the Bank receives the related payments. This difference does not materially impact our Audited Consolidated Financial Statements.

 

Charge-offs and Accounts Receivable

 

The Compendium requires companies to establish deadlines for the charge-off of loans and accounts receivable. IFRS does not require any such deadline for charge-offs. A charge-off due to impairment would be recorded, if and only if, all efforts at collection of the loan or account receivable had been exhausted. Accordingly, this difference does not materially impact our Audited Consolidated Financial Statements.

 

Assets Received in Lieu of Payment

 

The Compendium requires that the initial value of assets received in lieu of payment be the value agreed upon with a debtor as a result of the loan settlement or the value awarded in an auction, as applicable. These assets are required to be written off one year after their acquisition, if the assets have not been previously disposed of. IFRS requires that assets received in lieu of payment be initially accounted for at fair value. Subsequently, asset valuation depends on the classification provided by the entity for that type of asset. No deadline is established for charging-off an asset. The Bank has adjusted the Audited Consolidated Financial Statements accordingly.

 

Loan Loss Allowances

 

Prior to the adoption of IFRS 9 on January 1, 2018, the Bank calculated loan loss allowances in accordance with IAS 39. The main difference between Chilean Bank GAAP and IFRS 9 and IAS 39 regarding loan loss allowances is that loan loss allowances under Chilean GAAP are calculated using expected loss models based on specific guidelines set by the FMC, which in turn are based on an expected losses approach while IAS 39 used an incurred loss approach. According to both Chilean Bank GAAP and IFRS, loan loss allowances are calculated using expected loss models. The models adopted with IFRS 9 used an expected loss approach, however these are not in accordance with specific guidelines under Chilean Bank GAAP given by the FMC. The FMC has not yet adopted IFRS 9 and therefore the Bank has adjusted the Audited Consolidated Financial Statements to fully comply with IFRS standards. The most significant impact of IFRS 9 on the Bank’s financial statements arises from the new impairment requirements. Impairment losses will increase and become more volatile for financial instruments in the scope of the IFRS 9 impairment model. Based on the assessment made the total impact (net of tax) of the adoption of IFRS 9 on the opening balance on the Bank’s equity at 1 January 2018 was Ch$82,454 million (net of tax).

 

Provisions for Country Risk and for Contingent Loan Risk

 

Under Chilean Bank GAAP, the Bank provisions for country risk to cover the risk taken when holding or committing resources with any foreign country. These allowances are established according to country risk classifications established by the FMC and therefore are not in accordance with IFRS as issued by the IASB. Our Audited Consolidated Financial Statements have been adjusted accordingly.

 

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Also under Chilean Bank GAAP, the Bank has established allowances related to the undrawn available credit lines and contingent loans in accordance with the FMC. Prior to the adoption of IFRS 9, IAS 39 only permitted allowances following internal models based on incurred debt. With the adoption of IFRS 9, provisions for contingent loans are calculated based on expected credit loss. The Bank has adjusted the Audited Consolidated Financial Statements accordingly.

 

These differences do not materially impact our financial statements.

 

Equity instrument at FVOCI

 

Under IFRS 9, the Bank may make an irrevocable election to present subsequent changes in the fair value of the equity instrument in other comprehensive income. Gains or losses on derecognition of these equity instruments are not transferred to profit or loss. Under Chilean GAAP, the Bank can apply IAS 39 and accordingly, account those equity instruments at cost. The Bank’s Audited Consolidated Financial Statements have been adjusted accordingly.

 

Loans at FVOCI

 

The Bank has determined to classify a small portion of its portfolio loans as fair value through other comprehensive income, when management expects to sell if market conditions are favorable, or when the Financial Risk Committee authorizes an operation to be sold entirely or in part. For IFRS 9 purposes, the Bank reclassifies those loans into a separate portfolio and determines its fair value. Under Chilean GAAP, those loans are accounted at amortized cost.

 

Deferred taxes

 

The Bank records, when appropriate, deferred tax assets and liabilities for the estimated future tax effects attributable to differences between the carrying amount of assets and liabilities and their tax bases. Due to the adjustments made to the consolidated financial statements, we adjust deferred taxes accordingly.

 

Provision for Mandatory Dividends

 

This provision is made in accordance with the Bank’s internal policy and Article 79 of the Chilean Companies Law, pursuant to which at least 30% of net income for the period is distributed, except in the case of a contrary resolution adopted at the respective shareholders’ meeting by unanimous vote of the outstanding shares. While the Bank uses the same policy under Chilean Bank GAAP and IFRS, the net income used to calculate the provision is adjusted in accordance with IFRS principles. However, for the distribution of dividends, the Bank uses the net income according to Chilean Bank GAAP.

 

Capital Markets

 

Under the General Banking Law, banks in Chile may purchase, sell, place, underwrite and act as paying agents with respect to certain debt securities. Likewise, banks in Chile may place and underwrite certain equity securities. Bank subsidiaries may also engage in debt placement and dealing, equity issuance advice and securities brokerage, as well as in financial leasing, mutual fund and investment fund administration, investment advisory services and merger and acquisition services. These subsidiaries are regulated by the FMC.

 

Legal Provisions Regarding Banking Institutions with Economic Difficulties

 

Article 112 of the New General Banking Law provides that if specified adverse economic circumstances exist at any bank, its Board of Directors must approve a financing plan to correct the situation and present it to the FMC. In its proposal, the bank must state the scheduled time within which the plan will be completed, which may not exceed 6 months. If one of the measures contained in the financing plan is to increase the capital of the bank by the amount necessary to return the bank to financial stability, the Board of Directors must call a special shareholders’ meeting to the capital increase. If the shareholders reject the capital increase, the FMC may apply one or more of the restrictions stated in Article 116 of the New General Banking Law for a period not exceeding 6 months, which may be renewed once for the same period. These restrictions include limiting the bank’s ability to grant loans to any person or legal entity linked (directly or through third parties) to the property or management of the bank, limiting loan renewals for more than 180 days, limiting security documents governing existing loans, among others.

 

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If the approval of shareholders is required for a different measure included in the plan, the Board of Directors must call the shareholders’ meeting within 15 days. The General Banking Law provides that the bank may receive a three-year term loan from one or more banking institutions. The terms and conditions of such a loan must be approved by the directors of both banks, as well as by the FMC, but need not be submitted to any institution’s shareholders for their approval. In any event, a creditor bank cannot grant interbank loans to an insolvent bank in an amount exceeding 25.0% of the creditor bank’s regulatory capital. If the bank is unable to pay the loan to its creditors, article 115 of the General Banking Law provides that a bank’s unpaid debt may be: (i) capitalized in a merger between the bank and creditor bank, where the creditor bank may establish the terms and conditions of the merger provided such terms and conditions are approved by the FMC; (ii) used to complete a capital increase agreed by the bank, provided that the shares are issued by a third party; and (iii) to subscribe and pay a capital increase. The shares acquired by the creditor bank must be sold within a period of 180 days, which can be extended by the FMC for a further 180 days.

 

Dissolution and Liquidation of Banks

 

The FMC may establish that a bank should be liquidated for the benefit of its depositors or other creditors when such bank does not have the necessary solvency to continue its operations. In such case, the FMC must revoke a bank’s authorization to exist and order its mandatory liquidation, subject to agreement by the Central Bank. The FMC must also revoke a bank’s authorization if the reorganization plan of such bank has been rejected twice. The resolution by the FMC must state the reason for ordering the liquidation and must name a liquidator, unless the FMC assumes this responsibility. When a liquidation is declared, all checking accounts and other demand deposits received in the ordinary course of business, are required to be paid by using existing funds of the bank, its deposits with the Central Bank or its investments in instruments that represent its reserves. If these funds are insufficient to pay these obligations, the liquidator may seize the rest of the bank’s assets, as needed. If necessary and in specified circumstances, the Central Bank will lend the bank the funds necessary to pay these obligations. Any such loans are preferential to any claims of other creditors of the liquidated bank.

 

On January 12, 2019, Law No. 21,130 was published in the Official Gazette of Chile. The law modernizes banking legislation including the General Banking Law by, among other things, transferring the supervisory powers of the SBIF to the FMC, updating the capital and risk management requirements applicable to banking companies in accordance with the Basel III standards, and introducing measures for the early regularization and intervention of banking companies that are at risk of insolvency.

 

With respect to measures for early regularization, Law No. 21,130 establishes an obligation on banks to inform the FMC if any of the regulatory non-compliance situations listed in Article 112 of the New General Banking Law arise or if it has detected any event indicative of financial instability or deficient administration. Within five days of notifying the FMC, the bank must present a regularization plan approved by its board of directors containing concrete measures that shall remedy the relevant situation and ensure the bank’s normal performance. The bank must comply with the regularization plan within 6 months of the resolution approving it. During the implementation of the plan, the bank must also submit periodic reports on its progress to the FMC, and the FMC may require the implementation of additional measures and/or prohibitions it deems necessary for the plan’s success.

 

Article 161 of the New General Banking Law provides that directors, managers, administrators and attorneys-in-fact who, without written authorization from the FMC, agree to, perform or cause the execution of any of the acts prohibited under Article 116 of the New General Banking Law shall be imprisoned for a term within the medium to maximum range. If a bank fails to submit the regularization plan, the plan is rejected by the FMC, the bank fails to comply with any of the measures set out in the plan, the bank repeatedly breaches the plan’s terms or is subject to fines, or if any serious event occurs that raises concerns for the bank’s financial stability, the FMC may appoint a delegated inspector, who shall have powers to, among other things, suspend any agreement of the board of directors or act of the attorneys-in-fact of the institution, and/or a provisional administrator, who shall have all the ordinary faculties that the law and the by-laws provide for the board of directors, or whoever acts in its place, and for the general manager.

 

Other amendments incorporated by Law No. 21,130 include the elimination of creditors’ agreements as a mechanism for regularizing a bank’s financial situation, the incorporation of modifications to financial system capitalization and preventive capitalization, and the incorporation of further requirements for bank directors.

 

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Obligations Denominated in Foreign Currencies

 

Santander-Chile must also comply with various regulatory and internal limits regarding exposure to movements in foreign exchange rates (See “Item 11. Quantitative and Qualitative Disclosures About Market Risk”).

 

Loans and Investments in Foreign Securities

 

Under current Chilean banking regulations, banks in Chile may grant loans to foreign individuals and entities and invest in certain securities of foreign issuers. Banks may grant commercial loans and foreign trade loans, and can buy loans granted by banks abroad. Banks in Chile may also invest in debt securities traded in formal secondary markets. Such debt securities must be (1) securities issued or guaranteed by foreign sovereign states or their central banks or other foreign or international financial entities, and (2) bonds issued by foreign companies. If the sum of investment in foreign securities and loans granted outside of Chile surpasses 70.0% of regulatory capital, the amount that exceeds 70.0% is subject to a mandatory reserve of 100.0%.

 

Table 1

 

Rating Agency  Short Term  Long Term
Moody’s   P2  Baa3
Standard and Poor’s   A3  BBB-
Fitch   F2  BBB-
Dominion Bond Rating (DBRS)   R-2  BBB (low)

 

In the event that the sum of: (a) loans granted abroad that are not to subsidiaries of Chilean companies, and that have a rating of BB- or less and do not trade on a foreign stock exchange, and (b) the investments in foreign securities which have a rating that is below that indicated in Table 1 above, but is equal to or exceeds the ratings mentioned in the Table 2 below and exceeds 20.0% (and 30.0% for banks with a BIS ratio equal or exceeding 10% of the regulatory capital of such bank), the excess is subject to a mandatory reserve of 100.0%.

 

Table 2

 

Rating Agency  Short Term  Long Term
Moody’s   P2  Ba3
Standard and Poor’s   A-2  BB-
Fitch   F2  BB-
Dominion Bond Rating (DBRS)   R-2  BB (low)

 

In addition, banks may invest in foreign securities whose ratings are equal or exceed those mentioned in Table 3 below for an additional amount equal to 70% of their regulatory capital. This limit constitutes an additional margin and is not subject to the 100% mandatory reserve.

 

Additionally, a Chilean bank may invest in foreign securities whose rating is equal to or exceeds those mentioned in Table 3 below in: (i) demand deposits with foreign banks, including overnight deposits in a single entity; and (ii) securities issued or guaranteed by sovereign states or their central banks or securities issued or guaranteed by foreign entities within the Chilean State, though investment will be subject to the limits by issuer up to 30.0% and 50.0%, respectively, of the regulatory capital of the Chilean bank that makes the investment. If these foreign securities do not have a rating, the individual limit will be 10.0% of regulatory capital.

 

Table 3

 

Rating Agency  Short Term  Long Term
Moody’s   P1  Aa3
Standard and Poor’s   A1+  AA-
Fitch   F1+  AA-
DBRS   R-1 (high)  AA(low)

 

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Moreover, the sum of all demand deposits with foreign banks, including overnight deposits to related parties, as defined by the Central Bank and the FMC cannot surpass 25.0% of a bank’s regulatory capital. This limit excludes foreign branches of Chilean banks or their subsidiaries, but must include amounts deposited by these entities in related parties abroad.

 

Chilean banks may only invest in equity securities of foreign banks and certain other foreign companies which may be affiliates of the bank or which would be complementary to the bank’s business if such companies were incorporated in Chile.

 

United States Supervision and Regulation

 

Financial Regulatory Reform

 

Banking statutes and regulations are continually under review by the United States Congress. In addition to laws and regulations, the U.S. bank regulatory agencies may issue policy statements, interpretive letters and similar written guidance. Many changes have occurred as a result of the 2010 Dodd-Frank Act and its implementing regulations, most of which are now in place. More recently, there have been several statutory and regulatory initiatives aimed at providing relief for the financial services industry. In 2018 the United States government enacted the Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) which, among other things, revised the thresholds for total consolidated assets at which certain enhanced prudential standards apply to bank holding companies. EGRRCPA made clear that the Board of Governors of the Federal Reserve System (the “Federal Reserve Board”) retains the right to apply enhanced prudential standards to foreign banking organizations (“FBOs”) with greater than $100 billion in global total consolidated assets, such as Santander Spain.

 

In October 2019, the federal banking agencies issued final rules that, pursuant to EGRRCPA, adjust the thresholds at which certain enhanced prudential standards and capital and liquidity requirements apply to certain banking organizations, including large FBOs such as Santander Spain. As a result, Santander Spain is now generally subject to less restrictive enhanced prudential standards and capital and liquidity requirements than under previously applicable regulations.

 

In November 2020 the United States held national elections and a new administration is now in place. We believe that it is likely that there will be further material changes in the way major financial institutions are regulated in the United States. Although it remains difficult to predict the exact impact these changes will have on Santander Spain’s U.S. operations, the new administration is expected to increase the regulatory requirements on large financial institutions compared to the previous administration.

 

Volcker Rule

 

Section 13 of the U.S. Bank Holding Company Act of 1956, as amended, and its implementing rules (collectively, the “Volcker Rule”) prohibit “banking entities” from engaging in certain forms of proprietary trading or from sponsoring or investing in “covered funds,” in each case subject to certain exceptions. The Volcker Rule also limits the ability of banking entities and their affiliates to enter into certain transactions with covered funds with which they or their affiliates have certain relationships. Banking entities such as Santander-Chile and Santander Spain were required to bring their activities and investments into compliance with the requirements of the Volcker Rule by the end of the conformance period applicable to each requirement. Santander Spain has assessed how the Volcker Rule affects its businesses and subsidiaries, including Santander-Chile, and has brought its activities into compliance. The Group has adopted processes to establish, maintain, enforce, review and test the compliance program designed to achieve and maintain compliance with the Volcker Rule. The Volcker Rule contains exclusions and certain exemptions for market-making, hedging, underwriting, trading in U.S. government and agency obligations, as well as certain foreign government obligations, and trading solely outside the United States, and also permits certain ownership interests in certain types of funds to be retained. Santander Spain’s non-U.S. banking organization subsidiaries, including Santander-Chile, are largely able to continue their activities outside the United States in reliance on the “solely outside the U.S.” exemptions from the Volcker Rule. Those exemptions generally exempt proprietary trading, and sponsoring or investing in covered funds if, among other restrictions, the essential actions take place outside the United States and any transactions are not with U.S. persons.

 

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On July 21, 2017 the five regulatory agencies charged with implementing the Volcker Rule announced the coordination of reviews of the treatment of certain foreign funds that are investment funds organized and offered outside of the United States and that are excluded from the definition of covered fund under the agencies’ implementing regulations. Also, in July 2017, the Federal Reserve issued guidelines for banking entities seeking an extension to conform certain “seeding” investments in covered funds to the requirements of the Volcker Rule.

 

As of October 2019, the five regulatory agencies charged with implementing the Volcker Rule finalized amendments to the Volcker Rule. These amendments tailor the Volcker Rule’s compliance requirements to the amount of a firm’s trading activity, revise the definition of trading account, clarify certain key provisions in the Volcker Rule, and modify the information companies are required to provide the federal agencies. Santander-Chile will still largely rely on the “solely outside the U.S. exemption” to conduct its trading activities.

 

In June 2020, the five federal agencies finalized additional amendments to the Volcker Rule related to the restrictions on ownership interests in and relationships with covered funds. These amendments became effective on October 1, 2020 with no impact on Santander Chile. Santander Spain will continue to monitor Volcker Rule-related developments and assess their impact on its operations, including those of Santander-Chile, as necessary.

 

U.S. Anti-Money Laundering, Anti-Terrorist Financing, and Foreign Corrupt Practices Act Regulations

 

Santander-Chile, as a foreign private issuer whose securities are registered under the U.S. Securities Exchange Act of 1934, is subject to the U.S. Foreign Corrupt Practices Act (the “FCPA”). The FCPA generally prohibits such issuers and their directors, officers, employees and agents from using any means or instrumentality of U.S. interstate commerce in furtherance of any offer or payment of money to any foreign official or political party for the purpose of influencing a decision of such person in order to obtain or retain business. It also requires that the issuer maintain books and records and a system of internal accounting controls sufficient to provide reasonable assurance that accountability of assets is maintained, and accurate financial statements can be prepared. Penalties, fines and imprisonment of Santander-Chile’s officers and/or directors can be imposed for violations of the FCPA.

 

Furthermore, Santander-Chile is subject to a variety of U.S. anti-money laundering and anti-terrorist financing laws and regulations, such as the Bank Secrecy Act of 1970, as amended, and the USA PATRIOT Act of 2001, as amended, and a violation of such laws and regulations may result in substantial penalties, fines and imprisonment of Santander-Chile’s officers and/or directors.

 

The Anti-Money Laundering Act of 2020 (“AML Act”), enacted on January 1, 2021 as part of the National Defense Authorization Act, does not directly impose new requirements on banks, but requires the U.S. Treasury Department to issue National Anti-Money Laundering and Countering the Financing of Terrorism Priorities, and conduct studies and issue regulations that may, over the next few years, significantly alter some of the due diligence, recordkeeping and reporting requirements that the Bank Secrecy Act and Patriot Act impose on banks. The AML Act also contains provisions that promote increased information-sharing and use of technology, and increases penalties for violations of the Bank Secrecy Act and includes whistleblower incentives, both of which could increase the prospect of regulatory enforcement.

 

Disclosure pursuant to Section 219 of the Iran threat reduction and Syria human rights act

 

Pursuant to Section 219 of the Iran Threat Reduction and Syria Human Rights Act of 2012, which added Section 13(r) to the Securities Exchange Act of 1934, as amended (the “Exchange Act”), an issuer is required to disclose in its annual or quarterly reports, as applicable, whether it or any of its affiliates knowingly engaged in certain activities, transactions or dealings relating to Iran or with individuals or entities designated pursuant to certain Executive Orders. Disclosure is generally required even where the activities, transactions or dealings were conducted in compliance with applicable law.

 

As we are part of the Santander Group, we must also disclose the exposure of other entities of the Santander Group to Iran. The following activities are disclosed in response to Section 13(r) with respect to the Santander Group and its affiliates. During the period covered by this annual report:

 

a)Santander UK holds five blocked accounts for three customers, with the first customer holding one GBP savings account and one GBP current account, the second customer holding one GBP savings account, and the third customer holding two GBP current accounts. All three customers, who are resident in the UK, are currently designated by the US under the Specially Designated Global Terrorist (SDGT) sanctions program. Revenues and profits generated by Santander UK on these accounts in the year ended December 31, 2020 were negligible relative to the overall profits of Banco Santander S.A.

 

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b)Santander UK holds two frozen current accounts for two UK nationals who are designated by the US under the SDGT sanctions program. The accounts held by one customer were fully inaccessible at the time of the US designation and were blocked at the time of the account going into a debit balance. The accounts held by the second customer were blocked immediately following the US designation and have remained frozen throughout 2020. These accounts are frozen in order to comply with Articles 2, 3 and 7 of Council Regulation (EC) No 881/2002 imposing certain specific restrictive measures directed against certain persons and entities associated with the Al-Qaeda network, by virtue of Commission Implementing Regulation (EU) 2015/1815. The accounts are in arrears (£1,844.73 in debit combined) and are currently being managed by Santander UK Collections & Recoveries department. No revenues or profits were generated by Santander UK on these accounts in the year ended December 31, 2020.

 

c)Santander Consumer Bank, S.A. holds seven blocked correspondent accounts for Bank Melli. Three USD accounts and four EUR accounts. The accounts have been blocked since 2008. Bank Melli is currently designated by the US under the Specially Designated Global Terrorist (SDGT) sanctions program. No revenues or profits were generated by Santander Consumer Bank, S.A. on these accounts in the year ended December 31, 2020.

 

d)The Santander Group also has certain legacy performance guarantees for the benefit of Bank Mellat (stand-by letters of credit to guarantee the obligations – either under tender documents or under contracting agreements – of contractors who participated in public bids in Iran) that were in place prior to April 27, 2007.

 

In the aggregate, all of the transactions described above resulted in gross revenues and net profits in the year ended December 31, 2020, which were negligible relative to the overall revenues and profits of Banco Santander, S.A. The Santander Group has undertaken significant steps to withdraw from the Iranian market such as closing its representative office in Iran and ceasing all banking activities therein, including correspondent relationships, deposit taking from Iranian entities and issuing export letters of credit, except for the legacy transactions described above. The Santander Group is not contractually permitted to cancel these arrangements without either (i) paying the guaranteed amount (in the case of the performance guarantees), or (ii) forfeiting the outstanding amounts due to it (in the case of the export credits). As such, the Santander Group intends to continue to provide the guarantees and hold these assets in accordance with company policy and applicable laws.

 

C. Organizational Structure

 

Santander Spain controls Santander-Chile through its holdings in Teatinos Siglo XXI Inversiones S.A. and Santander Chile Holding S.A. which are controlled subsidiaries. Santander Spain control over 67.18% of our shares and actual participation when excluding non-controlling interests participating in Santander Chile Holding S.A. of 67.12%.

 

Shareholder  Number of Shares  Percentage
Santander Chile Holding S.A.    66,822,519,695    35.46 
Teatinos Siglo XXI Inversiones S.A.    59,770,481,573    31.72 

 

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The chart below sets forth the names and areas of responsibility of our senior managers as of the date of the filing of this annual report:

 

 

 

  

D. Property, plants and equipment

 

We are domiciled in Chile and own our principal executive offices located at Bandera 140, 20th floor, Santiago, Chile. At December 31, 2020, we owned the locations at which 35.7% of our branches were located. The remaining branches operate at rented locations. We believe that our existing physical facilities are adequate for our needs.

 

Main Properties as of December 31, 2020  Number
Central Offices     
Owned    4 
Rented    5 
Total    9 
      
Branches     
Owned    93 
Rented    264 
Total    357 
      
Other property(1)     
Owned    55 
Rented    5 
Total    60 

____________________

(1) Consists mainly of parking lots, mini-branches and property owned by our subsidiaries.

 

ITEM 4A. UNRESOLVED STAFF COMMENTS

 

None.

 

ITEM 5. OPERATING AND FINANCIAL REVIEW AND PROSPECTS

 

Accounting Standards Applied in 2020

 

Santander-Chile is a Chilean bank and maintains its financial books and records in Chilean pesos and prepares its consolidated financial statements in accordance with IFRS as issued by the IASB in order to comply with requirements of the SEC. As required by the General Banking Law, which subjects Chilean banks to the regulatory supervision of the FMC, and which mandates that Chilean banks abide by the accounting standards stipulated by the FMC, our locally-filed consolidated financial statements have been prepared in accordance with Chilean Bank GAAP as issued by the FMC. The accounting principles issued by the FMC are substantially similar to IFRS but there are some exceptions, as described in Item 4. Therefore, our locally-filed consolidated financial statements have been adjusted according to IFRS as issued by the IASB.

 

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Critical Accounting Policies

 

Our consolidated financial statements include various estimates and assumptions, including but not limited to the adequacy of the allowance for loan losses, estimates of the fair value of certain financial instruments and the selection of useful lives of certain assets.

 

We evaluate these estimates and assumptions on an ongoing basis. Management bases its estimates and assumptions on historical experience and on various other factors that it believes to be reasonable under the circumstances. Actual results in future periods could differ from those estimates and assumptions, and if these differences were significant enough, our reported results of operations would be affected materially. We believe that the following are the most critical judgment areas or involve a higher degree of complexity in the application of the accounting policies that currently affect our financial condition and results of operations.

 

Adoption of IFRS 9 in 2018: Allowance for Loan Losses

 

Since January 2018, the Bank has replaced the “incurred loss” model in IAS 39 with the “expected credit loss (ECL)” model of IFRS 9. See “Note 2—Accounting Changes” of our Audited Consolidated Financial Statements.

 

The new single impairment model applies to all financial assets measured at amortized cost and fair value through other comprehensive income (“FVOCI”), including loan commitments and contingent loans. The Bank accounted the ECL related to financial assets measured at amortized cost and FVOCI as a loss allowance in the statement of financial position and the carrying amount of these assets is stated net of the loss allowance. The ECL related to contingent loans are accounted as a provision in the statement of financial position. For financial assets that are measured at fair value through other comprehensive income, the loss allowance is recognized in other comprehensive income and does not reduce the carrying amount of the financial asset in the statement of financial position. The new model uses a dual measurement approach, under which the loss allowance is measured as either: (a) 12-month expected credit losses or (b) lifetime expected credit losses.

 

Based on changes in credit quality since initial recognition, IFRS 9 outlines a “three-stage” impairment model as illustrated by the following chart:

 

 Change in credit quality since initial recognition
Stage 1 Stage 2 Stage 3
Initial recognition Significant increase in credit risk since initial recognition Credit impaired assets
12-month expected credit losses Lifetime expected credit losses Lifetime expected credit losses

 

The Bank, at the end of each reporting period, evaluates whether a financial instrument’s credit risk has increased since initial recognition, and consequently classifies the financial instrument in the relevant stage:

 

·Stage 1: At initial recognition of a loan or when there has been an improved credit risk following a significant increase or impairment of assets, the Bank recognizes an allowance based on 12 months ECL.

 

·Stage 2: When a loan has shown a significant increase in credit risk since origination, the Bank records an allowance for the lifetime ECL. Stage 2 loans also include loans where the credit risk has improved following a Stage 3 classification.

 

·Stage 3: Loans considered credit-impaired. The Bank records an allowance for the lifetime ECL, setting the probability of default at 100%.

 

The Bank considers reasonable and verifiable information available without undue cost or effort to it that may affect the credit risk on a financial instrument, including forward-looking information to determine whether there is or has been a significant increase in credit risk since initial recognition of a loan. Forward-looking information includes past events that affect future performance, current conditions and forecasts of future economic conditions.

 

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Expected credit loss measurement

 

The expected credit losses is the probability-weighted estimate of credit losses, i.e., the present value of all cash shortfalls. A cash shortfall is the difference between the cash flows that are due to an entity in accordance with the contract and the cash flows that the entity expects to receive. The three main components in measuring expected credit losses are:

 

·PD: The probability of default is an estimate of the likelihood of default over a given time period. A default may only happen at a certain time over the assessed period, if the facility has not been previously de-recognized and is still in the portfolio.

 

·LGD: The loss given default is an estimate of the loss arising after a specific default. It is based on the difference between the contractual cash flows due and those that the lender would expect to receive, including from the realization of any collateral.

 

·EAD: The exposure at default is an estimate of the exposure at a future default date, taking into account expected changes in the exposure after the reporting date, including repayments of principal and interest, whether scheduled by contract or otherwise, expected drawdown on committed facilities and accrued interest from missed payments.

 

For measuring 12-month and lifetime expected credit losses, cash shortfalls are identified as follows:

 

·12-month expected credit losses: the portion of lifetime expected credit losses that represents the expected credit losses that result from default events on the financial instruments that are possible within the 12 months after the reporting date.

 

·Lifetime expected credit losses: the expected credit losses that result from all possible default events over the expected life of the financial instrument.

 

Forward-looking information

 

The ECL model includes a broad range of forward-looking information as economic inputs, such as:

 

·GDP growth;

 

·Unemployment rates;

 

·Central Bank interest rates; and

 

·Real estate prices.

 

Interbank loans

 

According to the new balance presentation required under IFRS 9, the Bank has grouped interbank loans with loans and accounts receivable since both are measured at amortized cost and are evaluated together for impairment purposes.

 

Contingent loans

 

The Bank enters into various irrevocable loan commitments and contingent liabilities. Even though these obligations may not be recognized on the statement of financial position, they contain credit risk and, therefore, form part of the overall risk of the Bank. When the Bank estimates the ECL for contingent loan commitments and letters of credit, it estimates the expected portion of the loan commitment that will be drawn down over its expected life.

 

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Loans and account receivable measured at fair value through other comprehensive income

 

When the Bank enters into arrangements with its major customers for project finance and syndicated loans, the amount requested sometimes exceeds the Bank’s limit for single client exposure under credit risk policy, so these operations are approved under the condition that a portion of the loans be sold in the near term. The Bank also has loans that it expects to sell if market conditions are favorable to the Bank. These loans are measured at fair value through other comprehensive income and are subject to impairment requirements.

 

Valuation of Financial Instruments

 

Fair value is the price that would be received to sell an asset or that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date. IFRS 13 provides a hierarchy that separates the inputs and/or valuation technique assumptions used to measure the fair value of financial instruments. The hierarchy reflects the significance of the inputs used in making the measurement.

 

The hierarchy gives the highest priority to (unadjusted) quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The Bank uses valuation techniques appropriate in the circumstances and for which sufficient data are available to measure fair value, maximizing the use of relevant observable inputs and minimizing the use of unobservable inputs.

 

For financial instruments with no available market prices, fair values are estimated using recent transactions in analogous instruments, and in the absence thereof, the present values or other valuation techniques based on mathematical valuation models sufficiently accepted by the international financial community. In the use of these models, consideration is given to the specific particularities of the asset or liability to be valued, and especially to the different kinds of risks associated with the asset or liability.

 

These techniques are significantly influenced by the assumptions used, including the discount rate, the estimates of future cash flows and prepayment expectations. See “Note 38—Fair Value of Financial Assets and Liabilities” in our Audited Consolidated Financial Statements.

 

Derivative Activities

 

Derivatives are measured at fair value on the statement of financial position and the net unrealized gain (loss) on derivatives is classified as a separate line item within the income statement. Under IFRS, banks must mark-to-market derivatives. Within the fair value of derivatives are included Credit Valuation Adjustment (“CVA”) and Debit Valuation Adjustment (“DVA”), all with the objective that the fair value of each instrument includes the credit risk of its counterparty and the Bank’s own risk. The CVA is a valuation adjustment to OTC derivatives as a result of the risk associated with the credit exposure assumed by each counterparty in each future period. The DVA is a valuation adjustment similar to the CVA but, in this case, it arises as a result of the Bank’s own risk assumed by its counterparties. The following inputs are used to calculate the CVA and DVA:

 

·Expected exposure: Including for each transaction the mark-to-market (MtM) value plus an add-on for the potential future exposure for each period. Mitigating factors such as collateral and netting agreements are taken into account, as well as a temporary impairment factor for derivatives with interim payments.

 

·LGD: percentage of final loss assumed in a counterparty credit event/default.

 

·Probability of default: for cases where there is no market information, proxies based on comparable companies in the same industry and with the same external rating as the counterparty, are used.

 

·Discount factor curve.

 

Impairment of Available-for-Sale Financial Assets Prior to 2018

 

Available for sale financial assets are evaluated for impairment throughout the year and at each reporting date in order to assess whether events or changes in circumstances indicate that these assets are impaired, such as an adverse change in business climate or observable market data, indicate that these assets may be impaired. If there is objective evidence of an impairment of an asset, an impairment test is performed by comparing the investments’ recoverable amount, which is the higher of its value in use and fair value less costs to sell, with its carrying amount.

 

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The Bank evaluates available for sale financial assets with unrealized losses as of the end of each period and concludes if these were impaired. This review consists of evaluating the economic reasons for any declines, the credit ratings of the securities’ issuers, and the Bank’s intention and ability to hold the securities until the unrealized loss is recovered. See “Note 12— Debt Instruments at Fair Value through Other Comprehensive Income” in our Audited Consolidated Financial Statements.

 

Deferred Tax Assets and Liabilities

 

The Bank records, when appropriate, deferred tax assets and liabilities for the estimated future tax effects attributable to differences between the carrying amount of assets and liabilities and their tax bases. The measurement of deferred tax assets and liabilities is based on the tax rate, in accordance with the applicable tax laws, using the tax rate that applies to the period when the deferred asset and liability will be settled. The future effects of changes in tax legislation or tax rates are recorded in deferred taxes beginning on the date on which the law is enacted or substantially enacted. See “Note 16—Current and Deferred Taxes” of our Audited Consolidated Financial Statements.

 

Provisions – Contingent Liabilities

 

Provisions related to contingencies associated to pending signature of contracts, potential clients and other administrative claims, operational risk arise from financial transactions, potential property tax associated to leasing contracts are quantified using the best available information of uncertain future events that are not wholly within control of the Bank. These are reviewed and adjusted at each reporting date. See “Note 22—Provisions and Contingent Provisions” of our Audited Consolidated Financial Statements.

 

Adoption of IFRS 16 Leases

 

On January 1, 2019, IFRS 16 Leases has become effective; this standard sets out the principles for the recognition, measurement, presentation and disclosure of leases. The objective is to ensure that lessees and lessors provide relevant information in a manner that faithfully represents those transactions. IFRS 16 introduces a single lessee accounting model and requires a lessee to recognize assets and liabilities for all leases with a term of more than 12 months, thus a lessee is required to recognize a right-of-use asset representing its right to use the underlying leased asset and a lease liability representing its obligation to make lease payments.

 

The Bank has elected to adopt IFRS 16 using a modified retrospective approach at the date of initial application, therefore, it has recognized a right-of-use asset for an amount equal to the lease liability, which amounted to Ch$154,284 million. For more details, see Note 14 of our Audited Consolidated Financial Statements.

 

Covid-19 Support Measures

 

The Bank has conducted an exhaustive analysis of the measures implemented as a result of COVID-19, under the perspective of modified assets. The payment holiday program granted to our consumer loan portfolio included 3-month grace periods and modified terms and installments, and allowed modified interest rates, to the current lower market rate, and was considered a substantial modification of the original contractual conditions. Therefore, these consumer loans were accounted for as the termination of the original loan and the recognition of a new financial asset. In line with our internal guide, these modifications are classified as modifications for commercial reasons, because they are not attributable to the financial difficulty of the debtor, and a new loan operation has been originated under current market conditions.

 

For the mortgage loan portfolio, original contractual conditions were not modified, instead, the clients signed an addendum for the postponed installments, and a complementary operation was generated, with the mortgage guarantee covering both operations. Neither the monthly installments nor the rates were modified. This measure was granted only to clients with less than 30 days past due, and we have observed, once the postponed periods have ended, that 98% of our clients are meeting their obligations in a timely manner. In line with our internal guide, we have concluded that the modifications granted to customers with no past due days were classified as modifications for commercial reasons, while clients with any past due or that have had some restructuring (marked special risk), were classified as modifications for the financial difficulty of the debtor, and the Bank has calculated the difference between the gross carrying amount and the present value of the modified loans discounted at the original effective interest rate. The amount was not material to the Bank.

 

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A. Operating Results

 

Chilean Economy

 

All of our operations and substantially all of our customers are located in Chile. Accordingly, our financial condition and results of operations are substantially dependent upon economic conditions prevailing in Chile. In 2018, the Chilean economy grew 4.0% While during 2019 the Chilean economy only grew 1.1% due to lower global growth, which was affected by the China-U.S. trade dispute and the social unrest that affected Chile in the last quarter of the year. In 2020, the Chilean economy suffered due to the COVID-19 pandemic with extensive lockdowns in place, which led to an economic contraction of approximately 6.0% in 2020. Chilean GDP is expected to grow around 4.5% in 2021.

 

As of December 2020, the average unemployment rate for 2020 was 10.2%, compared to 7.1% in the same period of 2019. The higher unemployment rate in 2020 was due to the loss of jobs during the lockdowns caused by the pandemic.

 

The exchange rate appreciated by 4.5% in 2020 and depreciated by 7.0% in 2019. After a strong depreciation in the last months of 2019 after the social unrest, the peso began to appreciate once more at the beginning of 2020. However, as the COVID-19 pandemic began to spread around the world, the uncertainty and lower economic expectations made the exchange rate depreciate more than 14% and reach Ch$860 in April. In the following months, the exchange rate began to appreciate once more as quarantines began to be lifted and China improved its growth expectations. The Central Bank also actively intervened in the exchange rate market in order to regulate the peso and push it towards historical levels, and the pension fund withdrawals forced pension funds to liquidate international equities, further appreciating the peso.

 

CPI inflation remained at 3.0% in 2020. The Central Bank continued to relax monetary policy throughout much of 2020 given the contraction of the economy in 2020 from the pandemic and an inflation rate consistently at or below the Central Bank’s target of 3%. The current Monetary Policy Rate is 0.5% compared to 1.75% at year-end 2019.

 

The growth of the Chilean banking sector evolved in line with overall economic developments and the acquisition carried out by Chilean banks of loan portfolios previously owned by non-banks. Total loans as of December 31, 2020, in the Chilean financial system, excluding loans held abroad by Chilean banks, grew 2.8% year-over-year. Total customer deposits (defined as time deposits plus checking accounts), excluding amounts held by Chilean banks abroad, increased 7.1% year-over-year as of December 31, 2020. The non-performing loans (defined as loans with an installment that is at least 90 days past-due) to total loans ratio decreased from 1.9% at year-end 2019 to 1.6% at year-end 2020. This decrease occurred due to the high liquidity levels in the system after the government approved various initiatives to help the population during the COVID-19 pandemic.  

 

Impact of Inflation

 

Our assets and liabilities are denominated in Chilean pesos, Unidades de Fomento (UF) and foreign currencies. Inflation impacts our results of operations as some loan and deposit products are contracted in UF. The UF is revalued in monthly cycles. Each day in the period beginning on the tenth day of the current month through the ninth day of the succeeding month, the nominal peso value of the UF is indexed up (or down in the event of deflation) in order to reflect a proportionate amount of the change in the Chilean Consumer Price Index during the prior calendar month. One UF equaled Ch$29,070.33 at December 2020, Ch$28,309.94 at December 31, 2019 and Ch$27,565.79 at December 31, 2018. High levels of inflation in Chile could adversely affect the Chilean economy and could have an adverse effect on our business, financial condition and results of operations. Negative inflation rates also negatively impact our results. Inflation measured as the annual variation of the UF was 2.7% in 2020, 2.7% in 2019 and 2.9% in 2018. There can be no assurance that Chilean inflation will not change significantly from the current level. Although we currently benefit from moderate levels of inflation, due to the current structure of our assets and liabilities (i.e., a significant portion of our loans are indexed to the inflation rate, but there are significantly less features in deposits and other funding sources that would increase the size of our funding base), there can be no assurance that our business, financial condition and result of operations in the future will not be adversely affected by changing levels of inflation. In summary:

 

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·UF-denominated assets and liabilities. The effect of any changes in the nominal peso value of our UF-denominated interest earning assets and interest-bearing liabilities is reflected in our results of operations as an increase (or decrease, in the event of deflation) in interest income and expense, respectively. Our net interest income will be positively affected by an inflationary environment to the extent that our average UF-denominated interest earning assets exceed our average UF-denominated interest-bearing liabilities. Our net interest income will be positively affected by deflation in any period in which our average UF-denominated interest-bearing liabilities exceed our average UF-denominated interest earning assets. Our net interest income will be negatively affected in a deflationary environment if our average UF-denominated interest earning assets exceed our average UF-denominated interest-bearing liabilities.

 

·Inflation and interest rate hedge. A key component of our asset and liability policy is the management of interest rate risk. The Bank’s assets generally have a longer maturity than our liabilities. As the Bank’s mortgage portfolio grows, the maturity gap tends to rise as these loans, which are contracted in UF, have a longer maturity than the average maturity of our funding base. As most of our long-term financial instruments and mortgage loans are contracted in UF and most of our deposits are in nominal pesos, the rise in mortgage lending increases the Bank’s exposure to inflation and to interest rate risk. The size of this gap is limited by internal and regulatory guidelines in order to avoid excessive potential losses due to strong shifts in interest rates. In order to keep this duration gap below regulatory limits, the Bank issues long term bonds denominated in UF or interest rate swaps. The financial cost of the bonds and the efficient part of these hedges is recorded as net interest income. In 2019, the loss from the swaps taken in order to hedge mainly for inflation and interest rate risk and included in net interest income totaled a loss of Ch$15,461 million in 2020 compared to a loss of Ch$31,346 million in 2019 and a loss of Ch$18,799 million in 2018. The average gap between our interest earnings assets and total liabilities linked to the inflation, including hedging, was Ch$6,173,541 million in 2020, Ch$4,279,082 million in 2019 and Ch$4,537,476 million in 2018. Therefore, our sensitivity to a 100 basis point shift in UF inflation considering our year end gap would be approximately Ch$62 billion.

 

·The financial impact of the gap between our interest earning assets and liabilities denominated in UF including hedges was Ch$173,668 million in 2020, Ch$114,340 million in 2019 and Ch$126,260 million in 2018. Although annual UF inflation ended at the same level as 2019, in 2020 we took advantage of the inflation volatility and therefore had a 51.9% increase in these results.

 

   As of December 31,  % Change
Impact of inflation on net interest income   2020    2019    2018    2020/2019   2019/2018
    (in millions of Ch$) 
Results from UF GAP(1)    173,668    114,340    126,260    51.9%   (9.4%)
Annual UF inflation    2.7%   2.7%   2.9%          

____________________

(1)UF GAP is net interest income from asset and liabilities denominated in UFs and include the results from hedging the size of this gap via interest rate swaps.

 

·Peso-denominated assets and liabilities. Interest rates prevailing in Chile during any period primarily reflect the inflation rate during the period and the expectations of future inflation. The sensitivity of our peso-denominated interest earning assets and interest-bearing liabilities to changes to such prevailing rates varies. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Interest Rates.” We maintain a substantial amount of non-interest-bearing peso-denominated demand deposits. Because such deposits are not sensitive to inflation, any decline in the rate of inflation would adversely affect our net interest margin on inflation indexed assets funded with such deposits, and any increase in the rate of inflation would increase the net interest margin on such assets. The ratio of the average of such demand deposits and average shareholder’s equity to average interest-earning assets was 33.5%, 30.5%, and 30.6%, for the years ended December 31, 2020, 2019 and 2018, respectively.

 

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Interest Rates

 

Interest rates earned and paid on our assets and liabilities reflect, to a certain degree, inflation, expectations regarding inflation, changes in short term interest rates set by the Central Bank and movements in long term real rates. The Central Bank manages short term interest rates based on its objectives of balancing low inflation and economic growth. Because our liabilities are generally re-priced sooner than our assets, changes in the rate of inflation or short-term rates in the economy are reflected in the rates of interest paid by us on our liabilities before such changes are reflected in the rates of interest earned by us on our assets. Therefore, when short term interest rates fall, our net interest margin is positively impacted, but when short term rates increase, our interest margin is negatively affected. At the same time, our net interest margin tends to be adversely affected in the short term by a decrease in inflation rates since generally our UF-denominated assets exceed our UF-denominated liabilities. See “Item 5. Operating and Financial Review and Prospects—A. Operating Results—Impact of Inflation—Peso-denominated assets and liabilities.” An increase in long term rates has a positive effect on our net interest margin, because our interest earning assets generally have longer terms than our interest-bearing liabilities. A flattening of the yield curve (i.e. long-term rates falling quicker than short-term rates) negatively affects our margins by lowering loan yields at a greater pace than deposits costs. In addition, because our peso-denominated liabilities have relatively short re-pricing periods, they are generally more responsive to changes in inflation or short-term rates than our UF-denominated liabilities. As a result, during periods when or expected inflation exceeds the previous period’s inflation, customers often switch funds from UF-denominated deposits to peso-denominated deposits, which generally bear higher interest rates, thereby adversely affecting our net interest margin.

 

Foreign Exchange Fluctuations

 

The Chilean government’s economic policies and any future changes in the value of the Chilean peso against the U.S. dollar could adversely affect our financial condition and results of operations. The Chilean peso has been subject to significant devaluation in the past and may be subject to significant fluctuations in the future. The Central Bank exchange rate appreciated 4.5% in 2020 and depreciated 7.0% in 2019. A significant portion of our assets and liabilities are denominated in foreign currencies, principally the U.S. dollar, and we historically have maintained and may continue to maintain material gaps between the balances of such assets and liabilities. Our current strategy is not to maintain a significant difference between the balances of our assets and liabilities in foreign currencies. In 2020 and 2019, the Bank held significant short-term assets in US$ overnight deposits in order to maintain strong liquidity levels in this currency due to the social unrest and then the pandemic. In 2018, the Bank, in its spot position, usually held more liabilities than assets in foreign currencies, mainly the U.S. dollar, as a result of an ample supply of U.S. dollar deposits from companies that receive export revenues, foreign correspondent bank loans and bonds issued abroad. In either case, any differences are usually hedged using forwards and cross-currency swaps. Including derivatives, the Bank seeks to run no foreign currency risk in its non-trading balance sheet. Because such assets and liabilities, as well as interest earned or paid on such assets and liabilities, and gains and losses realized upon the sale of such assets, are translated to Chilean pesos in preparing our financial statements, our reported income is affected by changes in the value of the Chilean peso relative to foreign currencies (principally the U.S. dollar). The translation gain or loss over assets and liabilities (excluding derivatives held for trading) and derivatives accounted under hedge accounting standards are included as foreign exchange transactions in the income statement. The translation and mark-to-market of foreign currency derivatives held for trading is recognized as a gain or loss in the net results from mark-to-market and trading. The Bank also uses a sensitivity analysis with both internal limits and regulatory limits to seek to manage the potential loss in net interest income resulting from fluctuations of interest rates on U.S. dollar denominated assets and liabilities and a VaR model to limit foreign currency trading risk.

 

See “Item 11. Quantitative and Qualitative Disclosures About Market Risk—E. Market Risks—Foreign exchange fluctuations” for more detail on the Bank’s exposure to foreign currency.

 

Segmentation Criteria

 

The accounting policies used to determine the Bank’s income and expenses by reporting segment are the same as those described in the summary of accounting policies in “Note 1—Summary of Significant Accounting Policies” of the Bank’s Consolidated Financial Statements and are customized to meet the needs of the Bank’s management. The Bank earns most of its income in the form of interest income, fee and commission income and income from financial operations.

 

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To evaluate a segment’s financial performance and make decisions regarding the resources to be assigned to segments, the Chief Operating Decision Maker (CODM) bases his or her assessment on the segment’s interest income, fee and commission income, and expenses. The Bank’s reporting segments have three Chief Operating Decision Makers: (i) the Director of Retail banking, (ii) the Director of the Middle-market segment and (iii) the Director of Corporate Investment Banking, each of which report to our Chief Executive Officer. All reporting segment information is presented following this structure.

 

Under IFRS 8, the Bank has aggregated operating segments with similar economic characteristics according to the aggregation criteria specified in the standard. A reporting segment consists of clients that are offered differentiated but, considering how their performance is measured, homogenous services based on IFRS 8 aggregation criteria, thus they form part of the same reporting segment. The clients included in each business segment are constantly revised and reclassified if a client no longer meets the criteria for the segment they are in and transferred to a different CODM. Therefore, variations of loan volumes and profit and loss items reflect business trends as well as client migration effects. Overall, this aggregation has no significant impact on the understanding of the nature and effects of the Bank’s business activities and the economic environment.

 

The Bank’s reportable segments are (i) Retail banking, (ii) Middle-market, (iii) Corporate Investment Banking and (iv) Corporate Activities (“Other”). See “Note 4—Reporting Segments” of our Audited Consolidated Financial Statements for more information.

 

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Results of Operations for the Years Ended December 31, 2020 and 2019

 

In this section, we discuss the results of our operations for the year ended December 31, 2020 compared to the year ended December 31, 2019. For a discussion of the results of our operations for the year ended December 31, 2019 compared to the year ended December 31, 2018, please refer to “Item 5. – A. Operating Results – Results of Operations for the Year Ended December 31, 2098 Compared to the Year Ended December 31, 2018” in our Annual Report on Form 20-F for the year ended December 31, 2019.

 

The following discussion is based upon and should be read in conjunction with the Audited Consolidated Financial Statements. The Audited Consolidated Financial Statements have been prepared in accordance with IFRS as issued by the IASB. The following table sets forth the principal components of our net income for the years ended December 31, 2020 and 2019.

 

Consolidated Income Statement Data IFRS

 

   2020  2020  2019  % Change
2020/2019
   (U.S.$ thousands)(1)  (Ch$ million)   
Interest income and expense                    
Interest income   3,133,222    2,232,327    2,321,381    (3.8%)
Interest expense   (896,149)   (638,479)   (904,417)   (29.4%)
Net interest income   2,237,074    1,593,848    1,416,964    12.5%
Fees and income from services                    
Fees and commission income   633,236    451,162    498,658    (9.5%)
Fees and commission expense   (258,094)   (183,884)   (211,572)   (13.1%)
Total net fees and commission income   375,143    267,278    287,086    (6.9%)
Financial transactions, net                    
Net income (expense) from financial operations   127,444    90,800    (78,165)   (216.2%)
Net foreign exchange gain   82,807    58,997    279,857    (78.9%)
Financial transactions, net   210,251    149,797    201,692    (25.7%)
Other operating income   11,518    8,206    13,001    (36.9%)
Net operating profit before provision for loan losses   2,833,985    2,019,129    1,918,743    5.2%
Provision for loan losses   (671,276)   (478,264)   (323,311)   47.9%
Net operating profit   2,162,709    1,540,865    1,595,432    (3.4%)
Operating expenses                    
Personnel salaries and expenses   (573,596)   (408,670)   (410,157)   (0.4%)
Administrative expenses   (351,524)   (250,450)   (233,612)   7.2%
Depreciation and amortization   (153,587)   (109,426)   (106,092)   3.1%
Impairment of property, plant and equipment   (895)   (638)   (2,726)   (76.6%)
Other operating expenses   (109,206)   (77,806)   (49,303)   57.8%
Total operating expenses   (1,188,808)   (846,990)   (801,890)   5.6%
Net Operating income   973,901    693,875    793,542    (12.6%)
Income from investments in associates and other companies (2)   1,948    1,388    1,146    21.1%
Income before tax   975,849    695,263    794,688    (12.5%)
Income tax expense   (200,055)   (142,533)   (175,074)   (18.6%)
Income from continuous operations   775,794    552,730    619,614    (10.8%)
Income from discontinued operations (2)   0    0    1,699    (100.0%)
Consolidated net income for the year   775,794    552,730    621,313    (11.0%)
Net income for the year attributable to:                    
Equity holders of the Bank   768,613    547,614    619,091    (11.5%)
Non-controlling interests   7,181    5,116    2,222    130.2%

____________________

(1)Amounts stated in U.S. dollars at and for the year ended December 31, 2020 have been translated from Chilean pesos at the exchange rate of Ch$712.47 = U.S.$1.00 as of December 31, 2020.

 

(2)As of December 31, 2020, the Bank is in process of selling its share participation on Redbanc S.A. and Transbank S.A. and has classified its participation as an investment available for sale in accordance with IFRS 5 “Non-current Assets Held for Sale and Discontinued Operations”. The Bank sold its stake in Sociedad Nexus S.A. in October 2019 and January 2020. See Note 38 of our Audited Consolidated Financial Statements.

 

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Results of Operations for the Years Ended December 31, 2020 and 2019

 

Net income for the year attributable to equity holders of the Bank decreased 11.5% in 2020 compared to 2019 and totaled Ch$547,614 million. Our return on annualized average equity was 14.8% in 2020 compared to 18.0% in 2019.

 

In 2020, net operating profit before loan losses was Ch$2,019,129 million, an increase of 5.2% compared to 2019. Our net interest income increased 12.5% in 2020 compared to 2019. This was mainly driven by loan growth, higher gains from inflation-indexed assets and lower cost of funds due to the high liquidity in the market and a lower rate environment. Overall, our net interest margin declined to 3.8% in 2020 from 4.0% in 2019.

 

Net fees and commission income decreased 6.9% to Ch$267,278 million in the twelve-month period ended December 31, 2020 compared to the same period in 2019. Lower consumption in the economy and a higher saving rate negatively affected fees from lines of credit. Fees from collections decreased 30.3% in 2020 compared to 2019. This line item includes, among other items, fees collected on behalf of insurance companies for insurance that is sold with some loan products, especially mortgage loans. Lower loan origination due to the pandemic lowered this fee item. Insurance brokerage fees and fees from checking accounts also declined after a law was passed that increased banks liability for cyber fraud and prohibited the sale of insurance for this item. This was partially offset by the rise in fees from credit, debit and ATM cards which increased 35.3% in 2020. The switch to the four-part pricing model, which uses the international interchange fees set by the main card brands (i.e. MasterCard, Visa, AMEX), and out of the pricing model set by Chile’s main credit card acquirer (Transbank) resulted in a lower fee expenses.

 

Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain (loss), totaled Ch$149,797 million in the year ended December 31, 2020, a decrease of 25.7% compared to the same period in 2019. These results include the results of our Treasury Division’s transactions with customers, as well as the results of our non-client treasury operations, mainly the Financial Management Division. Client treasury services totaled Ch$145,222 million, an increase of 4.7% compared to 2019. The higher market volatility due to the COVID-19 pandemic led to higher demand for hedging from our Corporate and Middle-market clients. The results from non-client treasury income decreased 92.7% to Ch$4,576 million in 2020 compared to 2019. This lower result was mainly due to the results of the Bank’s Financial Management Division that decreased 56.2% to Ch$27,918 million in 2020 compared to 2019 and the results from CVA which totaled a loss of Ch$23,216 million. The growth of the Bank’s derivative portfolio and the increase in counterparty risk drove the rise in CVA adjustment loss in 2020.

 

Total other operating income decreased by 36.9% in 2020 compared to 2019, totaling a gain of Ch$8,206 million. This was mainly due to lower income from insurance compensation due to damages since in 2019 the Bank received compensation for the damages to our branches during the social unrest that affected Chile in October- December of 2019.

 

For the year ended December 31, 2020 provisions for expected credit loss totaled Ch$478,264 million and increased 47.9% compared to 2019. This rise was mainly due to growth of our loan book and an increase in expected losses driven by the economic slowdown due to the COVID-19 pandemic.

 

As a result of the factors mentioned above, net operating profit decreased 3.4% in 2020 compared to 2019 and totaled Ch$1,540,865 million.

 

Operating expenses in the year ended December 31, 2020 increased 5.6% compared to the corresponding period in 2019. The efficiency ratio was 41.9% in 2020 and 41.8% in 2019.

 

The 0.4% decrease in personnel salaries and expenses was mainly due to a decrease in variable incentives, severance payments, training and other benefits that decreased 6.9%, while salary costs only grew by 1.9%. Headcount decreased 6.5% in 2020, ending the year at 10,470 employees in the Bank.

 

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Administrative expenses increased 7.2% in the year ended December 31, 2020 compared to the corresponding period in 2019, mainly due to higher IT and communications costs, as many of our employees worked from home and new systems that would work remotely were implemented.

 

Depreciation and amortization expense increased 3.1% in 2020 compared to 2019. This increase was mainly due to a higher depreciation of fixed assets in the period.

 

In 2020, impairment expenses totaled Ch$638 million, a 76.6% decrease compared to the previous year as there was a strong impairment of fixed assets in 2019 as a result of the social unrest that affected Chile in October – December 2019.

 

Other operating expenses were Ch$77,806 million in 2020, an increase of 57.8% compared to 2019. This was mainly due to higher provisions for contingencies due to the effects of the COVID-19 pandemic and a rise in cyber fraud insurance costs.

 

Total income tax expense by the Bank in 2020 was Ch$142,533 million, a 18.6% decrease compared to 2019, mainly driven by the 8.9% decrease in net income before taxes.

 

Net Interest Income

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$, except percentages)      
Retail banking    1,049,543    960,361    9.3%
Middle-market    346,225    298,587    16.0%
Corporate Investment banking    114,229    98,154    16.4%
Total reporting segments    1,509,997    1,357,102    11.3%
Other(1)    83,851    59,862    40.1%
Net interest income    1,593,848    1,416,964    12.5%
Average interest-earning assets    42,239,387    35,850,253    17.8%
Average non-interest-bearing demand deposits    10,403,347    7,466,991    39.3%
Net interest margin(2)    3.77%   3.95%     
Average shareholders’ equity and average non-interest-bearing demand deposits to total average interest-earning assets    33.5%   30.5%     

____________________

(1)Consists mainly of net interest income from the Financial Management Division, including the inflation gap, and the cost of funding our financial assets held for trading. Each segment obtains funding from its clients. Any surplus deposits are transferred to the Financial Management Division, which in turn makes such excess available to other areas that need funding. The Financial Management Division also sells the funds it obtains in the institutional funding market at a transfer price equal to the market price of the funds. This segment also includes intra-segment income and activities not assigned to a given segment or product line.

 

(2)Net interest margin is net interest income divided by average interest-earning assets.

 

For the year ended December 31, 2020 our net interest income totaled Ch$1,593,848 million and increased 12.5% from Ch$1,416,964 million in 2019. Average interest earning assets increased 17.8% in the same period. During 2020, the loan portfolio grew 5.1%, but mainly in lower yielding commercial and mortgage loans. The higher growth from interest earning assets came from short-term assets as the Bank invested the higher liquidity in the system in low-risk and low-yielding assets. This caused the average interest rate earned on interest earning assets indexed to the UF to decrease from 5.9% in 2019 to 5.2% in 2020, despite similar levels of UF inflation in both years. The nominal yield earned on peso-denominated interest earning assets also declined from 8.2% in 2019 to 6.2% in 2020 due to a lower rate environment for most of 2020 and growth in low-yielding and low risk peso denominated assets. All the factors mentioned above led to a decline in the overall average interest earned over interest earning assets from 6.5% in 2019 to 5.3% in 2020.

 

Average nominal interest rate earned on interest earning assets  2020  2019
Ch$    6.2%   8.2%
UF    5.2%   5.9%
Foreign currencies    2.7%   3.4%
Total    5.3%   6.5%

 

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The average rate paid on our interest bearing liabilities decreased to 2.2% in 2020 from 3.5% in 2019. This was mainly due to a lower rate environment in 2020 triggered by the Central Bank’s relaxation of monetary policy due to lower than expected economic growth. This especially reduced the nominal rate paid on Ch$ denominated time deposits. The nominal rate paid over the average balance of these deposits fell from 3.3% in 2019 to 1.3% in 2020. The Central Bank also gave liquidity lines to the banks at the Monetary Policy Rate, which was set at 0.5% for most of the year with a maturity of these lines of up to four years. The rate paid on foreign currencies also declined as the exchange rate appreciated.

 

Average nominal interest rate paid on interest bearing liabilities  2020  2019
Ch$    1.3%   3.3%
UF    5.4%   5.1%
Foreign currencies    1.5%   2.3%
Total    2.2%   3.5%

 

Additionally, in 2020, average non-interest bearing demand deposits increased 39.3%, which helped to lower total funding costs as well.

 

In summary, the growth of lower yielding assets partially offset by a cheaper funding cost and mix, led to a decline in our net interest margin to 3.77% in 2020 compared to 3.95% in 2019.

 

Net interest income from our reporting segments totaled Ch$1,509,997 million and increased 11.3% compared to 2019. This rise was mainly due to the growth of the loan book, which grew 5.1% in 2020 and the improved funding mix driven by lower time deposit costs and a greater amount of non-interest bearing demand deposits. The changes in net interest income by segment in 2020 as compared to 2019 were as follows:

 

·Net interest income from Retail banking increased 9.3%, led by a 5.9% increase in loan volumes. Mortgage loans continued to grow steadily in the year, as rates remained fairly low compared to historical levels although they did increase compared to 2019. Consumer loans decreased during the year due to the lower demand during the pandemic. Government aid coupled with the access to private pension accounts also resulted in low demand for consumer loans. Retail also includes SMEs, which had a strong loan growth due to the strong demand of FOGAPE government-guaranteed loans in the year. However, these loans however, are lower yielding, as the interest rate is capped at the Central Bank Monetary Policy Rate (currently at 0.5%) plus a spread of 3.0%.

 

·Net interest income from the Middle-market segment increased 16.0% in 2020 mainly due to loan growth of 0.5% in 2020 and an improved funding in the year driven by the rise in demand deposits.

 

·Net interest income from the Corporate Investment Banking segment increased 16.4% in 2020 compared to 2019. Loans increased 2.0%, mainly driven by working capital lines of credit in order to maintain high liquidity levels during the pandemic. The spread of this product rose during the year. The improved funding mix also drove the growth in net interest income in this segment.

 

·Other net interest income consists mainly of net interest income from the Bank’s ALCO, which includes the net interest income from the Bank’s debt instruments recorded at fair value through other comprehensive income, deposits in the Central Bank, and the financial cost of supporting our cash position and financial investments held for trading (the interest income from which is recognized as net income from financial operations and not interest income). The result of the Bank’s inflation gap is also included in this line. The net interest income included as “other” increased 40.1% to Ch$83,851 million in 2020 compared to 2019. This was mainly due to the higher average UF inflation gap in the year as management took advantage of the higher inflation rate recorded in the second half of the year.

 

The following table shows our balances of loans and accounts receivable from customers and interbank loans by segment at the dates indicated.

 

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   At December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch)      
Retail banking    24,279,248    22,926,377    5.9%
Middle-market    8,136,402    8,093,496    0.5%
Corporate Investment banking    1,635,217    1,603,633    2.0%
Other (1)    289,026    48,009    502.0%
Total loans    34,339,893    32,671,515    5.1%

____________________

(1)Includes interbank loans.

 

The following table shows interest income of financial assets by valuation as of December 31, 2020 and 2019.

 

   At December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Financial assets measured at amortized cost(1)    2,114,620    2,195,339    (3.7%)
Financial assets measured al FVOCI(2)    105,417    97,319    8.3%
Other interest    13,586    21,979    (38.2%)
Interest income not including income from hedge accounting    2,233,623    2,314,637    (3.5%)

____________________

(1)Financial assets measured at amortized cost include loans measured at amortized cost as described above and investments under resale agreements. The effective interest method is used in the calculation of the amortized cost of the financial asset and in the allocation and recognition of the interest revenue over the relevant period.

 

(2)Financial assets measured at fair value through other comprehensive income include the interest income from debt instruments. These mainly consisted of securities and bonds of the Chilean Central Bank that contain contractual terms that give rise on specific dates to cash flows that are solely payments of principal and interest (SPPI), and are measured at FVOCI.

 

Fee and Commission Income

 

Net fees and commission income decreased 6.9% to Ch$267,278 million in the twelve-month period ended December 31, 2020 compared to the same period in 2019. The following table sets forth certain components of our income from services (net of fees paid to third parties directly connected to providing those services, principally fees relating to credit card processing and ATM network administration) in the years ended December 31, 2020 and 2019.

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Credit, debit and ATM cards    73,297    54,189    35.3%
Collections    23,242    33,355    (30.3%)
Insurance brokerage    39,764    49,664    (19.9%)
Letters of credit    36,277    35,039    3.5%
Checking accounts    34,825    35,949    (3.1%)
Custody and brokerage services    10,376    9,154    13.3%
Lines of credit    7,428    10,314    (28.0%)
Others    42,069    59,422    (29.2%)
Total fees and commission income, net    267,278    287,086    (6.9%)

 

Fees from credit, debit and ATM cards increased 35.3% in 2020. The switch to the four-part pricing model, which uses the international interchange fees set by the main card brands (i.e. MasterCard, Visa, AMEX), and out of the pricing model set by Chile’s main credit card acquirer (Transbank) drove this result mainly via a reduction in card expenses. We also increased the number of ATMs during the year, from 1,088 in 2019 to 1,199 in 2020, giving us higher fees from clients from other banks and financial institutions using our machines.

 

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Fees from collections decreased 30.3% in 2020 compared to 2019. This line item includes, among other items, credit-related insurance collected on behalf of insurance companies, such as fire and earthquake insurance that are mandatory with mortgage loans. During 2020 the lower origination of loans negatively affected this line item.

 

Insurance brokerage fees decreased 19.9% due to lower demand as a result of by the pandemic. Brokerage of fraud insurance also declined after a law was passed that made banks liable for cyber fraud and prohibited the sale of insurance for this item. This was partially offset by the increase in sales of car and life insurance policies as advances in our digital platforms have enabled clients to search for and purchase these products online.

 

Fees from letters of credit and other contingent operations increased 3.5% in 2020. This line corresponds to international and foreign trade financing business with clients. Business growth drove this revenue line in 2020 as export growth remained solid in 2020, driven by higher commodity prices and demand from China.

 

Fees from checking accounts decreased 3.1% in 2020 compared to 2019. This was mainly due to the effects of the cyber fraud law, where some checking account plan prices had to be readjusted due to the elimination of components of fraud insurance for checking accounts. This was partially offset by the rise in the Bank’s checking account base. The number of checking accounts increased 29.2% to 1,378,539 driven by digital onboarding platforms such as Santander Life. Our corporate cash management services also continued to boost fee growth in this product.

 

Brokerage and custody fees increased 13.3% in 2020 as compared to 2019 due to higher volumes in our brokerage business, custody fees, and bond issuances for our clients.

 

Fees from lines of credit decreased 28.0% due to a decrease of usage of these lines as a result of the fall in consumption, the greater access to liquidity due to the withdrawal of pension fund savings and the rise in household savings rate during the pandemic.

 

The 29.2% decrease in other fee income in 2020 compared to 2019 was mainly due to lower fees earned by our Corporate Investment Banking segment for investment banking and advisory services, in line with the slowdown of economic growth. Fees from the brokerage of mutual funds also decreased 6.9% in 2020 compared to 2019 and totaled Ch$44,072 million. As rates decreased, especially those earned by money market funds, average fees charged over these funds fell in tandem. In December 2013, our Asset Management business was sold, but we continue to serve as an exclusive broker for Santander Asset Management, the acquirer of our asset management business.

 

The following table sets forth, for the periods indicated our fee income broken down by segment for the periods indicated:

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Retail banking    213,431    230,627    (7.5%)
Middle-market    38,335    38,712    (1.0%)
Corporate Investment banking    23,180    29,103    (20.4%)
Other    (7,668)   (11,356)   (32.5%)
Total fees and commission income, net    267,278    287,086    (8.1%)

 

Fees from Retail banking decreased 7.5% in 2020 compared to 2019. Lower product usage due to the pandemic and the economic slowdown drove this decline in retail fees along with the negative impact of the new regulations regarding cyber fraud on insurance brokerage and checking account fees. This was offset by the growth of card fees as mentioned above.

 

The 1.0% decrease in fees from the Middle-market segment was mainly due to lower economic activity due to the pandemic.

 

Fees from the Corporate Investment banking segment decreased 20.4% in 2020 compared to 2019, mainly due to lower investment banking fees as a result of lower economic growth.

 

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Fees in Other decreased from a loss of Ch$11,356 million in 2019 to a loss of Ch$7,668 million in 2020 mainly due to lower insurance fees paid to Zurich, our insurance partner.

 

Financial Transactions, Net

 

The following table sets forth information regarding our income (loss) from financial transactions for the years ended December 31, 2020 and 2019.

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Net income from financial operations    90,800    (78,165)   --% 
Foreign exchange gain, net    58,997    279,857    (78.9%)
Total financial transactions, net    149,797    201,692    (25.7%)

 

Total financial transactions, net, which is the sum of net income from financial operations and foreign exchange gain, totaled Ch$149,797 million in the year ended December 31, 2020, a decrease of 25.7% compared to the same period in 2019. These results include the results of our Treasury Division’s trading business and financial transactions with customers, as well as the results of our Financial Management Division.

 

Internal Bank policy does not allow significant foreign currency mismatches and requires that the results included in Total financial transactions, net include not only the market-to-market of our foreign currency spot position, but also the results of the derivatives used to hedge currency risk. The mark-to-market of our spot position is included in the line item Foreign exchange gain, net along with the effect of those derivatives accounted for under hedge accounting rules. The derivatives used to hedge foreign currency risk, but which are classified as trading are included in the line item Net income from financial operations. For more details regarding our management and exposure to foreign currency risk, see “Item 11. Quantitative and Qualitative Disclosures About Market Risk—E. Market Risks—Market risk management— Market risk – local and foreign financial management.”

 

The results from net income (loss) from financial operations totaled a gain of Ch$90,800 million in 2020 compared to a loss of Ch$78,165 million in 2019.

 

   For the year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Net (loss) gains on trading derivatives    42,704    (162,183)   --% 
Net gains on financial assets at fair value through profit or loss    1,671    11,878    (85.9%)
Net gains on derecognition of financial assets measured at amortized cost    80,679    63,672    26.7%
Sale of loans and accounts receivables from customers    (62)   3,310    (101.9%)
Current portfolio
   48    63    (23.4%)
Charged-off portfolio
   (110)   3,248    (103.4%)
Repurchase of issued bonds    1,848    3,265    (43.4%)
Other income (expense) from financial operations    (36,039)   1,893    (2004.8%)
Total income (expense)    90,800    (78,165)   (216.2%)

 

The gain from financial operations in 2020 compared to a gain in 2019 was mainly due to:

 

(i)A gain of Ch$42,704 million in the sub-item net gains on trading derivatives compared to a loss of Ch$162,183 million in 2020. Movements in foreign currency and interest rates affect this line item because it includes the valuation adjustments of our derivatives classified as trading. After a sharp depreciation of the peso at the end of 2019 and during the initial months of 2020, the peso strengthened significantly during the rest of the year. The Central Bank exchange rate appreciated 4.5% in 2020, which led to a net gain from trading of derivatives. From the peak on March 20, 2020 to December 31, 2020 the peso appreciated 18.0% compared to the US dollar. Regarding rates, after an initial sell-off of Chilean bonds during the initial period of the pandemic, rates across the yield curve descended sharply and stabilized. This volatility resulted in important movements in the net gain (loss) from trading derivatives. We use derivatives classified as trading, mainly forwards and cross-currency swaps, to hedge the net foreign currency spot position between short-term assets and short-term liabilities and it includes results from our client foreign currency business, such as the sale of currency derivatives, like forwards. At year end 2019 and throughout 2020, the Bank continued to maintain relatively high levels of short-term dollar liquidity deposited overnight in high rated banks given the social unrest and year-end 2019, followed by the pandemic in 2020. Therefore, in both periods, on average, the Bank had more short-term assets in dollars than short-term liabilities, which was hedged through a short-term foreign currency liability position classified as trading. In 2019, as the peso depreciated, this resulted in a loss in this line item and in 2020, as the peso appreciated, this resulted in a gain in this line item.

 

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(ii)The 26.7% increase in the gains on the derecognition of financial assets measured at amortized cost, which totaled Ch$80,679 million. This increase was mainly due a decline in local interest rates as yields came down along the whole nominal and UF peso yield curve, that increased the realized gain from these investments, especially in the second quarter of 2020. These investments are mainly comprised of fixed income instruments issued by the Central Bank of Chile and the Republic of Chile.

 

This was partially offset by:

 

(iii)Lower gains from financial assets at fair value through profit or loss, which decreased 85.9% and ended the year at a gain of Ch$1,671 million. In this line item the mark-to-market and interest income of the trading fixed income portfolio are recognized. Although local interest rates remained low, the yield curve steepened as the year progressed, reducing the gain from investments compared to 2019. These investments are also mainly comprised of Chilean Central Bank instruments.

 

(iv)In 2020, the Bank repurchased certain bonds at a price below par, resulting in the gain recorded in this line item. Due to the high liquidity this year from the high growth in demand deposits and the Central Bank lines, the repurchasing program was stronger than previous years, and although the gains were not as strong as 2019, it was seen as a medium-term strategy to lower the cost of funds. See “Note 20—Issued Debt Instruments and Other Financial Liabilities—b) Senior Bonds” in the Audited Consolidated Financial Statements.

 

(v)The net loss of Ch$36,039 million in the sub-line item others was mainly due to a larger loss from credit value adjustment of our derivative portfolio that is included in this line item. The growth of the Bank’s derivative portfolio and the increase in counterparty risk, caused by the pandemic drove the rise in CVA loss in 2020.

 

The net result from foreign exchange transactions totaled a gain of Ch$58,997 million in 2020 compared to Ch$279,857 million in 2019.

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Net profit or loss from foreign currency exchange differences    90,133    (89,893)   (200.3%)
Hedge-accounting derivatives    (27,624)   362,374    (107.6%)
Translation gains and losses over assets and liabilities indexed to foreign currencies, net    (3,512)   7,376    (147.6%)
Net results from foreign exchange gain    58,997    279,857    (78.9%)

 

Included in these results is the sub-item Net profit or loss from foreign currency exchange differences which includes the mark-to-market of the Bank’s spot position and results from our client foreign currency business, such as currency transactions. The Central Bank exchange rate appreciated 4.5% in 2020 and depreciated 7.0% in 2019, which reflects the gain from our net liability spot position in 2020 versus a net loss for 2019. This is offset by the results from hedge-accounting derivatives and the results from derivatives classified as trading.

 

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Results from the sub-item hedge-accounting derivative are mainly comprised of the mark-to-market of derivatives that are used to mainly hedge the foreign currency risk of our long-term foreign currency funding. Therefore, we generally have a net foreign currency asset position in our hedge-accounting derivatives. These are mainly cross-currency swaps that are accounted under hedge accounting rules. These derivatives produced a loss of Ch$3,512 million in 2020, due to the appreciation of the peso in the 2020.

 

Finally, the Bank has some assets and liabilities that are in Chilean pesos, but indexed to foreign currency. This position produced a loss in 2020 of Ch$3,512 million.

 

In order to more easily compare the results from financial transactions, net, we present the following table that separates the results by lines of business for 2020 and 2019.

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Client treasury products    107,538    101,519    5.9%
Market-making with clients    37,703    37,129    1.5%
Client treasury services    145,222    138,648    4.7%
Sale of loans and charged-off loans    (126)   3,310    (103.8%)
CVA adjustments    (23,216)   (3,957)   486.7%
Financial Management Division and others(1)    27,918    63,691    (56.2%)
Non-client treasury income (loss)    4,576    63,044    (92.7%)
Total financial transactions, net    149,797    201,692    (25.7%)

____________________

(1)The Financial Management Division manages the structural interest rate risk, the structural position in inflation-indexed assets and liabilities, capital requirements and liquidity levels. The aim of the Financial Management Division is to provide stability and continuity in our net interest income from commercial activities, and to ensure that we comply with internal and regulatory limits regarding liquidity, regulatory capital, reserve requirements and market risk.

 

Client treasury services totaled Ch$145,222 million, an increase of 4.7% compared to 2019. The results from client treasury products and market-making mainly include the results from the sale of derivatives, foreign exchange and fixed income instruments to our client base. In 2020, the results from client treasury products increased 5.9%. The higher market volatility due to the COVID-19 pandemic led to higher demand for hedging from our Corporate and Middle-market clients. The results from market-making with client services increased 1.5% in 2020, mainly due an improvement in business volumes of tailor-made treasury services and cash management sold to specific corporate clients, even after a strong year in this line item in 2019. These results may vary year-to-year as some large operations with corporate clients may not be repeated in subsequent years.

 

The results from non-client treasury income decreased 92.7% to Ch$4,576 million in 2020 compared to 2019. These results include the income from sale of loans, including charged-off loans, CVA adjustments and the results from our Financial Management Division. The results of the Bank’s Financial Management Division decreased 56.2% to Ch$27,918 million in 2020 compared to 2019. During 2020, the Bank prepaid various bonds and interbank borrowings in foreign currency as cheaper local funding became available from non-interest bearing deposits and Central Bank lines. These liability management exercises included the unwinding of the rate and currency hedges. In some instances, this resulted in an initial loss recognized in this line item, but a cheaper funding cost going forward. This was partially offset by higher results derived from gains on the derecognition of financial assets measured at amortized cost, which totaled Ch$80,679 million in 2020.

 

The results from the sale of loans totaled a loss of Ch$126 million in 2020 compared to a gain of Ch$3,310 million in 2019 due to lower demand for these sales during the pandemic.

 

The results from CVAs totaled a loss of Ch$23,216 million. This was mainly due to a loss from CVA adjustments of our derivative portfolio which is included in this line item, since the CVA generated by derivatives taken for hedging and on behalf of clients is not part of client income or part of Financial Management’s profit and loss. The growth of the Bank’s derivative portfolio and the increase in counterparty risk drove the rise in CVA adjustment loss in 2020.

 

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Other Operating Income

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Income from assets received in lieu of payment    5,934    5,613    5.7%
Release of contingencies provisions    503    -    --% 
Other income    1,769    7,388    (76.1%)
     Leases    -    -    --% 
     Income from sale of property, plant and equipment    865    2,456    (64.8%)
     Compensation from insurance companies due to damages    702    4,681    (85.0%)
     Other    202    251    (19.5%)
Total    8,206    13,001    (36.9%)

 

Total other operating income decreased by 36.9% in 2020 compared to 2019 and totaled a gain of Ch$8,206 million. This was mainly due to lower income from insurance compensation due to damages as the Bank received compensation for the damages to our branches during the social unrest that affected Chile in October- December of 2019. This was slightly compensated by a release of non-credit contingencies in 2020, and a 5.7% increase in income from assets received in lieu of payment.

 

Expected Credit Loss Allowance

 

The following table sets forth certain information relating to our provision for expected credit losses for the years ended 2020 and 2019.

 

   As of December 31, 2020
   Stage 1  Stage 2  Stage 3 
   Individual  Collective  Individual  Collective  Individual  Collective  Total
   (in millions of Ch$)
Commercial loans    (20,055)   (9,617)   (35,861)   (23,410)   (115,730)   (86,016)   (290,691)
Mortgage loans    -    (16,603)   -    5,966    -    (7,636)   (18,273)
Consumer loans    -    (19,024)   -    18,914    -    (161,466)   (161,576)
Contingent loans    (1,335)   1,600    (1,624)   (4,023)   14    (423)   (5,789)
Loans and AR at FVOCI    (1,253)   -    -    -    -    -    (1,253)
Debt at FVOCI    -    (682)   -    -    -    -    (682)
Total Expected credit losses allowance    (22,643)   (44,326)   (37,485)   (2,552)   (115,716)   (255,543)   (478,264)

 

   As of December 31, 2019
   Stage 1  Stage 2  Stage 3 
   Individual  Collective  Individual  Collective  Individual  Collective  Total
   (in millions of Ch$)
Commercial loans    (3,002)   (4,930)   (10,469)   (8,686)   (79,501)   (33,657)   (140,245)
Mortgage loans    -    (1,177)   -    (4,998)   -    (8,237)   (14,412)
Consumer loans    -    (8,875)   -    (15,280)   -    (145,328)   (169,483)
Contingent loans    45    589    10    24    152    188    1,008 
Loans and AR at FVOCI    5    -    -    -    -    -    5 
Debt at FVOCI    -    (184)   -    -    -    -    (184)
Total Expected credit losses allowance    (2,952)   (14,577)   (10,459)   (28,940)   (79,349)   (187,034)   (323,311)

 

87

 

For the year ended December 31, 2020 provisions for expected credit loss totaled Ch$478,264 million and increased 47.9% compared to 2019. This rise was mainly due to growth of our loan book and an increase in expected losses driven by the economic slowdown as the COVID-19 pandemic forced many cities into lockdown. In April, the Bank completed a calibration of parameters, resulting in additional allowance for Ch$2,066 million. Additionally, with current COVID-19 infection rates having increased and continued high levels of uncertainty in the macro-economic outlook and to address a potential lag in defaults, the Bank’s management has determined to recorded overlay or post-model adjustments overlays for an amount of Ch$59,000 million, wherein Ch$29,000 million addressed macroeconomics’ variables and Ch$30,000 million associated to expected behavior of Fogape loans. The table below breaks down these results by main product item:

 

   Year ended December 31,  % Change
    2020    2019    2020/2019
    (in millions of Ch$)      
Commercial loans   (290,691)   (140,245)   107.3%
Mortgage loans   (18,273)   (14,412)   26.8%
Consumer loans   (161,576)   (169,483)   (4.7%)
Contingent loans   (5,789)   1,008    --% 
Loans and AR at FVOCI   (1,253)   5    --% 
Debt at FVOCI   (682)   (184)   270.7%
Total Provision For Loan Losses   (478,264)   (323,311)   47.9%