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Fair Value of Financial Assets and Liabilities

12 Months Ended

Dec. 31, 2019

Fair Value of Financial Assets and Liabilities [abstract]

Fair Value of Financial Assets and Liabilities

40.

Fair Value of Financial Assets and Liabilities:

Banco de Chile and its subsidiaries have defined a corporate framework for valuation and control related with the process to the fair value measurement.

Within the established framework includes the Product Control Unit (PCU), which is independent of the business areas and reports to the Financial Management and Control Division Manager. This function befalls on the Financial Control and Treasury Manager, through the Financial Risk Information and Control Section is responsible for independent verification of price and results of trading (including derivatives) and investment operations and all fair value measurements.

To achieve the appropriate measurements and controls, the Bank and its subsidiaries, take into account at least the following aspects:

(i)

Industry standard valuation.

To value financial instruments, Banco de Chile uses industry standard modeling and inputs, including quota value, share price, discounted cash flows and valuation of options through Black-Scholes-Merton, according to the case. The input parameters for the valuation correspond to rates, prices and levels of volatility for different terms and market factors that are traded in the national and international market and that are provided by main sources of the market.

(ii)

Quoted prices in active markets.

The fair value for instruments with quoted prices in active markets is determined using daily quotes from electronic systems information (such as Bolsa de Comercio de Santiago, Bloomberg, LVA and Risk America, etc.). This quote represents the price at which these instruments are regularly traded in the financial markets.

(iii)

Valuation techniques.

If no specific quotes are available for the instrument to be valued, valuation techniques will be used to determine the fair value.

Due to the fact that, in general, the valuation models require a set of market parameters as inputs, the aim is to maximize information based on observable or prices-related quotations for similar instruments in active markets. To the extent there is no information available in direct from the markets, data from external suppliers of information, prices of similar instruments and historical information are used to validate the valuation parameters.

(iv)

Fair value adjustments.

Part of the fair value process considers two adjustments to the market value of each instrument calculated based on the market parameters. The Bid/offer adjustment represents the impact on the valuation of an instrument depending on whether the position corresponds to a long (bought) or a short (sold). To calculate this adjustment is used the direct quotes from active markets or indicative prices or derivatives of similar assets depending on the instrument, considering the Bid, Mid and Offer, respectively. Finally, the adjustment made for CVA and DVA for derivatives corresponds to the credit risk recognition of the issuer, either of the counterparty (CVA) or of Banco de Chile (DVA).

(v)

Fair value control.

A process of independent verification of prices and rates is executed daily, in order to control the market parameters used by Banco de Chile in the valuation of the financial instruments relating to the current state of the market and from them the best estimate derived of the fair value. The objective of this process is to control that the official market parameters provided by the respective business area, before being entered into the valuation, are within acceptable ranges of differences when compared to the parameters prepared independently by the Financial Risk Information and Control Section. As a result, value differences are obtained at the level of currency, product and portfolio.

In the event significant differences exist, these differences are scaled according to the amount of individual materiality of each market factor and aggregated at the portfolio level, according to the grouping levels within previously defined ranges. These ranges are approved by the Finance, International and Financial Risk Committee.

Complementary and in parallel, the Financial Risk Information and Control Section generates and reports on a daily basis Profit or Loss ("P&L") and Exposure to Market Risks, which allow for proper control and consistency of the parameters used in the valuation.

(vi)

Judgmental analysis and information to Management.

In particular, in cases where there are no market quotations for the instrument to be valued and there are no prices for similar transactions instruments or indicative parameters, a specific controls and reasoned analysis must be carried out in order to estimate the fair value of the operation. Within the valuation framework described in the Reasonable Value Policy (and its procedure) approved by the Board of Directors of Banco de Chile, a required level of approval is set in order to carry out transactions where market information is not available or it is not possible to infer prices or rates from it.

(a)

Fair value hierarchy

Banco de Chile and its subsidiaries, classify all the financial instruments among the following levels:

Level 1:

These are financial instruments whose fair value is calculated at quoted prices (unadjusted) in extracted from liquid and deep markets. For these instruments there are observable market prices (return internal rates, quote value, price) the observable market, so that assumptions are not required to determine the value.

In this level, the following instruments are considered: currency futures, debt instruments issued by Chilean Central Bank and Treasury, which belong to benchmarks, mutual fund investments and equity shares.

For the instruments of the Central Bank of Chile and the General Treasury of the Republic, all those mnemonics belonging to a Benchmark, in other words corresponding to one of the following categories published by the Santiago Stock Exchange, will be considered as Level 1: Pesos-02, Pesos-03, Pesos-04, Pesos-05, Pesos-07, Pesos-10, UF-02, UF-04, UF-05, UF-07, UF-10, UF-20, UF-30. A Benchmark corresponds to a group of mnemonics that are similar in duration and are traded in an equivalent way, i.e., the price (return internal rates in this case) obtained is the same for all the instruments that make up a Benchmark. This feature defines a greater depth of market, with daily quotations that allow classifying these instruments as Level 1.

In the case of debt issued by the Government, the internal rate of return of the market is used to discount all flows to present value. In the case of mutual funds and equity shares, the current market price per share, this multiplied by the number of instruments results in the fair value.

The preceding described valuation methodology is equivalent to the one used by the Bolsa de Comercio de Santiago (Santiago Stock Exchange) and corresponds with the standard methodology used in the market and is in accordance with standards used in IFRS.

Level 2:

They are financial instruments whose fair value is calculated based on prices other than in quoted in Level 1 that are observable for the asset or liability, directly (that is, as prices or internal rates of return) or indirectly (that is, derived from prices or internal rates of return from similar instruments). These categories include:

Quoted prices for similar assets or liabilities in active markets.

Quoted prices for identical or similar assets or liabilities in markets that are not active.

Inputs data other than quoted prices that are observable for the asset or liability.

Inputs data corroborated by the market.

At this level there are mainly derivatives instruments, debt issued by banks, debt issued by Chilean and foreign companies, issued in Chile or abroad, mortgage notes, financial brokerage instruments and some issuances by the Central Bank of Chile and the General Treasury of Chile, which do not belong to benchmarks.

To value derivatives, depends on whether they are impacted by volatility as a relevant market factor in standard valuation methodologies; for options the Black-Scholes-Merton formula is used; for the rest of the derivatives, forwards and swaps, discounted cash flows method is used.

For the remaining instruments at this level, as for debt issues of Level 1, the valuation is done through cash flows model by using an estimated yield to maturity that can be derived or estimated from internal rates of return of similar securities as mentioned above.

In the event that there is no observable price for an instrument in a specific term, the price will be inferred from the interpolation between periods that have observable quoted price in active markets. These models incorporate various market variables, including the credit quality of counterparties, exchange rates and interest rate curves.

Valuation Techniques and Inputs for Level 2 Instrument:

Type of Financial

Instrument

Valuation Method

Description: Inputs and Sources

Local Bank and

Corporate Bonds

Discounted cash

flows model

Prices (internal rates of return) are provided by third party price providers that are widely used in the Chilean market.

Model is based on a Base Yield (Central Bank Bonds) and issuer spread.

The model is based on daily prices and risk/maturity similarities between Instruments.

Offshore Bank and

Corporate Bonds

Prices (internal rates of return) are provided by third party price providers that are widely used in the Chilean market.

Model is based on daily prices.

Local Central Bank

and Treasury Bonds

Prices (internal rates of return) are provided by third party price providers that are widely used in the Chilean market.

Model is based on daily prices.

Mortgage

Notes

Prices (internal rates of return) are provided by third party price providers that are widely used in the Chilean market.

Model is based on a Base Yield (Central Bank Bonds) and issuer spread.

The model takes into consideration daily prices and risk/maturity similarities between instruments.

Time

Deposits

Prices are provided by third party price providers that are widely used in the Chilean market.

Model is based on daily prices and considers risk/maturity similarities between instruments.

Cross Currency Swaps,

Interest Rate Swaps,

FX Forwards, Inflation

Forwards

Forward Points, Inflation forecast and local swap rates are provided by market brokers that are widely used in the Chilean market

Offshore rates and spreads are obtained from third party price providers that are widely used in the Chilean market.

Zero Coupon rates are calculated by using the bootstrapping method over swap rates.

FX Options

Black-Scholes

Model

Prices for volatility surface estimates are obtained from market brokers that are widely used in the Chilean market.

Level 3:

These are financial instruments whose fair value is determined using non-observable inputs data neither for the assets or liabilities under analysis nor for similar instruments. An adjustment to an input that is significant to the entire measurement can result in a fair value measurement classified within Level 3 of the fair value hierarchy, if the adjustment uses significant non-observable data entry.

The instruments likely to be classified as Level 3 are mainly Corporate Debt by Chilean and foreign companies, issued both in Chile and abroad.

Valuation Techniques and Inputs for Level 3 Instrument:

Type of Financial

Instrument

Valuation Method

Description: Inputs and Sources

Local Bank and Corporate Bonds

Discounted cash flows model

Since inputs for these types of securities are not observable by the market, we model interest rate of returns for them based on a Base Yield (Central Bank Bonds) and issuer spread. These inputs (base yield and issuer spread) are provided on a daily basis by third party price providers that are widely used in the Chilean market.

Offshore Bank and Corporate Bonds

Discounted cash flows model

Since inputs for these types of securities are not observable by the market, we model interest rate of returns for them based on a Base Yield (US-Libor) and issuer spread. These inputs (base yield and issuer spread) are provided on a weekly basis by third party price providers that are widely used in the Chilean market.

(b)

Level hierarchy classification and figures:

The following table shows the figures by hierarchy, for instruments recorded at fair value in the statement of financial position as of December 31, 2018 and 2019.

	Level 1				Level 2				Level 3				Total
	2018		2019		2018		2019		2018		2019		2018		2019
	MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$
Financial Assets
Financial assets held-for-trading
From the Chilean government and Central Bank		178,692		93,032		1,344,780		1,030,657		―		―		1,523,472		1,123,689
Other instruments issued in Chile		1,663		3,272		107,078		316,971		20,866		55,094		129,607		375,337
Instruments issued abroad		4,446		―		―		―		―		―		4,446		―
Mutual fund investments		87,841		373,329		―		―		―		―		87,841		373,329
Subtotal		272,642		469,633		1,451,858		1,347,628		20,866		55,094		1,745,366		1,872,355
Derivative contracts for trading purposes
Forwards		―		―		735,444		956,632		―		―		735,444		956,632
Swaps		―		―		738,130		1,761,952		―		―		738,130		1,761,952
Call options		―		―		4,839		4,961		―		―		4,839		4,961
Put options		―		―		120		1,076		―		―		120		1,076
Futures		―		―		―		―		―		―		―		―
Subtotal		―		―		1,478,533		2,724,621		―		―		1,478,533		2,724,621
Hedge derivative contracts
Fair value hedge (Swaps)		―		―		1,116		32		―		―		1,116		32
Cash flow hedge (Swaps)		―		―		34,298		61,562		―		―		34,298		61,562
Subtotal		―		―		35,414		61,594		―		―		35,414		61,594
Total		―		―		1,513,947		2,786,215		―		―		1,513,947		2,786,215
Financial assets at fair value through other comprehensive income
Debt instruments ⁽¹⁾:
From the Chilean government and Central Bank		99,132		66,953		65,090		42,109		―		―		164,222		109,062
Instruments issued in Chile		―		―		747,653		1,221,862		23,021		7,069		770,674		1,228,931
Instruments issued abroad		―		―		108,544		19,853		―		―		108,544		19,853
Subtotal		99,132		66,953		921,287		1,283,824		23,021		7,069		1,043,440		1,357,846
Equity instruments:
Instruments issued in Chile		―		―		8,939		7,446		―		―		8,939		7,446
Instruments issued abroad		723		955		―		―		89		96		812		1,051
Subtotal		723		955		8,939		7,446		89		96		9,751		8,497
Total		99,855		67,908		930,226		1,291,270		23,110		7,165		1,053,191		1,366,343
Total		372,497		537,541		3,896,031		5,425,113		43,976		62,259		4,312,504		6,024,913

Financial liabilities
Derivative contracts for trading purposes
Forwards		―		―		631,089		673,932		―		―		631,089		673,932
Swaps		―		―		854,708		2,097,022		―		―		854,708		2,097,022
Call options		―		―		2,921		1,529		―		―		2,921		1,529
Put options		―		―		1,534		2,209		―		―		1,534		2,209
Futures		―		―		―		―		―		―		―		―
Subtotal		―		―		1,490,252		2,774,692		―		―		1,490,252		2,774,692
Hedge derivative contracts
Fair value hedge (Swaps)		―		―		6,164		9,286		―		―		6,164		9,286
Cash flow hedge (Swaps)		―		―		31,818		34,443		―		―		31,818		34,443
Subtotal		―		―		37,982		43,729		―		―		37,982		43,729
Total		―		―		1,528,234		2,818,421		―		―		1,528,234		2,818,421

(1)

As of December 31, 2019, 98% of instruments of Level 3 have denomination "Investment Grade". Also, 100% of total of these financial instruments correspond to domestic issuers.

(c)

Level 3 Reconciliation

The following tables show the reconciliation between the beginning and ending balances of instruments classified as Level 3, whose fair value is reflected in the Financial Statements.

	2018
	Balance as of January 1, 2018		Gain (Loss) Recognized in Income (1)		Gain (Loss) Recognized in Equity (2)			Purchases		Sales			Transfer from Level 1 and 2		Transfer to Level 1 and 2			Balance as of December 31, 2018
	MCh$		MCh$		MCh$			MCh$		MCh$			MCh$		MCh$			MCh$
Financial Assets
Financial assets held-for-trading:
Other instruments issued in Chile		8,012		176		—			48,740		(36,062	)		—		—			20,866
Subtotal		8,012		176		—			48,740		(36,062	)		—		—			20,866

Financial assets at fair value through OCI:
Debt instruments:
Other instruments issued in Chile		46,265		2,539		(292	)		—		(20,520	)		—		(4,971	)		23,021
Equity instruments:
Instruments issued abroad		50		—		39			—		—			—		—			89
Subtotal		46,315		2,539		(253	)		—		(20,520	)		—		(4,971	)		23,110

Total		54,327		2,715		(253	)		48,740		(56,582	)		—		(4,971	)		43,976

	2019
	Balance as of January 1, 2019		Gain (Loss) Recognized in Income (1)			Gain (Loss) Recognized in Equity (2)			Purchases		Sales			Transfer from Level 1 and 2		Transfer to Level 1 and 2			Balance as of December 31, 2019
	MCh$		MCh$			MCh$			MCh$		MCh$			MCh$		MCh$			MCh$
Financial Assets
Financial assets held-for-trading:
Other instruments issued in Chile		20,866		(38	)		—			48,017		(26,504	)		13,368		(615	)		55,094
Subtotal		20,866		(38	)		—			48,017		(26,504	)		13,368		(615	)		55,094

Financial assets at fair value through OCI:
Debt instruments:
Other instruments issued in Chile		23,021		968			(517	)		—		(18,177	)		1,774		—			7,069
Equity instruments:
Instruments issued abroad		89		—			7			—		—			—		—			96
Subtotal		23,110		968			(510	)		—		(18,177	)		1,774		—			7,165

Total		43,976		930			(510	)		48,017		(44,681	)		15,142		(615	)		62,259

(1)

It is recorded in the income statement under "Net financial operating income"

(2)

It is recorded in Equity under "Other Comprehensive Income"

(d)

Transfers between levels:

The following tables show transfers between levels for financial assets and liabilities whose fair value is recorded in the consolidated financial statements:

	Transfers from level 1 to level 2
	2018
Financial assets	MCh$

Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		496

Instruments issued abroad
From the Chilean Government and Central Bank		―

	Transfers from level 2 to level 1
	2018
Financial assets	MCh$

Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		―

Instruments issued abroad
From the Chilean Government and Central Bank		―

	Transfers from level 1 to level 2
	2019
Financial assets	MCh$

Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		84

Financial assets at fair value through OCI
From the Chilean Government and Central Bank		―

	Transfers from level 2 to level 1
	2019
Financial assets	MCh$

Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		17

Financial assets at fair value through OCI
From the Chilean Government and Central Bank		―

(e)

Sensitivity of Level 3 instruments to changes in key assumptions of the input parameters for the valuation model:

The following table shows the impact on the fair value of Level 3 financial instruments using alternative assumptions that are reasonably possible.

It is believed that the positive and negative impacts are similar:

	As of December 31, 2018					As of December 31, 2019
	Level 3		Sensitivity to changes in key assumptions of models			Level 3		Sensitivity to changes in key assumptions of models
Financial Assets	MCh$		MCh$			MCh$		MCh$
Financial assets held-for-trading
Other instruments issued in Chile		20,866		(26	)		55,094		(466	)
Subtotal		20,866		(26	)		55,094		(466	)
Financial assets at fair value through OCI
Debt instrument:
Other instruments issued in Chile		23,021		(195	)		7,069		(86	)
Equity instrument:
Instruments issued abroad		89		―			96		―
Subtotal		23,110		(195	)		7,165		(86	)
Total		43,976		(221	)		62,259		(552	)

With the purpose to determine the sensitivity of the financial investments to changes in significant market factors, the Bank has made alternative calculations at fair value, changing those key parameters for the valuation and which are not directly observable in screens. In the case of financial assets presented in the table above, which corresponds to bank bonds and corporate bonds, input prices, prices based on broker quotes or runs were used, considering that these instruments do not have current prices or observables. Prices are generally calculated as a base rate plus a spread. For local bonds, this was determined by applying only a 10% impact on the price, while for offshore bonds this was determined by applying only a 10% impact on the spread because the base rate is hedged with instruments on interest rate swaps so-called hedge accounting. The impact of 10% is considered a reasonable move considering the market performance of these instruments and comparing it against the adjustment bid/offer that is provided for by these instruments.

(f)

Other assets and liabilities not measured at fair value:

The following table summarizes the fair values of the Bank's main financial assets and liabilities that are not recorded at fair value in the Statement of Financial Position. The values shown in this note do not attempt to estimate the value of the Bank's income-generating assets, nor forecast their future behavior. The estimated fair value is as follows:

	Book Value				Fair Value
	2018		2019		2018		2019
	MCh$		MCh$		MCh$		MCh$
Assets
Cash and due from banks		880,081		2,392,166		880,081		2,392,166
Transactions in the course of collection		289,194		331,420		289,194		331,420
Investments under resale agreements		97,289		142,329		97,289		142,329
Subtotal		1,266,564		2,865,915		1,266,564		2,865,915
Loans and advances to banks
Domestic banks		99,776		149,974		99,776		149,974
Chilean Central Bank		1,100,831		630,053		1,100,831		630,053
Foreign banks		293,777		360,054		286,063		358,542
Subtotal		1,494,384		1,140,081		1,486,670		1,138,569
Loans to Customers at amortized cost
Commercial loans		15,209,534		16,039,411		14,949,852		15,988,330
Residential mortgage loans		8,017,743		9,163,019		8,451,099		9,888,506
Consumer loans		4,113,977		4,181,609		4,116,261		4,215,509
Subtotal		27,341,254		29,384,039		27,517,212		30,092,345
Total		30,102,202		33,390,035		30,270,446		34,096,829

Liabilities
Current accounts and other demand deposits		9,584,488		11,326,133		9,584,488		11,326,133
Transactions in the course of payment		44,436		98,869		44,436		98,869
Obligations under repurchase agreements		303,820		308,734		303,820		308,734
Saving accounts and time deposits		10,656,174		10,856,618		10,632,350		10,795,125
Borrowings from financial institutions		1,516,759		1,563,277		1,506,940		1,555,129
Other financial obligations		118,014		156,229		119,024		160,361
Subtotal		22,223,691		24,309,860		22,191,058		24,244,351
Debt issued
Letters of credit for residential purposes		15,040		10,229		15,982		11,081
Letters of credit for general purposes		1,328		669		1,411		725
Bonds		6,772,990		7,912,621		6,897,317		8,340,272
Subordinated bonds		686,194		889,895		732,611		1,004,621
Subtotal		7,475,552		8,813,414		7,647,321		9,356,699
Total		29,699,243		33,123,274		29,838,379		33,601,050

Other financial assets and liabilities not measured at their fair value, but for which a fair value is estimated, even if not managed based on such value, include assets and liabilities such as placements, deposits and other time deposits, debt issued, and other financial assets and obligations with different maturities and characteristics. The fair value of these assets and liabilities is calculated using the Discounted Cash Flow model and the use of various data sources such as yield curves, credit risk spreads, etc. In addition, because some of these assets and liabilities are not traded on the market, periodic reviews and analyzes are required to determine the suitability of the inputs and determined fair values.

(g)

Levels of other assets and liabilities:

The table below sets forth the fair value of Financial Assets/Liabilities not measured at fair value on the balance sheet, for the years ended December 31, 2018 and 2019:

	Level 1				Level 2				Level 3				Total
	Estimated Fair Value				Estimated Fair Value				Estimated Fair Value				Estimated Fair Value
	2018		2019		2018		2019		2018		2019		2018		2019
	MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$
Assets
Cash and due from banks		880,081		2,392,166		―		―		―		―		880,081		2,392,166
Transactions in the course of collection		289,194		331,420		―		―		―		―		289,194		331,420
Investments under resale agreements		97,289		142,329		―		―		―		―		97,289		142,329
Subtotal		1,266,564		2,865,915		―		―		―		―		1,266,564		2,865,915
Loans and advances to banks
Domestic banks		99,776		149,974		―		―		―		―		99,776		149,974
Central bank		1,100,831		630,053		―		―		―		―		1,100,831		630,053
Foreign banks		―		―		―		―		286,063		358,542		286,063		358,542
Subtotal		1,200,607		780,027		―		―		286,063		358,542		1,486,670		1,138,569
Loans to Customers at amortized cost
Commercial loans		―		―		―		―		14,949,852		15,988,330		14,949,852		15,988,330
Residential mortgage loans		―		―		―		―		8,451,099		9,888,506		8,451,099		9,888,506
Consumer loans		―		―		―		―		4,116,261		4,215,509		4,116,261		4,215,509
Subtotal		―		―		―		―		27,517,212		30,092,345		27,517,212		30,092,345
Total		2,467,171		3,645,942		―		―		27,803,275		30,450,887		30,270,446		34,096,829

Liabilities
Current accounts and other demand deposits		9,584,488		11,326,133		―		―		―		―		9,584,488		11,326,133
Transactions in the course of payment		44,436		98,869		―		―		―		―		44,436		98,869
Obligations under repurchase agreements		303,820		308,734		―		―		―		―		303,820		308,734
Savings accounts and time deposits		―		―		―		―		10,632,350		10,795,125		10,632,350		10,795,125
Borrowings from financial institutions		―		―		―		―		1,506,940		1,555,129		1,506,940		1,555,129
Other financial obligations		―		―		―		―		119,024		160,361		119,024		160,361
Subtotal		9,932,744		11,733,736		―		―		12,258,314		12,510,615		22,191,058		24,244,351
Debt Issued
Letters of credit for residential purposes		―		―		15,982		11,081		―		―		15,982		11,081
Letters of credit for general purposes		―		―		1,411		725		―		―		1,411		725
Bonds		―		―		6,897,317		8,340,272		―		―		6,897,317		8,340,272
Subordinate bonds		―		―		―		―		732,611		1,004,621		732,611		1,004,621
Subtotal		―		―		6,914,710		8,352,078		732,611		1,004,621		7,647,321		9,356,699
Total		9,932,744		11,733,736		6,914,710		8,352,078		12,990,925		13,515,236		29,838,379		33,601,050

We estimate fair values for these assets/liabilities, as follows:

●

Short-Term Financial Assets/Liabilities: For assets and liabilities with no specific maturity (on demand) or terms of less than three months we use the carrying or book values as proxies of their fair value, since their tenors are not believed to significantly affect their valuation. As a result, these assets/liabilities are categorized in Level 1. This assumption is applied to the following assets/liabilities:

Assets		Liabilities
- Cash and due from banks		- Current accounts and other demand deposits
- Transactions in the course of collection		- Transactions in the course of payments
- Investment under resale agreements		- Obligations under repurchase agreements
- Loans and advance to domestic banks

●

Loans to Customers at amortized cost and Advance to foreign banks: Fair value is determined by using the discounted cash flow model and internally generated discount rates, based on internal transfer rates derived from our internal transfer price process. Once the present value is determined, we deduct the related loan loss allowances in order to incorporate the credit risk associated with each contract or loan. As we use internally generated parameters for valuation purposes, we categorize these instruments in Level 3.

●

Letters of Credit and Bonds: In order to determine the present value of contractual cash flows, we apply the DCF model by using market interest rates that are available in the market, either for the instruments under valuation or instruments with similar features that fit valuation needs in terms of currency, maturities and liquidity. The market interest rates are obtained from third party price providers widely used by the market. As a result of the valuation technique and the quality of inputs (observable) used for valuation, we categorize these financial liabilities in Level 2.

●

Saving Accounts, Time Deposits, Borrowings from Financial Institutions, Subordinated Bonds and Other borrowings financial: The DCF model is used to obtain the present value of committed cash flows by applying a bucket approach and average adjusted discount rates that are derived from both market rates for instruments with similar features and our internal transfer price process. As we use internally generated parameters and/or apply significant judgmental analysis for valuation purposes, we categorize these financial assets/liabilities in Level 3.

(h)

Offsetting of financial assets and liabilities:

In accordance with IAS 32 Financial Instruments: Presentation, the Bank should report financial assets and financial liabilities on a net basis on the balance sheet only if there is a legally enforceable right to set off the recognized amounts and there is intention to settle on a net basis, or to realize the asset and settle the liability simultaneously. Because Bank's netting agreements do not qualify for balance sheet netting, it presents its financial instruments on a gross basis on the balance sheet.

The following table shows the impact of netting arrangements on all derivative financial instruments that are subject to enforceable master netting agreements or similar agreements (including financial collaterals), but do not qualify for balance sheet netting.

The "Net amounts" presented below are not intended to represent the Bank's actual exposure to credit risk, as a variety of credit mitigation strategies are employed in addition to netting and collateral arrangements.

	Effect of offsetting on balance sheet					Related amount not offset
	Gross amount		Amounts offset	Net amounts reported on the balance sheet		Financial Instruments			Financial Collateral			Net amount
	MCh$		MCh$	MCh$		MCh$			MCh$			MCh$
As of December 31, 2018
Derivative financial assets		1,513,947	―		1,513,947		(1,007,130	)		(30,036	)		476,781
Derivative financial liabilities		1,528,234	―		1,528,234		(1,007,130	)		(233,450	)		287,654

		Effect of offsetting on balance sheet					Related amount not offset
		Gross amount	Amounts offset		Net amounts reported on the balance sheet		Financial Instruments			Financial Collateral			Net amount
		MCh$	MCh$		MCh$		MCh$			MCh$			MCh$
As of December 31, 2019
Derivative financial assets		2,786,215	―		2,786,215		(2,113,970	)		(43,337	)		628,908
Derivative financial liabilities		2,818,421	―		2,818,421		(2,113,970	)		(418,988	)		285,463

Derivative assets and liabilities

The "Financial Instruments" column identifies financial assets and liabilities that are subject to set off under netting agreements, such as the ISDA Master Agreement of derivative exchange or clearing counterparty agreements, whereby all outstanding transactions with the same counterparty could be offset and close-out netting applied across all outstanding transaction covered by the agreements if an event of default or other predetermined events occur ("early contract termination").

Financial collateral refers to cash and non-cash collateral obtained, typically daily or weekly, to cover the net exposure between counterparties by enabling the collateral to be realized in an event of default or if other predetermined events occur ("early contract termination").