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Fair Value of Financial Assets and Liabilities:

12 Months Ended

Dec. 31, 2020

Disclosure of redesignated financial assets and liabilities [text block] [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 the Treasury and the Central Bank of Chile, 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 Chilean 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, 2019 and 2020.

	Level 1				Level 2				Level 3				Total
	2019		2020		2019		2020		2019		2020		2019		2020
	MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$
Financial Assets
Financial assets held-for-trading
From the Chilean government and Central Bank		93,032		75,701		1,030,657		4,083,591		—		—		1,123,689		4,159,292
Other instruments issued in Chile		3,272		1,002		316,971		99,302		55,094		5,494		375,337		105,798
Instruments issued abroad		—		164		—		—		—		—		—		164
Mutual fund investments		373,329		400,902		—		—		—		—		373,329		400,902
Total		469,633		477,769		1,347,628		4,182,893		55,094		5,494		1,872,355		4,666,156
Derivative Instruments
Derivative contracts for trading purposes
Forwards		—		—		956,632		551,964		—		—		956,632		551,964
Swaps		—		—		1,761,952		2,013,247		—		—		1,761,952		2,013,247
Call options		—		—		4,961		269		—		—		4,961		269
Put options		—		—		1,076		1,462		—		—		1,076		1,462
Futures		—		—		—		—		—		—		—		—
Subtotal		—		—		2,724,621		2,566,942		—		—		2,724,621		2,566,942
Hedge derivative contracts
Fair value hedge (Swaps)		—		—		32		—		—		—		32		—
Cash flow hedge (Swaps)		—		—		61,562		51,062		—		—		61,562		51,062
Subtotal		—		—		61,594		51,062		—		—		61,594		51,062
Total		—		—		2,786,215		2,618,004		—		—		2,786,215		2,618,004
Financial assets at fair value through other comprehensive income
Debt instruments ⁽¹⁾:
From the Chilean government and Central Bank		66,953		—		42,109		163,600		—		—		109,062		163,600
Instruments issued in Chile		—		—		1,221,862		860,327		7,069		36,596		1,228,931		896,923
Instruments issued abroad		—		—		19,853		—		—		—		19,853		—
Subtotal		66,953		—		1,283,824		1,023,927		7,069		36,596		1,357,846		1,060,523
Equity instruments:
Instruments issued in Chile		—		—		7,446		6,869		—		—		7,446		6,869
Instruments issued abroad		955		670		—		—		96		91		1,051		761
Subtotal		955		670		7,446		6,869		96		91		8,497		7,630
Total		67,908		670		1,291,270		1,030,796		7,165		36,687		1,366,343		1,068,153
Total Financial Assets		537,541		478,439		5,425,113		7,831,693		62,259		42,181		6,024,913		8,352,313

Financial liabilities
Derivative contracts for trading purposes
Forwards		—		—		673,932		637,164		—		—		673,932		637,164
Swaps		—		—		2,097,022		2,130,393		—		—		2,097,022		2,130,393
Call options		—		—		1,529		306		—		—		1,529		306
Put options		—		—		2,209		2,099		—		—		2,209		2,099
Futures		—		—		—		—		—		—		—		—
Subtotal		—		—		2,774,692		2,769,962		—		—		2,774,692		2,769,962
Hedge derivative contracts
Fair value hedge (Swaps)		—		—		9,286		6,519		—		—		9,286		6,519
Cash flow hedge (Swaps)		—		—		34,443		65,172		—		—		34,443		65,172
Subtotal		—		—		43,729		71,691		—		—		43,729		71,691
Total Financial liabilities		—		—		2,818,421		2,841,653		—		—		2,818,421		2,841,653

(1)	As of December 31, 2020, 100% 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.

	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

	2020
	Balance as of January 1, 2020		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, 2020
	MCh$		MCh$			MCh$			MCh$		MCh$			MCh$		MCh$		MCh$
Financial Assets
Financial assets held-for-trading:
Other instruments issued in Chile		55,094		(708	)		—			49,424		(98,316	)		—		—		5,494
Subtotal		55,094		(708	)		—			49,424		(98,316	)		—		—		5,494

Financial assets at fair value through OCI:
Debt instruments:
Other instruments issued in Chile		7,069		323			(647	)		71,539		(70,897	)		29,209		—		36,596
Equity instruments:
Instruments issued abroad		96		—			(5	)		—		—			—		—		91
Subtotal		7,165		323			(652	)		71,539		(70,897	)		29,209		—		36,687

Total		62,259		(385	)		(652	)		120,963		(169,213	)		29,209		—		42,181

(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
Financial assets	2019
	MCh$
Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		84

Instruments issued abroad
From the Chilean Government and Central Bank		—

	Transfers from level 2 to level 1
Financial assets	2019
	MCh$
Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		17

Instruments issued abroad
From the Chilean Government and Central Bank		—

	Transfers from level 1 to level 2
Financial assets	2020
	MCh$
Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		425

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

	Transfers from level 2 to level 1
Financial assets	2020
	MCh$
Financial assets held-for-trading instruments
From the Chilean Government and Central Bank		109

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, 2019					As of December 31, 2020
	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		55,094		(466	)		5,494		(8	)
Subtotal		55,094		(466	)		5,494		(8	)
Financial assets at fair value through OCI
Debt instrument:
Other instruments issued in Chile		7,069		(86	)		36,596		(525	)
Equity instrument:
Instruments issued abroad		96		—			91		—
Subtotal		7,165		(86	)		36,687		(525	)
Total		62,259		(552	)		42,181		(533	)

With the purpose of determining 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 the financial assets listed in the table above, which correspond to Bank Bonds and Corporate Bonds, it was considered that, since there are no current observables prices, the input prices will be based on brokers’ quotes. The prices are usually calculated as a base rate plus a spread. For Local Bonds it was determined to apply a 10% impact on the price, while for the Off Shore Bonds it was determined to apply a 10% impact only on the spread, since the base rate is covered by interest rate swaps instruments in the so-called accounting hedges. The 10% impact is considered reasonable, taking into account the market performance of these instruments and comparing it against the bid / offer adjustment that is provisioned 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
	2019		2020		2019		2020
	MCh$		MCh$		MCh$		MCh$
Assets
Cash and due from banks		2,392,166		2,560,216		2,392,166		2,560,216
Transactions in the course of collection		331,420		163,252		331,420		163,252
Investments under resale agreements		142,329		76,407		142,329		76,407
Subtotal		2,865,915		2,799,875		2,865,915		2,799,875
Loans and advances to banks
Domestic banks		149,974		259,788		149,974		259,788
Central Bank of Chile		630,053		2,380,033		630,053		2,380,033
Foreign banks		360,054		299,377		358,542		297,778
Subtotal		1,140,081		2,939,198		1,138,569		2,937,599
Loans to Customers at amortized cost
Commercial loans		16,039,411		17,120,207		15,988,330		16,968,143
Residential mortgage loans		9,163,019		9,352,720		9,888,506		10,075,011
Consumer loans		4,181,609		3,628,656		4,215,509		3,711,582
Subtotal		29,384,039		30,101,583		30,092,345		30,754,736
Total		33,390,035		35,840,656		34,096,829		36,492,210

Liabilities
Current accounts and other demand deposits		11,326,133		15,167,229		11,326,133		15,167,229
Transactions in the course of payment		98,869		882,944		98,869		882,944
Obligations under repurchase agreements		308,734		288,917		308,734		288,917
Saving accounts and time deposits		10,856,618		8,899,541		10,795,125		8,885,015
Borrowings from financial institutions		1,563,277		3,669,753		1,555,129		3,415,959
Other financial obligations		156,229		191,713		160,361		217,311
Subtotal		24,309,860		29,100,097		24,244,351		28,857,375
Debt issued
Letters of credit for residential purposes		10,229		6,532		11,081		7,201
Letters of credit for general purposes		669		254		725		280
Bonds		7,912,621		7,700,402		8,340,272		8,390,594
Subordinated bonds		889,895		886,407		1,004,621		1,004,196
Subtotal		8,813,414		8,593,595		9,356,699		9,402,271
Total		33,123,274		37,693,692		33,601,050		38,259,646

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, 2019 and 2020:

	Level 1				Level 2				Level 3				Total
	Estimated Fair Value				Estimated Fair Value				Estimated Fair Value				Estimated Fair Value
	2019		2020		2019		2020		2019		2020		2019		2020
	MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$		MCh$
Assets
Cash and due from banks		2,392,166		2,560,216		—		—		—		—		2,392,166		2,560,216
Transactions in the course of collection		331,420		163,252		—		—		—		—		331,420		163,252
Investments under resale agreements		142,329		76,407		—		—		—		—		142,329		76,407
Subtotal		2,865,915		2,799,875		—		—		—		—		2,865,915		2,799,875
Loans and advances to banks
Domestic banks		149,974		259,788		—		—		—		—		149,974		259,788
Central Bank of Chile		630,053		2,380,033		—		—		—		—		630,053		2,380,033
Foreign banks		—		—		—		—		358,542		297,778		358,542		297,778
Subtotal		780,027		2,639,821		—		—		358,542		297,778		1,138,569		2,937,599
Loans to Customers at amortized cost
Commercial loans		—		—		—		—		15,988,330		16,968,143		15,988,330		16,968,143
Residential mortgage loans		—		—		—		—		9,888,506		10,075,011		9,888,506		10,075,011
Consumer loans		—		—		—		—		4,215,509		3,711,582		4,215,509		3,711,582
Subtotal		—		—		—		—		30,092,345		30,754,736		30,092,345		30,754,736
Total		3,645,942		5,439,696		—		—		30,450,887		31,052,514		34,096,829		36,492,210

Liabilities
Current accounts and other demand deposits		11,326,133		15,167,229		—		—		—		—		11,326,133		15,167,229
Transactions in the course of payment		98,869		882,944		—		—		—		—		98,869		882,944
Obligations under repurchase agreements		308,734		288,917		—		—		—		—		308,734		288,917
Savings accounts and time deposits		—		—		—		—		10,795,125		8,885,015		10,795,125		8,885,015
Borrowings from financial institutions		—		—		—		—		1,555,129		3,415,959		1,555,129		3,415,959
Other financial obligations		—		—		—		—		160,361		217,311		160,361		217,311
Subtotal		11,733,736		16,339,090		—		—		12,510,615		12,518,285		24,244,351		28,857,375
Debt Issued
Letters of credit for residential purposes		—		—		11,081		7,201		—		—		11,081		7,201
Letters of credit for general purposes		—		—		725		280		—		—		725		280
Bonds		—		—		8,340,272		8,390,594		—		—		8,340,272		8,390,594
Subordinate bonds		—		—		—		—		1,004,621		1,004,196		1,004,621		1,004,196
Subtotal		—		—		8,352,078		8,398,075		1,004,621		1,004,196		9,356,699		9,402,271
Total		11,733,736		16,339,090		8,352,078		8,398,075		13,515,236		13,522,481		33,601,050		38,259,646

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
As of December 31, 2019	MCh$		MCh$		MCh$		MCh$			MCh$			MCh$
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

	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
As of December 31, 2020	MCh$		MCh$		MCh$		MCh$			MCh$			MCh$
Derivative financial assets		2,618,004		—		2,618,004		(2,258,554	)		(85,614	)		273,836
Derivative financial liabilities		2,841,653		—		2,841,653		(2,258,554	)		(218,329	)		364,770

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”).