AS OF DECEMBER 31, 2018 AND 2017

as of December 31, 2018 and 2017

Introduction

As indicated in Note 2 on Summary of significant accounting policies, the financial statements of Banco Central de Chile were prepared in accordance with the “Policies of presentation and preparation of financial reports of Banco Central de Chile” approved by the Banco Central de Chile’s Board, which are consistent with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB).

International Financial Reporting Standards comprise the IFRS and International Accounting Standards (IAS) issued by the IASB, which are effective at the reporting date.

Banco Central de Chile has adopted IFRS 9 “Financial Instruments” starting from January 1, 2018 -its mandatory application date-, which supersedes IAS 39 “Financial Instruments: Recognition and Measurement.”

The requirements of this new standard represent a significant change with respect to the previous standard. These changes translate into amendments to the classification and valuation criteria for financial instruments with respect to those applied in the prior accounting period, whose impact on these financial statements is explained in Note 4 “Accounting changes.

Note 1

INCORPORATION AND DESCRIPTION OF BUSINESS

Banco Central de Chile was formed on August 22, 1925, by Decree Law 486. Banco Central de Chile is a constitutionally autonomous entity, has full legal capacity, its own assets and indefinite duration, created in accordance with Articles 108 and 109 of the Political Constitution of Chile and ruled by its Basic Constitutional Act.

Banco Central de Chile’s objective is to monitor the stability of both the Chilean currency and the normal functioning of domestic and foreign payments.

In order to meet its objectives, Banco Central de Chile regulates the amount of money and credit in circulation, executes credit transactions and international exchange, and dictates regulations on monetary credit, and financial and international exchange matters.

Additionally, Banco Central de Chile is exclusively empowered to issue banknotes and to mint coins.

Banco Central de Chile is domiciled in Santiago de Chile, and its main office is located at 1180 Agustinas street.

Note 2

SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

(a) Basis of preparation of the financial statements

These financial statements have been prepared in conformity with the criteria approved by the Banco Central de Chile’s Board, pursuant to Resolution 1456-01 dated 15 January 2009 and 1519-01 dated 14 January 2010, and 1867-01 dated 20 November 2014 and Resolution 2205-02 dated January 24, 2019, having a favorable report by the Superintendence of Banks and Financial Institutions, pursuant to Section 75 of Banco Central de Chile’s Basic Constitutional Act. The policies approved by the Board are consistent with International Financial Reporting Standards (IFRS), as issued by the International Accounting Standards Board (IASB).

The presentation of these financial statements is framed within an economic and accounting framework that fairly reflects the financial position of Banco Central de Chile, and at the same time, contributes to the economic analysis of Banco Central de Chile’ s transactions by clearly identifying whether they are undertaken by domestic or foreign agents. With this information it is possible to determine Banco Central de Chile’ s share in the domestic supply of monetary and credit assets and the related effects on Banco Central de Chile’ s foreign creditor position. For this reason, the economic concepts of international reserves and currency issuance are shown under the captions reserve assets and monetary base liabilities, respectively.

The translation of these financial statements is provided as a free translation from the Spanish language original, which is the official and binding version. Such translation has been made solely for the convenience of non-Spanish readers.

(b) Accounting basis of accrual and measurement

These financial statements are prepared on an accrual basis of accounting, except for cash flow information. The basis of measurement is the historical cost basis except for transactions with financial instruments measured at fair value, for which the Bank uses the fair value as reference.

The methods used to measure fair values are presented in note 3.

(c) Functional and presentation currency

As Banco Central de Chile’s main objective is to monitor the stability of the Chilean currency, which implies that open-market transactions play a significant role in the development of the monetary policy, being its main activity the issuance of banknotes and coins. The Chilean peso has been defined as the functional and presentation currency for the financial statements. The amounts in such statements are stated in millions of Chilean pesos, while the amounts of these notes are stated in millions of Chilean pesos or U.S. dollars, as applicable, rounded to the nearest decimal.

(d) Transactions in foreign currency and foreign currency translation

Banco Central de Chile’s functional currency is the Chilean peso. Consequently, all balances and transactions denominated in currencies other than the Chilean peso are considered to be denominated in a “foreign currency”. The balances of the financial statements expressed in these currencies are translated into Chilean pesos as follows:

1. (i) U.S. dollars are translated into Chilean pesos at the closing date “observed U.S. dollar” exchange rate pursuant to Section 44 of the Basic Constitutional Act, that governs Banco Central de Chile, referred to under No. 6 of Chapter I in the "General Provisions" of the Compendium of Foreign Exchange Regulations (Compendio de Normas de Cambios Internacionales).
2. (ii) Assets and liabilities stated in Chilean minted gold, are valued at the average London morning quotation of the "Gold Fixing" rate (U.S. dollars per fine troy ounce), in the morning of the closing business day of the financial statements.
3. (iii) Translation of foreign currencies other than the U.S. dollar is done at the exchange rates effective at the reporting date, which are always based upon the period-end “observed U.S. dollar” rate.
4. (iv) Special Drawing Rights (SDR) are adjusted for at the exchange rates for each of the business days of the month, reported by Banco Central de Chile, except for the last business day of the month in which the exchange rate reported by the International Monetary Fund (IMF) is considered.

Gains or losses from the purchase and sale of foreign currency, as well as the differences arising from the update of the balances in foreign currency, as a result of the variation of the exchange rates of such foreign currencies compared to the Chilean peso, are recorded as gains or losses for the year.

The principal exchange rates used as of each year-end are as follows:

(e) Statement of cash flows

The following factors are taken into account when preparing the statement of cash flows:

1. (i) Cash flows: cash and cash equivalents inflows and outflows. Cash equivalents are highly-liquid short-term investments and low risk of changes in value, as: deposits in foreign banks and cash balances in foreign currency and deposits in domestic banks.
2. (ii) Operating activities: correspond to normal activities carried out by Banco Central de Chile and other activities that cannot be classified as investing or financing activities.
3. (iii) Investing activities: correspond to the acquisition, disposal or disposition by other means of long-term assets and other investments not included in cash and cash equivalents.
4. (iv) Financing activities: these activities generate changes in the size and composition of net equity and liabilities that are not part of operating or investing activities.

(f) Financial assets and financial liabilities

1. (i) Initial recognition and measurement
   
   Financial assets and financial liabilities are recognized in the statement of financial position if and only if they become a part of the contractual provisions of such instrument. Financial assets and financial liabilities are initially measured at fair value, including, in the case of a financial asset or financial liability not recognized at fair value through profit or loss, the transaction costs that are directly attributable to the acquisition.
2. (ii) Derecognition
   
   The Bank derecognizes a financial asset when the contractual rights to the cash flows from the asset expire, or it transfers the rights to receive the contractual cash flows in a transaction in which substantially all of the risks and rewards of ownership of the financial asset are transferred, or where it neither transfers nor retains substantially all of the risks and rewards associated with the ownership and does not retain control over the assets transferred.
   
   The Bank derecognizes financial liabilities when the obligation specified in the contract is discharged or canceled, or expires
3. (iii) Offsetting
   
   Financial assets and financial liabilities are offset so that the Bank presents in the statement of financial position the net amount when Banco Central de Chile has a legal right to offset the amounts and intends either to settle them on a net basis or to realize the asset and settle the liability simultaneously.
4. (iv) Classification and subsequent measurement
   
   The accounting policy included in IFRS 9, on the classification and measurement of financial assets and financial liabilities, is applicable starting from January 1, 2018.
   
   Banco Central de Chile classifies its financial assets on the basis of its business model for asset management and the cash flow characteristics. At initial recognition, a financial asset is classified as at:
   
   1. - Amortized cost.
   2. - Fair value through other comprehensive income.
   3. - Fair value through profit or loss.

5. Financial assets are not reclassified after their initial recognition, unless the Bank changes its business model with a model to manage financial assets, in which case all financial assets affected are reclassified on Day 1 of the first reporting period following the change in the business model.
   
   The definition of each classification is indicated below.
   
   a) Amortized cost: a financial asset is measured at amortized cost if both of the following conditions are met:
   
   1. The financial asset is held within a business model the objective of which is to hold financial assets to collect the contractual cash flows; and
   2. The contractual terms of the financial asset give rise, on specified dates, to cash flows that are solely payments of principal and interest on the principal amount outstanding.

   These assets are subsequently measured at amortized cost using the effective interest method. The amortized cost is reduced for impairment losses. Interest revenue, foreign currency gains or losses, and impairment losses are recognized in profit or loss. Any gain or loss from the sale of a financial asset is recognized in profit or loss.
   
   b) Fair value through other comprehensive income (FVTOCI) if both of the following conditions are met and if it is not measured at fair value through profit or loss:
   

   1. The financial asset is held within a business model whose objective is achieved by collecting contractual cash flows and selling financial assets.
   2. Cash flows correspond only to payments of principal and interest.

   These assets are subsequently measured at fair value. Interest revenue calculated through the effective interest method, gains or losses from foreign exchange transactions, and impairment losses, are recognized in profit or loss. Other net gain or losses are recognized in other comprehensive income. Any gain or loss from the sale of a financial asset is recognized in profit or loss.
   
   At initial recognition of an investment in an equity instrument which is not held for trading, the Bank may make an irrevocable election, at initial recognition, to present subsequent changes in fair value in other comprehensive income. This election is made separately for each investment.
   
   c) Fair value through profit or loss (FVTPL): residual category for assets not meeting the aforementioned classifications.
   
   These assets are subsequently measured at fair value. Net gains or losses, including any interest revenue or dividends, are recognized in profit or loss.
   
   Banco Central de Chile classifies all its financial liabilities as subsequently measured at amortized cost, except for derivatives that are liabilities, which are measured at fair value.

6. (v) Business model assessment
   
   Banco Central de Chile performs an assessment, at portfolio level, of the business model under which the Bank holds financial assets. The objective of this assessment is to reflect how the Bank manages its investments. The information considered in the assessment is as follows:
   
   
   1. The policies and objectives established in the investment portfolio, and operation of such policies in practice. These policies and objectives include if the Bank’s strategy is focused on collecting interest revenue, maintaining an interest yield profile, or coordinating the lifespan of financial investments to the lifespan of liabilities or expected cash outflows, or obtaining cash flows from the sale of those assets.
   2. How the Bank assesses the performance of the investment portfolio and this is reported to the Bank’s key management personnel;
   3. The risks affecting the performance of the business model and investments held, and how such risks are managed.
   4. The frequency, value, and timing of the sales of financial instruments comprising the portfolio in prior periods, the rationale for those sales, and the expectations on future sales.
7. (vi) Assessment of whether the contractual cash flows are solely payments of principal and interest
   
   For the purposes of this assessment, ‘principal’ is defined as the fair value of the financial asset at initial recognition. ‘Interest’ is defined as the consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs (e.g., liquidity risk and administrative costs), as well as a profit margin.
   
   In assessing whether the contractual cash flows are solely payments of principal and interest, the Bank considers the instrument’s contractual terms. This includes assessing whether a financial assets has a contractual cash flow feature which changes the timing or the amount of contractual cash flows so that it would not meet such condition. In performing this assessment, the Bank considers:
   1. Contingent events which would may change the amount or the timing of cash flows;
   2. Terms which may adjust the contractual coupon, including variable-rate features;
   3. Prepayment and extension features;
   4. Terms limiting the Bank’s right to cash flows from specific assets (e.g., ‘non-recourse’ features).

   A prepayment feature is consistent with the criterion of solely payments of principal and interest if the prepayment amount represents substantially unpaid amounts of principal and interest on the principal amount outstanding, which may include reasonable additional compensation for the early termination of the contract. In addition, for a financial asset acquired at a discount or premium of its contractual nominal amount, a feature which allows or requires the prepayment of an amount which substantially represents the contractual nominal amount plus accrued (unpaid) contractual interests (which may include reasonable additional compensation for early termination) is treated as consistent with this criterion if the fair value of the prepayment feature is insignificant at initial recognition.

8. (vii) Derivative financial instruments
   
   Financial derivative contracts are initially recognized in the statement of financial position at fair value at the date on which the contract is entered into.
   
   Derivative contracts are entered into to hedge the investment portfolio’s risk exposure (currency and interest rate risk), and not specific assets. These are recognized as assets when their fair value is positive, and as liabilities when their fair value is negative.
   
   Banco Central de Chile does not use accounting hedges; accordingly, when entering into a derivative instrument, this is accounted for as held-for-trading derivative instrument (measured at fair value through profit or loss)
9. (viii) Securities lending
   
   Banco Central de Chile has a securities lending program with custodian banks for international reserves. Such program consists of lending securities owned by Banco Central de Chile to primary dealers, obliging them to constitute a collateral higher than the amount of the instrument lent, as applicable. Securities lent are not derecognized from the statement of financial position and their control is held in off-balance accounts.
10. (ix) Investment in equity instruments
    
    Banco Central of Chile has chosen the irrevocable option of presenting in other comprehensive income the subsequent changes in the fair values of investments in equity securities which, are within the scope of IFRS 9, and not held for trading.
    
    These assets are subsequently measured at fair value. Dividends are recognized as income in profit or loss unless the dividend clearly represents a recovery of part of the cost of the investment. Other net gain or losses are recognized in other comprehensive income and are never reclassified in profit or loss.

(g) REPO transactions

Purchase transactions of credit instruments under repurchase “REPO” agreements (liquidity injection transactions) are classified and measured at amortized cost at the effective rate basis (caption Loans to banks and financial institutions). For such transactions, Banco Central de Chile recognizes the cash disbursement and constitutes a right (asset), initially measured at the price agreed or reimbursement amount, which relates to its fair value. Collateral received (securities purchased) are not recognized in the statement of financial position.

(h) Cash and cash equivalents

For the presentation of the statements of financial position and cash flows, the Bank recognizes correspondent banks abroad, current accounts of external managers, cash balances in foreign currency and domestic correspondents as cash and cash equivalents.

(i) Monetary and non-monetary gold

Investments in monetary gold refer to the gold held by monetary authorities as reserve assets (central banks). Banco Central de Chile believes that the most appropriate treatment for this type of assets, in conformity with the hierarchy established by IFRS, derives from the application of the Conceptual Framework for Financial Reporting issued by the IASB.

Consequently, investments in monetary gold are recognized at their fair value at initial recognition. Subsequent to initial recognition, gains or losses from changes in fair value measured by the quotation obtained from the London Stock Exchange, are directly recognized in the statement of income.

Non-monetary gold is included as part of historical artistic and/or cultural heritage assets and is measured on a historical cost basis.

(j) Property, equipment and intangible assets

Property and equipment are mainly measured at acquisition cost, net of accumulated depreciation and any accumulated impairment losses. The goods that have met their useful life are stated at their residual value considering market reference prices. Depreciation is calculated on a straight-line basis.

Intangible assets are measured at acquisition cost, net of accumulated amortization and any accumulated impairment losses. Amortization is calculated on a straight-line basis.

Depreciation and amortization for 2018 and 2017 have been calculated considering the following estimated useful lives:

This caption comprises historical artistic and/or cultural heritage assets: Banknote and coin collection and works of art owned by the Bank. Because IFRS do not establish a specific accounting treatment for historical artistic and/or cultural heritage assets, it has been understood that the most appropriate treatment following the hierarchy established in IFRS, would be the application of Public Sector Accounting Standards (IPSAS), as IPSAS do address these items.

Under the acquisition method, the initial cost for a banknote and coin collection and works of art correspond to: (i) the acquisition cost when the asset is purchased, (ii) the amount of the donation when the asset is donated or (Ch$1) when the cost is not reliable. Historical artistic and/or cultural heritage assets for non-operating use are not subject to depreciation.

(k) Impairment of financial assets

Financial assets

The Bank recognizes a loss allowance account for expected credit losses on:

1. - Financial assets measured at amortized cost;
2. - Debt investments measured at fair value through other comprehensive income; and contract assets.

The Bank measures loss allowance accounts at an amount equal to the lifetime expected credit losses; except for the following, when they are measured at the amount of the twelve-month expected credit losses.

1. - Debt instruments determined to have low credit risk at the reporting date; and
2. - Other debt instruments and bank balances for which credit risk (i.e., the risk of a default occurring over the expected life of the financial instrument) has not increased significantly from initial recognition.

In determining whether the credit risk on a financial instrument has increased significantly from initial recognition in estimating expected credit losses, the Bank considers reasonable and sustainable information that is available without undue cost or effort. This includes quantitative and qualitative information and analyses, based on the Bank's historical experience and an informed credit assessment including forward-looking assessments.

The Bank quantitatively assumes that the credit risk of a financial asset has significantly increased if it is 30 days past due.

The Bank considers a financial asset to be in default when:

• It is not probable that the borrower or issuer will pay or meet their credit obligations in full, without actions by the Bank to recover the amount such as the performance of the guarantee (if any); or
• The financial asset is past due for more than 90 days.

Expected credit losses are the probability-weighted estimate of credit losses. Credit losses are measured as the present value of cash shortfalls (i.e., the difference between the cash flow due to the entity under the contract, and the cash flows that the Bank expects to receive).

Expected credit losses are discounted using the effective interest rate of the financial asset.

At each reporting date, the Bank assesses whether the financial assets recorded at amortized cost and debt instruments at fair value through other comprehensive income are credit-impaired. A financial asset is ‘credit-impaired’ if one or more events that have a detrimental impact on the estimated future cash flows of that financial asset have occurred. Evidence that a financial asset is credit-impaired include the following financial data from the issuer or borrower:

• A breach of contract, such as a default or event of default of more than 90 days;
• The borrower or issuer will probably enter in bankruptcy or another form of financial reorganization; or
• The disappearance of an active market for that financial asset because of financial difficulties.

Banco Central de Chile uses the “expected credit loss” model, using the standard risk model: ECL=PD * LGD * EAD

• ECL: Expected Credit Loss (Ch$)
• PD: Probability of Default (%)
• LGD: Loss Given Default (%)
• EAD: Exposure at Default (Ch$)

The impairment model is applicable to financial assets measured at amortized cost or at fair value through other comprehensive income (FVTOCI), except for investments in equity securities. Loss estimates will be measured using one of the following bases:

1. - 12-month expected credit losses: These are expected credit losses that may result from events of default within 12 months subsequent to the reporting date. If at the reporting date, the credit risk of a financial instrument has not significantly increased from initial recognition, Banco Central de Chile will measure the loss allowance at an amount equal to 12-month expected credit loss.
2. - Expected credit losses over the lifespan of the financial asset. These refer to expected credit losses resulting from possible default events during the lifespan of a financial instrument.

The amount of expected credit losses or reversals will be recognized as an impairment gain or loss in profit or loss. However, the allowance for the asset for losses account associated with assets measured at FVTOCI should be recognized in other comprehensive income and t will not reduce the carrying amount of the financial asset.

Non-financial assets

The carrying amount of non-financial assets is revised at each reporting date to determine whether ether is any indication of impairment. If such indications, exist, then the recoverable amount of the asset is estimated.

For impairment testing, assets are grouped together into the smallest group of assets that generates cash inflows from continuing use that are largely independent of the cash inflows of other assets or cash-generating units (CGUs).

The recoverable amount of an asset or CGU is the higher of its value in use and its fair value less costs to sell. Value in use is based on the estimated future cash flows, discounted at their present value using a pretax discount rate that reflects current market assessments of the time value of money and the risks specific to the asset or CGU.

An impairment loss is recognized if the carrying amount of an asset or CGU exceeds its recoverable amount.

(l) Employee benefits

Short-term benefits

Short-term employee benefits are recognized as expenses when the service is rendered on an accrual basis. An obligation is recognized for the expected amount payable if Banco Central de Chile has a present legal or constructive obligation to pay this amount as a result of past service provided by the employee and the obligation can be estimated reliably.

Long-term benefits

The Bank recognizes long-term benefits using an actuarial valuation method which considers demographic and financial variables (projected unit credit method). It is measured at the present value of all future payments using an annual discount interest rate, affected by the expected employment term and life expectancy of beneficiaries.

• Post-employment benefits correspond to employee benefits which are payable after the completion of employment in Banco Central de Chile, as stipulated in the collective agreement between Banco Central de Chile and the Labor Union of Banco Central de Chile.
• Other long-term employee benefits include: all employee benefits other than short-term benefits, benefits after the employment term and severance indemnity payments.

The actuarial calculation is based on the following assumptions:

• Mortality rate: for 2018 the Banco Central de Chile used the RV-2014 (RV-2014 for 2017) mortality table to determine the expected lives in the calculation of benefits associated with severance indemnity payments, post-employment benefits associated with the retirement plan’s health plan and benefits of the Former Association of Retired Employees and Beneficiaries of Pensions of Public Officials of Banco Central de Chile.
• Employee turnover: The probabilities of remaining an employee of Banco Central de Chile were calculated on the basis of the tables prepared by Banco Central de Chile organized in tranches by years of service.
• Salary growth rate: calculated as the annual average composed of the salary growth rate for a five-year period of 5.46% (2017: 5.71%).
• Discount rate: Banco Central de Chile used the nominal rate for BCP instruments at 10 years at the calculation date. For 2018, the discount rate was 4.40% (2017: 4.62%).

(m) Provisions and contingent liabilities

Provisions are liabilities for which there exists uncertainty related to their timing or amount. These provisions are recognized in the statement of financial position when both of the following requirements are met:

• A present obligation arising from past events; and
• At the reporting date of the financial statements it is probable that an outflow of resources embodying economic benefits will be required to settle the obligation; and a reliable estimate of the amount of the obligation can be made.

When an outflow of economic benefits is not probable, or when it is not possible to obtain a reliable measurement of the obligation, the Bank discloses a contingent liability.

(n) Revenue and expense recognition

The most relevant criteria used by Banco Central de Chile for recognizing revenue and expenses in the financial statements are:

Interest revenue and expenses are recognized based on the accrual period, applying the effective interest method except for interests for assets classified as FVTPL where the interest revenue is recognized on a straight-line basis using the coupon rate.

Fee and commission revenue and expenses and other revenue from the rendering of services are recognized in profit or loss over the period in which services are rendered.

Non-financial revenue, costs and expenses are recognized to the extent that economic events occur so that they are systematically recorded in the related accounting period.

Revenue and expenses from changes in the fair value of financial assets measured at fair value are reported in other comprehensive income (equity) and will be recognized in profit or loss at the date of disposal, except for changes in fair value for assets classified at FVTPL which are directly charged to profit or loss.

(o) Use of estimates and judgments

The preparation of financial statements requires management to make judgments, estimates and assumptions that affect the application of accounting policies and the reported amounts of assets, liabilities, income and expenses. Actual results may differ from these estimates..

Estimates and underlying assumptions are reviewed on an ongoing basis by Banco Central de Chile’s senior management in order to quantify some assets, liabilities, income, expenses and uncertainties. The changes from accounting estimates are recognized in the period in which the estimate is revised and in any future periods affected.

In particular, information about significant areas of estimation uncertainty and critical judgments in applying accounting policies that have the most significant effect on the amounts recognized in the financial statements are described in the following notes:

• Note 2(j) Property, equipment, and intangible assets, determination of useful life, depreciation or amortization and residual value.
• Note 3 Methodology applied for the measurement of fair value.
• Note 10(c) Caja Central de Ahorros y Préstamos and Asociación Nacional de Ahorro y Préstamo.
• Note 17 Provisions, including severance indemnity and post-employment benefits.

(p) New accounting pronouncements

A number of new accounting standards are applicable to annual periods beginning on or after January 1, 2019. Early adoption is permitted. However, the following standard and amendments has not been early adopted by Banco Central de Chile in preparing these financial statements.

IFRS 16 “Leases”

Beginning on January 1, 2019, the Bank must adopt IFRS 16, which replaces the following guidelines on leases: IAS 17 "Leases", IFRIC 4 “Determining whether an Arrangement Contains a Lease,” SIC 15 “Operating Leases – Incentives,” SIC 27 “Evaluating the Substance of Transactions Involving the Legal Form of a Lease.” The main effects of such standards applies to the lessee accounting, mainly because of the removal of the dual model of accounting: operating or finance lease, i.e., the lessee should recognize a "right to use an asset" and a liability for the lease (the present value of future payments of leases). For the lessor, the standard maintains the current practice, i.e., lessor continues to classify finance and operating leases. In accordance with the analysis of contracts entered into by the Bank and the potential impact of adopting this standard, the Bank concluded that it does not need to recognize a right-to-use asset and a lease liability because all the lease contracts held by Banco Central de Chile as lessee are revocable agreements, and the assets subject to such use contracts are low-value assets for asset and liability levels maintained by the Bank. Accordingly, the Bank will continue recognizing lease payments as expenses on a straight-line basis throughout the term of the contract.

Additionally, other standards have been issued but are not yet effective, which address matters that neither affect nor will affect the Bank’s current transactions.

Note 3

METHODOLOGY APPLIED FOR THE MEASUREMENT OF FAIR VALUE

The methodology for the calculation of fair value is applied to financial instruments held as foreign investments, classified as securities at fair value through profit or loss, instruments at fair value through equity, and instruments at amortized cost.

The fair value of international reserve securities is classified by level as shown in Note 7:

• Level 1, fair value measurements using quoted prices (unadjusted) in active markets for identical assets and liabilities, for which the Bank has the ability to access at the measurement date.
• Level 2, inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly.
• Level 3, fair value measurements using unobservable inputs for the asset or liability.

For financial assets and financial liabilities not recognized at fair value, fair value will be disclosed collectively in groups to allow comparison with the related carrying amounts, as shown in Note 7 (f).

Note 4

CHANGES IN ACCOUNTING POLICIES

Banco Central de Chile has initially applied IFRS 9 (4.1) and IFRS 15 (4.2) beginning on January 1, 2018. Certain other standards also become effective beginning on January 1, 2018, but they have no significant impact on the Bank's financial statements.

Because of the transition method adopted by Banco Central de Chile for applying these standards, the comparative information included in these financial statements has not been restated to reflect the requirements of such new standards.

4.1 Application of IFRS 9 Financial Instruments

Banco Central de Chile has adopted IFRS 9 “Financial Instruments” issued in July 2014 and effective for annual periods beginning on or after January 1, 2018. IFRS 9 requirements represent a significant change with respect to IAS 39 “Financial Instruments: Recognition and Measurement.”

Banco Central de Chile adopted the exemption that allows it not to restate comparative information from prior periods referred to changes in classification and measurement (including impairment). Differences in carrying amounts of financial assets and financial liabilities arising from the adoption of IFRS 9 are recognized in retained earnings as of January 1, 2018. Accordingly, the information presented for 2017, in general, does not reflect the requirements of IFRS 9 and, accordingly, its measurement is not comparable to information for 2018.

Impact on equity related to the application of IFRS 9 as of January 1, 2018.

The main changes related to the adoption of IFRS 9 are as follows:

i. Classification and measurement of financial assets and financial liabilities

IFRS 9 includes a new approach to classify and measure financial assets, which reflects the business model under which the assets are managed, as well as the nature of cash flows.

The standard includes three main categories to classify financial assets: measured at amortized cost, at fair value through other comprehensive income (FVTOCI), or at fair value through profit or loss (FVTPL). The standard eliminates the existing categories under IAS 39, held to maturity, loans and receivables, and available for sale.

The Bank's financial liabilities are not affected by the application of IFRS 9 with respect to their current accounting treatment, which results in all financial liabilities being measured at amortized cost except for financial derivatives.

The table below shows the former classification/measurement categories under IAS 39 and the new measurement categories under IFRS 9 for each type of financial asset as of January 1, 2018.

The following references explain how applying new classifications under IFRS 9 implied reclassifications and remeasurements to calculate the final carrying amounts:

a) Investment portfolio (I.P.)

Banco Central de Chile has reclassified its investments mainly as "Fair value through other comprehensive income" (FVTOCI), because these investments are framed within a mixed business model, the objective of which is achieved by obtaining contractual cash flows and selling financial assets. Additionally, the Bank has estimated that instruments that are classified as FVTOCI are simple debt instruments which comply with the SPPI (Solely Payments of Principal and Interest) the "SPPI test" defined in IFRS 9.

In general, new classifications have implied that investments held in the portfolio are classified as follows:

The new classification FVTOCI will imply that all fair value gains and losses should be presented in other comprehensive income and recognized in profit or loss upon disposal.

Investments classified at FVTPL are investments the cash flow structure of which does not comply with the SPPI test.

The change in remeasurement affects instruments classified at amortized cost and relates to the impairment estimate of term deposits and commercial paper amounting to MCh$1,782.7.

b) Reciprocal loans

The change in remeasurement relates to the estimation of impairment on reciprocal loans with countries that are members of ALADI, which amounts to MCh$634.3.

c) Other assets

Relates to the reclassification of taxes recoverable associated with the investment portfolio, which do not relate to financial assets.

d) IDS and BIS Shares

Banco Central of Chile has made the irrevocable option of presenting in other comprehensive income the subsequent changes in fair values of investments in equity securities which, being within the scope of IFRS 9, are not held for trading. The aforementioned option will imply the recognition of the dividends from such investments in profit or loss.

This remeasurement relates to the adjustment of the fair value of shares maintained in BIS, which implied an increase of MCh$26,373.1. For IDS shares, the Bank established that the best fair value reference for this type of financial asset is the acquisition cost, because such shares are not held for trading and have no active market.

e) Loan with SAOS and General Treasury transfers

The change in remeasurement relates to the estimation of impairment on both receivables for MCh$3,121.3.

ii. Impairment of financial assets

IFRS 9 replaces the “incurred loss” model of IAS 39 with the “expected credit loss” (ECL) model. This will require considerable judgment with respect to how changes in economic factors affect ECL, which will be determined on a weighted average basis.

The new impairment model will be applicable to financial assets measured at amortized cost or classified at fair value through other comprehensive income, except for investments in equity securities. Under IFRS 9, loss estimates are measured using one of the following bases:

• 12-month expected credit losses: These are expected credit losses that may result from default events within 12 months subsequent to the reporting date; and
• Lifetime expected credit losses: These are expected credit losses that may result from potential default events during the useful life of the financial instrument.

The following references explain how applying the new impairment approach based on expected losses affected financial assets on the application date of IFRS 9:

a) Reserve assets:

The effect resulting from the application of the expected loss model on assets measured at amortized cost implied a decrease of MCh$2,417.0 in such assets

The effect resulting from the application of the expected loss model on assets measured at FVTOCI implied a decrease of MCh$14,716.6 in retained earnings.

Banco Central de Chile has estimated that if an investment in a debt instrument involved a low credit risk as of the date of initial application of IFRS 9, it is assumed that the asset credit risk recorded no significant increase from its initial recognition.

The impairment calculation estimate is within Bucket 1, which recognizes "Expected losses within the next 12 months." When no allowance for impairment (cash, SDRs and position in the IMF) has been determined, it is because these items record a counterparty risk close to zero, or a guarantee covering the related risk exists.

b) Domestic assets:

The effect resulting from the application of the expected loss model on assets measured at amortized cost implied a decrease of MCh$3,121.3 in such assets.

The impairment calculation estimate is within Bucket 1, which recognizes "Expected losses within the next 12 months", except for the impairment of the National Savings and Loan System (SINAP) item (see Note 10 c), which is recorded in Bucket 3. For loans to banks, a provision equal to 0 has been determined, because such loans relate to repurchase agreements (REPOS), where Banco Central de Chile maintains a guarantee greater than 100% for each operation.

iii. Reconciliation of retained earnings to other comprehensive income

The reconciliation of "Retained Earnings" (RE) to "Other Comprehensive Income" (OCI) resulting from the application of IFRS 9 as of January 1, 2018, is detailed as follows:

iv. Transition

Banco Central de Chile has elected the exemption that allows it to not restate comparative information from prior periods concerning changes in classification and measurement (including impairment). The differences in carrying amounts of financial assets and liabilities arising from the adoption of IFRS 9 were recognized in retained earnings (accumulated deficit) as of January 1, 2018.

On the basis of the facts and circumstances that existed at the date of initial application, the following assessments were conducted:

• The determination of a business model in which a financial asset is held.
• The designation and revocation of prior designations of certain financial assets and financial liabilities as measured at fair value through profit or loss.
• The designation of certain investments in equity instruments not held for trading as measured at fair value through other comprehensive income.

4.2 Application of IFRS 15 Revenue from Contracts with Customers

The Bank's revenue mainly arises from financial instruments in accordance with IFRS 9, the effects of which have been described in Section 4.1 of this note. However, as a result of IFRS 15 entering into force, Banco Central de Chile reviewed its contracts related to other income that are within the scope of this standard and conducted an analysis based on the five steps required, concluding that all contracts analyzed involve the rendering of financial services, whose solely performance obligation relates to rendering each service, and accordingly, no effects on revenue recognition exist from the application of IFRS 15.

Note 5

FINANCIAL INSTRUMENT RISKS

The goal of Banco Central de Chile is to monitor the stability of the Chilean currency; i.e. maintain a low and stable inflation rate over time. Additionally, the Bank promotes the stability and effectiveness of the financial system, safeguarding the normal performance of internal and external payments.

In order to meet that goal, Banco Central de Chile has its international reserves, liquid assets in foreign currency which are mainly comprised of financial instruments that are traded and kept in custody abroad such as bonds and government notes, bank deposits, among others.

Additionally, Banco Central de Chile implements its monetary policy through the definition of an objective level for the nominal inter-bank interest rate, known as the Monetary Policy Rate (Tasa de Política Monetaria, TPM in Spanish). In order for the inter-bank rate to be determined at this level, Banco Central de Chile regulates the availability of liquidity (or reserves) of the financial system through several financial instruments related to the management of debt and open-market transactions made by the local market through the issuance of notes and term deposits received.

Banco Central de Chile’s financial risks are related to those risks arising from managing the asset and liability portfolio and their effect on the Bank’s equity. Such risks can be classified as: Market risk, Credit risk, Liquidity risk, and Operational risk.

Financial risk management is established and based on general policies approved by Banco Central de Chile’s Board of Directors. In this respect, the definition of guidelines and assets and debt exposure limits are proposed to the General Management and the Council for the Management of the Financial Markets Division for their approval.

International Market Management and Domestic Market Management, which report to the Financial Markets Division, are responsible for implementing the policies established by the Board. While, within the same hierarchical line, the Management of Operations and Payment Systems records, processes and performs the settlement of transactions. Additionally, they manage the information systems in which these are carried out.

Corporate Risk Management monitors the compliance with the established limits, measures management results and risks and reports them to the Manager of the Financial Markets Division and the General Management. In addition, the Bank’ Controllership, which reports directly to the Board, assesses the effectiveness and efficiency of the internal control, risk management and governance of the financial asset and liability portfolio process.

Finally, Banco Central de Chile‘s Audit and Compliance Committee, which is an external advisor entity for the Board, is responsible, among other functions, for reporting on the effectiveness of the systems and the internal control procedures used in the financial asset and liability portfolio management, and assesses the reliability, integrity and timeliness of the information of the financial statements.

(a) Market risk

Market risk is the risk of potential losses from changes affecting the price or final value of a financial instrument or group of financial instruments. Risks are identified mainly by fluctuations in currencies and interest rates. Market risk affecting the Banco Central de Chile statement of financial position is dominated by international reserves mainly due to the increased volatility of currencies composing their investments, while for liabilities, the greatest impact arises from fluctuations in the inflation-adjusted unit which impacts the long-term debt.

Market risk of international reserves is limited by the investment policy establishing maturity and composition margins of currencies around referential parameters of the portfolios and through the diversification of currencies, securities and investment periods. Market risk is monitored through the daily term and detail by currency and through the follow-up of Value at Risk (VaR) and risk related to the Referential Buyer (Tracking Error or TE).

Table 5.1 sets out the different monitored market risk measurements.

For open-market transactions, this risk is mainly associated with changes in the market value of bonds and promissory notes issued by Banco Central de Chile, and the change in value of collaterals received in liquidity injection transactions. For collaterals the risk of value loss is mitigated by using margins and haircuts that write-down their value and allow the effective amount lent to be lower than the collateral received. For the placement of bonds and promissory notes, risk is mitigated in line with the provisions in current legislation contained in the Compendium of Financial Regulations ruling the placement and adjudication of debt that contemplates the use of competitive bidding processes among financial institutions. Upon issuance of instruments, the main risk is associated with changes in inflation that affect bonds issued in UF.

Monitored market risk indicators include the term and currency of notes issued. Tables 5.2 and 5.3 show such indicators.

(b) Credit risk

Credit risk is the risk of potential losses due to a counterparty failing to make a payment. The main source of risk arises from the investments in international reserves in debt instruments issued by foreign countries and financial institutions. A second source of credit risk comes from open market transactions and facilities that provide liquidity to the domestic financial system (Repo, FLI and FPL).

For international investments, the credit risk is mitigated by controls and limits established in the investment policies considering limits by type of risk (Sovereign, Supranational, Agencies and Banking), by type of instrument, issuer and counterparty, risk management of brokers and custodians. Additionally, the Company considers restrictions and controls by credit ranking related to the issuer of the instrument, which is calculated using the average ratings obtained from Fitch, Moody’s, Standard and Poor’s and DBRS; if only two ratings are available, the lowest will prevail; and in the event of only one rating is available, such rating will be used.

Tables 5.4 and 5.5 show the breakdown of reserves by credit rating and type of risk.

Credit risk associated with open-market transactions and facilities that inject liquidity into the local financial system (Repo, FLI FPL) is mitigated by requiring collaterals eligible according to their credit quality, which are valued at market prices at the time of their receipt and subject to the application of discounts or haircuts according to the instrument specific characteristics.

As of December 31, 2018, the Bank recorded Permanent Liquidity Facility (FPL) operations of Ch$160,258.1 million. The average amount for 2018 was Ch$6,944.4 million for FPL, collateralized through instruments issued by Banco Central de Chile and the General Treasury.

Table 5.6 and 5.7 shows the credit risk exposures related to the open-market transactions and facilities. We can identify that such risk is mitigated by the required collaterals, where Banco Central de Chile and General Treasury’s securities are eligible.

Table 5.8 shows the credit risk exposures associated with the swap purchase transactions. Note that such risk is mitigated through the guarantees required.

(c) Liquidity risk

Liquidity risk is the risk of not being able to settle an instrument or incurring losses when it is necessary to sell it due to a lack of market depth.

To reduce liquidity risk of the international reserves, a portfolio is mainly structured comprising fixed income securities traded in secondary markets of high liquidity and depth, and to a lesser extent short-term deposits in international commercial banks, with different due dates. The most liquid tranche includes instruments from the United States and Germany, as well as, overnight and weekend transactions, representing 65.9% of the internal investment portfolio in 2018 and 67.9% in 2017.

For open-market transactions, this risk relates to the possibility of issuing bonds and promissory notes or rolling them over in the primary market at prices that are too high compared to securities with similar characteristics traded in the secondary market. This type of risk is mitigated through the provisions in current legislation contained in the Compendium of Financial Regulations that governs the placement and adjudication of debt and by monitoring both secondary and primary markets and their institutions. In the event of a decrease in demand for its securities, the Banco Central de Chile could pay its maturities by issuing cash.

For further information on maturities for Banco Central de Chile’s financial liabilities, see Note 16 to these financial statements.

Tables 5.9 and 5.10 show a summary of the results of the granting of bonds and promissory notes for 2018 and 2017.

(d) Operational risk related to the financial instrument management

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events that prevent the normal performance of processes related to the financial instrument management.

The internal organization in Banco Central de Chile enables for an appropriate implementation of the design of processes related to financial instruments management, considering segregation of duties and responsibilities.

Consequently, the International Investments Management and Domestic Market Management with the Operations and Payment Systems Management, which report to the Financial Markets Division, are responsible for making investments and their settlement, respectively. The Corporate Risk Management, reporting to the General Management, is responsible for issuing the performance and financial risks and ensure the compliance with investment limits.

Each management involved in the processes related to the financial instrument management, manages and controls its own operational risks. However, the Accounting Management and Planning supports the divisions in the identification, analysis, evaluation and treatment of risks through a methodology that measures the inherent risk based on it feasibility and impact, and in the assessment of the residual risk we measure the effectiveness of the corresponding controls, in order to reduce the impact and/or possibility of occurrence. In addition, we track the action plans related to the risk management system and the business continuity system, including the results arising from the regular tests performed to ensure that the mechanisms developed to face contingency situations are working properly.

The Banco Central de Chile’s Controllership, which reports directly to the Board, reviews regulatory compliance, the existence of an appropriate internal control environment and security of the information technology applications and infrastructure, as well as several issues related to governance, risks management, information and communication.

In addition, we have computer applications operating with market quality standards and we carried out initiatives to improve operational continuity, maintaining an alternate operation site to ensure the operation in case of problems with the physical infrastructure of the building and an external processing site in case of eventual technological failures which could affect its main technological processing site. The aforementioned elements ensure that the decision-making and management evaluation process within Banco Central de Chile are appropriately defined.

Note 6

CASH AND CASH EQUIVALENTS

The detail of balances under cash and cash equivalents and their reconciliation to the statement of cash flows at each year-end is as follows:

Note 7

RESERVE ASSETS AND FAIR VALUES

(a) Reserve assets

Reserves assets are liquid assets in foreign currency held by Banco Central de Chile. They are instruments supporting monetary and foreign exchange policies, in order to meet Banco Central de Chile’s objective of safeguarding currency stability and the normal functioning of internal and external payment systems. Reserve assets comprise those external assets under the control of the monetary authority, which can dispose them immediately in order to fund the imbalances of the balance of payments and to indirectly regulate the magnitude of those imbalances.

Reserve assets

• Cash: relates to balances held in current accounts with foreign banks and cash balances in foreign currency.
• Investment portfolio: Relates to instruments eligible for investment and is composed of a portion directly managed by Banco Central de Chile (Internal Investment Portfolio) and other lower portion managed by external managers (External Investment Portfolio) through mandates approved by the Board.
• Monetary gold: corresponds to gold held as international reserve, expressed in Chilean minted gold, valued at the average quotation of the London Gold Fixing (U.S. dollar per fine troy ounce) and the differences arising from updating the gold positions are recorded as profit or loss for the year.
• Special drawing rights (SDR) correspond to reserve assets, equivalent to foreign currencies, assigned by the International Monetary Fund (IMF) to the member countries proportionally to the installment paid and valued in Chilean pesos considering the current parity reported by the International Monetary Fund.
• Reserve position in the International Monetary Fund (IMF): corresponds to the net difference between the assets (payments made to the IMF for subscription, and loans granted by Banco Central de Chile to the IMF for the participation in the financing program “New Arrangement to Borrow” (NAB) and liabilities (deposits maintained by the IMF in domestic currency) and is classified as an investment at amortized cost, measured at the cost indexed to Special Drawing Rights (SDR)..
• Reciprocal Loan Agreements (debit): represent the amount owed to Banco Central de Chile by the central banks comprising Aladi’s Agreement on Reciprocal Payments and Credits for the exports made by Chilean entities through such method. Their classification corresponds to non-derivative financial instruments, measured at amortized cost using the effective interest method.

As of December 31, 2018 and 2017, the distribution of investments in foreign currencies by currency is as follows:

As of December 31, 2018 and 2017, the distribution of investments in foreign currencies by currency is as follows:

(b) Detail by classes of assets of the investment portfolio

(c) Monetary gold

At the end of 2018, monetary gold amounted to US$10.1 (US$10.2 million in 2017) equivalent to 7,940 fine gold troy ounces valued at US$1,277.3 per ounce (US$1,291.0 in 2017). There was no change in the amount of troy ounces compared to 2017.

(d) Special drawing rights (SDR)

At each year-end, the balance of Special Drawing Rights (SDR) is as follows:

(e) Reserve position in the International Monetary Fund (IMF)

The reserve position balance in the IMF at each year-end is detailed as follows:

(f) Fair Values as of December 31

Banco Central de Chile determines the fair value of the assets and liabilities for which a difference exists between their carrying amount and their fair value as follows

- General Treasury transfers

Such amounts are derived from the provisions of Law No. 18.577 and its amendments, and Law No. 18.577 of 1986 by way of which Banco Central de Chile sold to CORFO loan portfolios granted to financial institutions for the latter to finance the acquisition, by third parties, of shares of such financial institutions. In accordance with Article No. 13 of Law No. 18.401, the differences generated from the recovery as a result of the discounts granted to the shareholders, would be covered by the Chilean Treasury through future General Treasury transfers of up to UF 15 million.

Such Decree determined that the total amount of the transfer that the General Treasury has to perform in favor of Banco Central de Chile is equivalent to UF 11.4 million and it has been established that such General Treasury transfer will be performed in annual partial payments, equivalent to, at least, one twentieth of the aforementioned total sum, starting on the eleventh year subsequent to the year in which the aforementioned decree was processed, which corresponds to January 25, 2011.

Fair value is determined on the basis of the present value of the annual payments indicated in such decree. BCU-30 market rates have been considered for the estimation of the present value of the payments.

- Cash receipts for subordinated obligation with financial institutions

This is generated by Law No. 18.401 of 1985 because of the financial crisis at the beginning of such decade. Such Law, specifically in Article 15, establishes that banks could substitute agreements pending the repurchase of portfolio with Banco Central de Chile, because of the new subordinated obligation, which in practice had an indefinite payment period.

In 1995, Law No. 19.396 was established supplementing the previous law incorporating a maximum term of 40 years for the payment of the debt in partial payments, which are determined in accordance with the profits obtained by banks, defining a minimum payment, fixed payment, annual payment, "surplus for future deficit" account and annual interest on the balance of the debt of 5%.

Through the present date, only Banco de Chile has subordinated obligation of Ch$88,567.2 million at the end of December, equivalent to UF 8,630,858.4981 The subordinated obligation of Banco de Chile is secured by 28,593,701,789 shares of such bank through Sociedad Administradora de Obligación Subordinada S.A. (SAOS), which at the end of September 2017 are equivalent to 28.75% of total shares of Banco de Chile.

The annual payment of the subordinated obligation has been made considering the net profits of Banco de Chile that can be distributed and ownership interest that Banco Central de Chile has through such guarantee. Despite the fact that a minimum payment of UF 3.2 million has been established, the average annual payment for the last 5 years has been over UF 5.0 million and as such under a conservative scenario, the final payment of the obligation would be made in 2019.

For the fair value estimation, an increase of 5% in the level of net distributable profits of Banco de Chile is used as scenario, considering the maintenance of the ownership interest that Banco Central de Chile has as pledge in such institution and in the discount of its cash flows at market rates bonds in UF of Banco de Chile with a period similar to the estimated term of the obligation plus 2.26%.

- Notes issued

The debt portfolio of Banco Central de Chile has been valued using the parameters developed by the Risk America portal.

Note 8

OTHER FOREIGN ASSETS

(a) Shares and contributions to the Inter-American Development Bank (IDB)

The accounting treatment of the shares and contributions is in conformity with Article 3 of DL 2943 dated 1979, according to which such shares and contributions as well as the notes evidencing them, must be recorded by Banco Central de Chile as investments with a charge to its own resources for accounting purposes.

The shares of Ordinary Capital of the Inter-American Development Bank and contributions to the International Monetary Fund, all from the General Treasury are measured at their acquisition cost or contribution plus the adjustments reported by each of the institutions, where appropriate.

During 2018, the Bank made no subscription of new shares or contributions to the IDB.

(b) Bank for International Settlements (BIS) Shares

During 2003, Banco Central de Chile’s Board Resolutions 1073-04 dated July 10, 2003 and 1084-02 dated September 16, 2003, authorized the incorporation of Banco Central de Chile as a member of the Bank for International Settlements (BIS). On September 26, 2003, in accordance with these resolutions, Banco Central de Chile acquired 3,000 shares of the BIS for SDR42,054,000.

During 2018, dividends were received in the amount of MUS$1.0 (MUS$1.2 in 2017).

Banco Central de Chile calculates the fair value considering its ownership interest in BIS equity by discounting 30% of the value determined, and replicating the method used by BIS for the last repurchase of shares issued in 1970.

Note 9

LOANS TO BANKS AND FINANCIAL INSTITUTIONS

This caption includes the following transactions, which are defined as non-derivative financial instruments, valued at amortized cost through the effective rate:

Note 10

TRANSACTIONS UNDER SPECIFIC LEGAL REGULATIONS

This caption includes the following transactions, which are defined as non-derivative financial instruments, valued at amortized cost through the effective rate:

(a) Loan for subordinated liability

The balances as of each year-end represent a subordinated liability ofBanco de Chile with Banco Central de Chile as established in the agreement amending payment terms dated 8 November 1996, in accordance with the provisions of Law No.19.396.

On that date, the parent company Sociedad Matriz del Banco de Chile, previously referred to asBanco de Chile, agreed to transfer the liability to SAOS S.A. (Sociedad Administradora de la Obligación Subordinada), based on paragraphs three and five of the law 19.396. Consequently, the liability must be paid in forty annual, consecutive and equal installments beginning in April 1997.

During 2018, Sociedad Administradora de la Obligación Subordinada SAOS S.A. paid UF 5,663,110.7754 to Banco Central de Chile, equivalent to Ch$152,930.2 million, of which UF 422,035.5311, equivalent to Ch$11,396.9 million, were allocated to the payment of interests of the debt and UF5,241,075.2443, equivalent to Ch$141,533.3 million to the credit amortization for subordinated liability (during 2017, a payment of UF5,344,803.0896, equivalent to Ch$142,003.3 million was made, from which UF660,655.2422, equivalent to Ch$17,522.6 million was destined to the payment of interest, and UF4,684,147.8474, equivalent to Ch$124,450.7 million to the repayment of principal owed).

At the end of 2018, the balance amounts to Ch$88,567.2 million, equivalent to UF 3,212,938.7891 (Ch$231,291.0 million in 2017, equivalent to UF 8,630,858.4981), as a result of applying IFRS 9 and beginning on this year the impairment model is applied to this asset, and its amount is part of the balance, reducing the liability by Ch$2.6 million for 2018.

(b) General Treasury transfers

The item “Tax transfers” under the specific legal regulation in the caption Transactions includes the following amounts:

In accordance with Article No. 13 of Law No. 18.401, the differences generated from the recovery as a result of the discounts granted to the shareholders, would be covered by the Chilean Treasury through future General Treasury transfers of up to UF 15 million, which as of December 31, 2018 amount to Ch$311,783.9 million, equivalent to UF 11.4 million (Ch$305,069.6 million in 2017, equivalent to UF 11.4 million).

The Executive Decree No. 1.526 issued by the Ministry of Finance in 2010, determined the total amount of the transfer that the General Treasury has to perform in favor of Banco Central de Chile due to the application of the above mentioned law, for UF11,383,983.4695 in annual installments equivalent, at least, to one twentieth of the aforementioned total sum, starting on the eleventh year subsequent to the year in which the aforementioned decree was processed, which corresponds to January 25, 2011. However, this decree expressly contemplates that the General Treasury will be able to make prepayments.

(c) Caja Central de Ahorros y Préstamos and Asociación Nacional de Ahorro y Préstamo

Through Decree Laws No. 1.381 of 1976 and No. 2.824 of 1979 the obligation imposed by Banco Central de Chile of granting loans to organizations which were part of the former National Savings and Loan System (SINAP) was regulated, because of the financial position affecting organizations in that system.

Banco Central de Chile granted the mentioned loans with a charge to its own resources through credit facilities for refinancing to organizations which were part of SINAP. In addition, the former Caja Nacional de Ahorros y Préstamos, part of SINAP, was also granted loans by the Chilean Government, with charge to the external resources from the Credit Program Agreement “AID 513–HG–006” entered into by the Republic of Chile, and applied through the Banco Central de Chile, as Fiscal Agent and Financial Agent, in accordance with Decree No.20 of the Finance Ministry of 1976.

Subsequently, through Law No. 18.900 dated January 16, 1990, Caja Central de Ahorros y Préstamos (CCAP) and Asociación Nacional de Ahorro y Préstamo (ANAP) ceased to exist and a procedure was established through which the respective equity would be liquidated and used to pay shareholders and the obligations of the institutions.

Article 3 of the law establishes that Caja Central de Ahorros y Préstamos shall cease its transactions and with consideration of existing commitment, whether it has settled the liquidations required by the law or not, and shall include an inventory of all its rights, obligations and equity and those of the Asociación de Ahorro y Préstamo. This account will be submitted to the review of the President of the Republic through the Ministry of Finance. This article also stipulates the President of the Republic will approve such account through executive decree issued by the Ministry of Finance published in the Official Gazette.

Likewise, Article 5 of the aforementioned law establishes that the General Treasury shall be responsible for any obligations of the SINAP that are not covered upon liquidating shareholders’ equity, the funds for which should be requested from the national budget, in conformity with Article 21 of Decree Law No. 1.263 dated 1975.

The recovery of such amounts depends on the determination of a specific date for the payment of that loans, from the General Treasury in favor of Banco Central de Chile, which is not possible to determine because the Ministry of Finance has not issued the Decree approving the account for the Caja and the Asociación.

Accordingly, based on considerations solely for accounting and financial reporting purposes, as provided in Articles 18 No.9 and No. 75 et seq. of the Basic Constitutional Act regulating the Banco Central de Chile, the criteria and standards on International Financial Reporting Standards (IFRS), the Bank has determined that starting from year-end 2014 this Institution’s financial statements will recognize an allowance for its losses in equity of Banco Central de Chile for the total amount of debt owed to the Bank by the entities comprising SINAP which are indefinitely in the process of liquidation.

Likewise, the obligation by the Chilean Treasury established in Law 18.900, which guarantees the obligations of the abovementioned entities which could not be covered by the amount resulting from their liquidation, as indicated in several opportunities by the Ministry of Finance, is subject to the legal budget and the publication in the Official Gazette of the executive decree approving the liquidation account for such entities, because this had not yet occurred or has a determined verification date; the Banco Central de Chile has opted to reflect this situation in the notes to the financial statements to comply with the requirement of substantiating the rationale behind these decisions. Additionally, expressly indicate that the information contained in the preceding paragraph will only affect the method for recognizing the “SINAP liquidation Law No. 18.900” loan for reporting purposes, in accordance with IFRS standards. Accordingly, this should not and cannot be deemed, in any case, as a waiver by Banco Central de Chile of its right to continue to require the total and full payment of such debt.

Prior to making the decision mentioned above, the Bank informed the Minister of Finance. In response, the Minister responded the Bank that even though the President of Chile will approve such account through an executive decree issued by the Ministry of Finance, such approval has not been formalized because the requirement established by law for such purpose has not been met. In addition, the Minister indicated that because of this situation the Ministry of Finance was unable to express any opinion with respect to the balances in such account but acknowledged the information provided by the Bank.

Additionally, in relation to the part of the debt of the former Caja Nacional de Ahorros y Préstamos assumed by such entity in accordance with Decree No.20 of the Ministry of Finance of 1976, considering that: (i) this transaction refers to an obligation in which the Banco Central de Chile was Fiscal Agent and Financial Agent of the General Treasury and (ii) once the condition established in Article 5 of Law No.18.900 has been complied with, the General Treasury will have the double status of creditor and debtor of such obligation. During this year, the Banco Central de Chile has determined that it is not applicable to recognize such part of the debt of the former Caja Nacional de Ahorros y Préstamos in its financial statements, and therefore, it derecognized such item from the Bank’s asset and liability account. But whilst the mentioned condition is not verified, it will be registered at its adjusted value off balance-sheet accounts, under the name and on behalf of the General Treasury, for identification purposes, in order to distinguish it clearly from the higher part of the debt of the former SINAP corresponding to such other part financed directly by the Bank using its own resources, adjusting also the impairment recognized as of December 31, 2014.

In this respect, as of December 31, 2018, the amount owed by the Banco Central de Chile for the settlement of the institutions that were part of SINAP, for the concept of credit facilities for refinancing granted directly to them charged to the bank’s own resources, amounts to Ch$1,308,775.2 million (Ch$1,211,447.4 million in 2017), included the impairment mentioned above. In addition, the updated value of the debt of the former Caja Nacional de Ahorros y Préstamos, member of SINAP, corresponding to the loans to related parties financed by the Chilean Government, through Banco Central de Chile, in accordance with Decree No.20 stated above, amounts to Ch$87,395.8 million (Ch$84,702.3 million in 2017), which has been recognized in order accounts maintained by the Bank acting as Fiscal Agent of Chile.

Note 11

PROPERTY AND EQUIPMENT

Reconciliation of property, equipment and intangible assets carrying amounts

This caption is mainly composed of the following balances and movements

Note 12

INTANGIBLE ASSETS

Reconciliation of Intangible Assets carrying amounts

Composition and movements of intangible assets

As of December 31, 2018 and 2017, the caption Depreciation and Amortization in the statement of income includes Ch$730.4 million and Ch$814.7 million on a straight-line basis.

Operating lease contracts

As of December 31, 2018 and 2017, there are no non-cancellable operating lease contracts. Conversely, assets subject to these contracts relate to low amount assets with respect to the levels of assets and liabilities held by the Bank. Accordingly, the Bank will continue recognizing lease payments as an expense during the term of the contract.

Note 13

FOREIGN LIABILITIES

This caption includes the following transactions:

This caption is composed of the following:

Note 14

MONETARY BASE

Liability of Banco Central de Chile composed of banknotes and coins of legal tender plus deposits of the financial system in Banco Central de Chile.

This caption is composed of the following:

(a) Banknotes and coins in circulation

Includes the amount of banknotes and coins of legal tender issued by Banco Central de Chile held by third parties, resulting from the total banknotes and coins received from suppliers and recorded as liabilities at their face value, less the banknotes and coins that are in the cash of Banco Central de Chile and in its vault.

Banknotes and coins in circulation are recorded at face value. The costs of printing and coining are recorded as expense in the caption issuance and distribution costs.

The distribution of banknotes and coins in circulation as of December 31 of each year is as follows:

(b) Deposits from financial institutions

 Deposits from financial institutions reflect the movements in drafts and deposits in local currency resulting from transactions performed by financial institutions with Banco Central de Chile. Their balance represents the funds or reserves in favor of financial institutions and is used for the constitution of cash positions.

(c) Deposits for technical reserve

This refers to compliance with the obligation on the technical reserve contemplated for banking entities in Article 65 of the General Banking Law, which establishes the alternative of maintaining deposits with Banco Central de Chile for such purposes. Such legal precept provides that deposits in current account and other deposits and on demand deposits, which a bank receives, as well as the amounts that has to destine to pay on demand obligations which it assumes within its financial line of business, to the extent that they exceed two times and a half their effective equity, should be maintained in cash or in a technical reserve consisting of deposits with Banco Central de Chile or in notes issued by the General Treasury at any term valued at market price.

Note 15

DEPOSITS AND OBLIGATIONS

Deposits received and obligations are financial liabilities for deposits and other transactions made with the General Treasury and financial institutions, and which are not affected by transaction costs. Subsequently, they are measured at amortized cost pursuant to the effective interest rate method with an effect in earnings. Unadjustable balances are stated at nominal value. Adjustable balances or those denominated in foreign currency include the effect of the accrued exchange rate and adjustments at the reporting date.

(a) Deposits and obligations with the General Treasury include:

(b) Other Deposits and Obligations include:

Note 16

NOTES ISSUED BY Banco Central de Chile

Notes issued by Banco Central de Chile are financial liabilities issued in order to adopt the decisions of the monetary and debt policy, initially measured at fair value, and are not affected by transaction costs. Subsequently, they are measured at amortized cost pursuant to the effective interest rate method with the effect recorded in earnings. Unadjustable balances are stated at their nominal value. Adjustable balances include the effect of the accrued adjustments at the reporting date.

Notes issued comprise: Central Bank of Chile bonds in UF (BCU), Central Bank of Chile bonds in Chilean pesos (BCP), Central Bank of Chile discountable promissory notes (PDBC), Indexed-promissory notes payable in coupons (PRC), and Optional indexed coupons (CERO) in UF.

The issuance of notes by Banco Central de Chile is the main element supporting the implementation of the monetary and debt policy in order to provide liquidity to the market and deepen its transactions in an efficient manner.

As of December 31, 2018 and 2017, maturities of these instruments are as follows:

Balances include interest and adjustments accrued as of December 31, 2018 and 2017.

Note 17

PROVISIONS

Banco Central de Chile has recorded provisions for severance indemnity, a benefit established in the Collective Labor Agreement in force for the periods 2015-2019 accounted for in accordance with the actuarial method of projected cost. At the same time, the benefits granted to the former Association of Retired Employees and Beneficiaries of Pensions of Public Officials of Banco Central de Chile and healthcare benefits for retirement plans are also included and detailed as follows:

As of December 31, 2018, the sensitivity of the actuarial liability amount from post-employment benefits considering changes indicated in actuarial assumptions generates the following effects:

Note 18

CAPITAL

(a) Capital

Section 5 of the Basic Constitutional Act of Banco Central de Chile established an initial capital for Banco Central de Chile at $500,000 million, which at December 31, 2018 corresponds to Ch$2,551,956.4 million (Ch$2,482,447.9 million as of December 31, 2017) adjusted to the Consumer Price Index as of that date, with a time lag of one month, which has to be paid according to transitory Article 2 of the Basic Constitutional Act.

In accordance with Section 77 of the Basic Constitutional Act of Banco Central de Chile, the deficit produced in any year will be absorbed with a debit to constituted reserves.

When there are no, or insufficient, reserves, the deficit produced in any period will be absorbed with a debit to capital.

As of December 31, 2018, Banco Central de Chile has negative equity of Ch$3,760,329.1 million (negative equity of Ch$5,783,336.5 million as of December 31, 2017) arisen mainly from differences between international reserve returns and the cost of liabilities at domestic interest rate due to gains and losses from changes in the exchange rates of assets in foreign currencies.

(b) Price-level adjusted capital

The Board decided to no longer apply comprehensive price-level adjustment to financial statements beginning in 2010, and therefore price-level adjustment on capital is no longer presented in the statement of financial position nor in the statement of comprehensive income; however, in order to comply the provisions of Section 5 of the Basic Constitutional Act of Banco Central de Chile, paragraph 2, which states “The capital may be increased by decision of the majority of the Board Members, through capitalization of reserves and adjusted by means of price-level adjustment”, as well as stated in Title VI of the same legislation, regarding the distribution of Banco Central de Chile’s surpluses included in Section 77, and the payment of the initial capital referred to in transitory Article 2. Once the initial capital, properly adjusted as stated in the terms of Section 5 is paid, the resulting surplus for each year, will be determined and calculated for the purposes of surplus distribution to the General Treasury as contained in Section 77, considering the annual adjustment to the equity recorded in memorandum accounts.

As of December 31, 2018, the negative capital price-level adjustment recognized in memorandum accounts amounted to a negative equity of Ch$183,135.4 million (negative equity of Ch$94,967.2 million in 2017), which resulted in adjusted capital at the reporting date of Ch$6,723,683.9 million (negative equity of Ch$5,093,240.9 million in 2017). The amount to price-level adjusted is capital at the reporting date which includes the capital adjusted at the prior year-end, plus the profit or loss from such year and its contributions by the General Treasury, if any, which does not consider valuation accounts. Note that as of to-date the related deficit has not been distributed yet and during 2018, there were no capital contributions by the General Treasury.

Note 19

NET GAIN FROM INTERNATIONAL RESERVES

(a) Investment portfolio

At each year-end, this caption is composed of the following:

(b) Other foreign transactions

Net gain or loss on foreign transactions comprise the following:

Nota 20

NET GAIN FROM DOMESTIC TRANSACTIONS

For the years ended December 31, 2018 and 2017, this caption is composed of the following:

Note 21

NET GAIN FROM DOMESTIC TRANSACTIONS

For the years ended December 31, 2018 and 2017, this caption is composed of the following:

Net gain (loss) from foreign exchange transactions for each year end, resulting mainly from the effect of exchange rate differences on foreign currency assets, as follows:

Note 22

ISSUANCE, DISTRIBUTION AND PROCESSING COSTS

At each year-end, this caption is composed of the following:

Note 23

FOREIGN CURRENCY BALANCES

The statement of financial position includes assets and liabilities payable in foreign currencies, whose balances as of December 31, 2018 and 2017 are as follows:

Note 24

CONTINGENCIES AND COMMITMENTS

There are no lawsuits that are in process against Banco Central de Chile; accordingly, the Bank has recorded no contingencies that are expected to have a material effect on equity.

Note 25

INCOME TAX

Pursuant to Article 7 of Decree Law No.3345 dated 1980, Banco Central de Chile is exempt from income taxes.

Note 26

Fiscal agency

Law 20,128 related to General Treasury Liability created the “Economic and Social Stabilization Fund” (FEES) and the “Pension Reserve Fund” (FRP)”. In conformity with the provisions of the aforementioned law, through Executive Decree 1383, dated 2006 of the Minister of Finance amended Executive Decree 1618 dated 2012, and appointed Banco Central de Chile as Fiscal Agent for the administration of resources referred to such funds, in conformity with the procedures, conditions, methods and other standards established in the aforementioned decree.

The Executive Decree 19 in 2011, issued by the Minister of Finance, appointed Banco Central de Chile as Fiscal Agent for the administration of the Strategic Contingency Fund.

In accordance with Article 5 of the abovementioned Executive Decree 1383, as amended by Decree 1618, investments of public resources managed by Banco Central de Chile, as Fiscal Agent, have been carried out in accordance with the guidelines established for these effects by the Minister of Finance. These investments have been recorded in off balance sheet accounts.

On June 18, 2015, via Agreement 1909-02, the current execution guidelines for the Pension Reserve Fund and the Economic and Social Stabilization Fund, respectively, were approved. On July 18, 2013, via Agreement 1765-04, the current execution guidelines for the Strategic Contingency Fund were approved.

Note 27

TRANSACTIONS WITH RELATED PARTIES

(a) Banco Central de Chile does not have any related companies.

(b) Compensation of the board and key executives:

In accordance with Banco Central de Chile’ s Basic Organic and Constitutional Law, compensation of the board is set by the President of the Republic for periods not exceeding two years, following a proposal made by a commission formed by former governors and deputy governors of the entity, appointed by the President of the Republic. In order to propose compensation, the act requires them to be based on the compensation paid to the highest-ranked executive positions in bank institutions within the private sector.

Compensation corresponding to the General Manager, the General Counsel and General Auditor of Banco Central de Chile, are at level one of the compensation structure, as they are positions established in Sections 24 through 26 of the Banco Central de Chile’ s Basic Constitutional Act.

The total gross compensation paid to the Board and key executives during 2018 amounted to Ch$1,441.8 million (Ch$1,445.2 million in 2017).

Nota 28

RELEVANT EVENTS

(a) Through Decree No.447, issued by the Ministry of Finance, dated March 16, 2018, and published in the Official Gazette on April 27, 2018, Mr. Alberto Raúl Naudon Dell'Oro was appointed on March 22, 2018 as Legal Advisor of Banco Central de Chile's Board of Directors for a term of ten years.

(b) Through Decree No.2144-01-180412 dated April 12, 2018, the Board agreed to appoint Mr. Ricardo Budinich Diez as member of the Audit and Compliance Committee for a term of three years, replacing Mr. Gustavo Favre Domínguez.

(c) Through Decree No.2144-02-180412, the by-laws of the Audit and Compliance Committee were modified increasing the number of members to 4.

(d) Through Decree No.2144-03-18041 dated April 12, 2018, the Board agreed to appoint Mr. Ramiro Mendoza Zuñiga as member of the Audit and Compliance Committee for a term of three years.

Note 29

SUBSEQUENT EVENTS

In the opinion of Management, between December 31, 2018 and the date of issuance of these financial statements the following subsequent events which could significantly affect the amounts presented in the financial statements have occurred:

(a) Change in US dollar and euro exchange rate

The exchange rate for U.S. dollar as of January 22, 2019 amounted to Ch$672.42 representing a decrease of Ch$23.27 compared with the exchange rate prevailing as of December 31, 2018. This represents a decrease in Banco Central de Chile’s equity of Ch$510,153.9 million.

The exchange rate for Euro as of January 22, 2019 amounted to Ch$764.37 representing a decrease of Ch$31.52 compared with the exchange rate prevailing as of December 31, 2018. This represents a decrease in Banco Central de Chile’s equity of Ch$165,325.7 million.

The total decrease in Banco Central de Chile’ s equity because of the decrease in the exchange rate for United States dollar and Euro on January 22, 2019 amounts to Ch$675,479.6 million..

(b) Approval of the financial statements

The financial statements as of December 31, 2018 were presented by the General Manager to the Banco Central de Chile’s Board on January 24, 2019, and approved for issue at the Meeting No.2205.

(c) Other

There are no subsequent events that might have a significant effect on the amounts presented herein or in Banco Central de Chile’s economic or financial position.

The Board President and Members of
Banco Central de Chile:

Report on the financial statements

We have audited the accompanying financial statements of Banco Central de Chile, which comprise the statements of financial position as of December 31, 2018 and 2017, and the related statements of comprehensive income, changes in equity, and cash flows for the years then ended, and the related notes to the financial statements.

Management’s responsibility for the financial statements

Management is responsible for the preparation and fair presentation of these financial statements in accordance with International Financial Reporting Standards; this includes the design, implementation and maintenance of internal controls relevant to the preparation and fair presentation of financial statements that are free from material misstatement, whether due to fraud or error.

Auditors’ responsibility

Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards in Chile. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free from material misstatement.

An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the auditors’ judgment, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity’s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity’s internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by management, as well as evaluating the overall presentation of the financial statements.

We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion.

Opinión

In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Banco Central de Chile as of December 31, 2018 and 2017 and the results of its operations and its cash flows for the years then ended in accordance with International Financial Reporting Standards.

The above translation of the auditors’ report is provided as a free translation from the Spanish language original, which is the official and binding version. Such translation has been made solely for the convenience of non-Spanish readers.

Mario Torres S. KPMG Ltda.

Santiago, January 24, 2019