2017 RISK MANAGEMENT ANNUAL REPORT 1 TABLE OF CONTENTS

Transcription

1

2 2017 RISK MANAGEMENT ANNUAL REPORT 1 TABLE OF CONTENTS 1. Executive Summary 2. Introduction 2.1 Regulatory Environment 2.2 The Scope 2.3 Risk Policy Framework in Banco Santander (Mexico) 3. Integral Risk Management 3.1 Basic Principles of Integral Risk Management 3.2 Instruments for proper Integral Risk Management 3.3 Management and control of risks 3.4 Governance Structure for Integral Risk Management 3.5 Risk Information Management 3.6 Risk appetite 4. Credit Risk Management 4.1 General Aspects 4.2 Credit Risk Cycle Risk Study Planning and setting boundaries Decision on operations Monitoring Measurement and Control Recovery Procedure 4.3 Risk Mitigation Techniques 4.4 Methodologies for Calculating Reserves for Credit Risk Regulatory framework Portfolios Authorized to Banco Santander (Mexico) for the use of internal Calculation of Reserves for Credit Risk Methodologies Principles of the Rating System Applied in Banco Santander (Mexico) Main Characteristics of Internal Methodologies with Foundation Approach Authorized to Banco Santander (Mexico) Main Characteristics of Internal Methodologies with Advanced Approach allowed to Banco Santander (Mexico) Internal Rating Systems Control 4.5 Counterparty Risk and Financial Instrument Transactions

3 2017 RISK MANAGEMENT ANNUAL REPORT Securitization Exposures Information 4.7 Distribution of Exposures by Credit Risk General Aspects Exposure by Portfolio Type Exposure by Remaining Term Exposure by Federative Entity Estimates of Credit Risk by Federative Entity Portfolio Companies by Economic Sector Exposure Estimates for Credit Risk by Economic Sector Portfolio Companies 5. Market Risk Management Trading Activity 5.1 Activities Subject to Market Risk Trading 5.2 Basic Principles in Risk Management Market Trading 5.3 Key processes in Risk Management Market Trading 5.4 Trading Market Risk Control A. Trading Market Risk Metrics B. Trading Market Control Risk Procedures C. Figures from the Reporting Period 5.5 Derivative Financial Instruments 6. Structural Risk Management 6.1 Activities subject to Structural Risk 6.2 Basic Principles on the Structural Risk Management 6.3 Key Processes in the Structural Risk Management 6.4 Control of structural risks A. Figures from the Reporting Period 6.5 Structural Risk in the Equity Portfolio 7. Liquidity Risk Management 7.1 Activities subject to Liquidity Risk 7.2 Basic principles on Liquidity Risk Management 7.3 Key Procedures in the Liquidity Risk Management 7.4 Control of Liquidity Risk A. Figures from the Reporting Period

4 2017 RISK MANAGEMENT ANNUAL REPORT 3 8. Operational Risk Management 8.1 General Aspects 8.2 Operational Risk Control 9. Capital 9.1 General Aspects 9.2 Function of the Capital 9.3 Calculation of the Capital Requirement for Credit Risk 9.4 Calculation of the Capital Requirement for Counterparty Risk 9.5 Calculation of the Capital Requirement for Market Risk 9.6 Calculation of the Capital Requirement for Operational Risk 9.7 Regulatory Capital

5 2017 RISK MANAGEMENT ANNUAL REPORT 4 1. Executive Summary With the publication of this report, Banco Santander (Mexico) complies with the obligation set forth in Article 88 of the CUB where banking institutions are obliged to disclose to the public, through its website, information on the comprehensive risk management that takes place on a daily basis in the institution. Specifically, banking institutions are required to publish the objectives and policies for managing each of the different types of risk faced, including their strategies, processes, methodologies and levels of risk assumed. The information to be published is classified as both quantitative and qualitative. Quantitative information shall be disclosed quarterly and qualitative information may be disclosed annually. The views expressed in this report and statistical information included (unless otherwise stated) comprises the following institutions: a) Banco Santander (México), S.A., Institución de Banca Múltiple, Grupo Financiero Santander México. b) Santander Hipotecario, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada. Grupo Financiero Santander México. c) Santander Vivienda, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada, Grupo Financiero Santander México. d) Santander Consumo, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada, Grupo Financiero Santander México. e) Santander Inclusión Financiera, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada, Grupo Financiero Santander México 1. Through December 2016, the Extraordinary Stockholders General Assemblies of Santander Hipotecario S.A. de CV. and Santander Vivienda S.A de CV. took place, in which the merge of both entities was agreed, Santander Hipotecario will be the merged company and Santander Vivienda the merger company. This report is prepared in accordance with applicable mexican regulations in determining exposures, capital requirements for risks and reserve estimate. Chapter 1 includes this Executive Summary. Chapter 2 includes generally the Regulatory Framework for Risk within Banco Santander (Mexico). Meanwhile Chapter 3 deals with Integral Risk Management, and outlines the basic principles and tools for proper Risk Management. It stresses that for the management of risk inherent in the Bank's operations, it is essential to understand and determine the behaviour of its financial situation and for the creation of a long-term value, fully attached to the regulatory requirements established by the CNBV (Spanish acronym for National Banking and Exchange Commission) and Banco de Mexico. It also delineates how the management and risk control is structured in three lines of defence to develop three distinct functions: a) First line of defence: Risk management from its genesis. 1 At the end of December 2017, 3 credits to 26 clients were given, reporting a total investment of MXN105,000, with an expected loss of MXN2,798. In the information reported in this document, this figures are included in credit to individuals (consumer).

6 2017 RISK MANAGEMENT ANNUAL REPORT 5 b) Second line of defence: responsible for overseeing risk-taking activities across the bank and report to senior management on risk related items. c) Third line of defence: Independent review of the risk activity. Banco Santander (Mexico) has an agile and efficient governance structure that, among other things, ensures: (i) the participation in risk decisions and in monitoring and control of the governing bodies and senior management; (ii) coordination between the different lines of defence set the functions of management and risk control; (iii) the alignment of objectives, the monitoring of compliance and the implementation of corrective measures, and (iv) the existence of an adequate environment management and risk control. Risk management and control require a high availability of hard data, capacity to analyse these data, and solid reporting procedures. Banco Santander (Mexico) management of risk information is governed by principles such as responsibility; technology architecture; risk data reconciliation; availability data; completeness and comprehensiveness; data quality indicators; quality control data; readiness; flexibility and adaptability; prospective approach and availability of documentation; data analysis and expert judgment. The third chapter also defines the risk appetite as the maximum level and type of risk that the organization is willing to take, within its risk capacity to achieve its strategic objectives and the development of its business plan. Chapter 4 describes major policies and fundamentals for credit risk management, as well as the detail of the key features of the methodologies to qualify the portfolios and determine the amount of the reserves for credit risk. From the point of view of credit risk management, segmentation is based on the distinction between three types of customers: Individuals: Includes all private persons, except those with an entrepreneurial activity. It comprises portfolios of non-revolving mortgage loans for housing, credit card and consumer loan not revolving portfolio. SMEs, companies and institutions: involves natural and juridical persons with business activity, as well as public and private entities of non-profit sector. Global Corporate Banking (GCB): It consists of corporate, financial and sovereign institutions, which make up a closed list, which is reviewed annually. Credit Risk goes through a cycle or life process, whose phases are valid for any operation, notwithstanding the important differences that can be seen in the cycles of the risks of different segments, specifically between the private persons and the companies. 2 Three stages are differentiated in the cycle of credit risk: pre-sale, sale and after-sales. This process is constant feedback, joining into the study of the risk and into the pre-sale planning and the 2 The processes belonging to the pre-sale stage are those referring to the study of risk and are conducted as a prelude to the credit risk approval step. The processes that belong to the sales phase are those that take place during the decision approving stage. Finally, the after-sales processes are those that take place after the approval of credit risk.

7 2017 RISK MANAGEMENT ANNUAL REPORT 6 results and conclusions of the after-sales phase. The processes that take place in each of the above phases are: a) Study of risk and credit rating procedure. b) Planning and setting limits. c) Decision on operations. d) Monitoring. e) Survey and Control. f) Recovery management. This chapter also details how credit risk is mitigated in general terms, through the use of securities. A security is defined as a measure of reinforcement added to an operation of credit in order to mitigate the loss in breach of the payment. The security is a component that mitigates the severity of the operation in case of default. The purpose of the security is to bring down the final operating loss, among other cases, where a long-term operation increases the risk of damage to the customer or because of possible and relevant external events that could jeopardize the success of the operation and to the creditor, it is difficult to manage. Likewise, Chapter 4 explains clearly the criteria under which admission and security management are governed: a) Expressly, subsidiary, accessory and essential character of the sureties. b) Prudent and expert assessment. c) Rating upgrade. d) Securities correct Instrumentation. e) Cautions on the conservation and availability of security. f) Capacity of execution and settlement of surety. g) Security block. h) Security amendment. i) Security implementation. j) Security expiration. Based on CUB provisions, this chapter explains that in order to calculate the reserves for Credit Risk, institutions may use: a) Standard Method. b) Some of the methods based on internal ratings, basic or advanced, provided prior authorization from the CNBV. Since 2012 the CNBV authorized Banco Santander to use internal methodologies with the Foundation Approach 3 to corporate businesses, Global Corporate Banking, financial institutions, banks and SME s. In 3 Under internal Methodologies with Foundation Approach (FIRB), the institutions obtained the Probability of Default on its positions subject to credit risk, while for the rest of the components of risk, the institutions must conform to the provisions in accordance to Paragraph C Section Three of CUB.

8 2017 RISK MANAGEMENT ANNUAL REPORT 7 October 2015, it allowed the use of internal methodologies with advanced approach 4 for calculating credit reserves for portfolios of SME s and property developers. The rest of the chapter details the main features of the internal methodologies authorized to Banco Santander (Mexico) and includes quantitative information on major exposures of the institution to credit risk. There is also a section on the counterparty risk, which is the one that the institution assumes with Government, government agencies, financial institutions, corporations, companies and individuals in its Treasury and correspondent banking activities. The survey and control of the credit risk on financial instruments, counterparty risk, is conducted by a specialized unit and with organizational structure independent of the business areas and control of this type of risk is performed daily, which allows to know the line of credit available with any counterparty. Chapter 5 provides information on the activities subject to trading market risk and discusses its development during this year. It also describes the different methodologies and metrics used in the institution. The perimeter of identification, measurement, control and monitoring of the market risk function covers those operations that assume the equity risk. The survey of market risk quantifies the potential change in value of the positions taken as a result of changes in market risk factors. The risk arises from changes in risk factors: interest rate, exchange rate, equity, credit spread and volatility of each of the above, and liquidity risk of the various products and markets in which it the institution operates. Trading activities include both the provision of financial services to customers, in which the entity is the counterpart, as the activity of sale and own positioning in financial instruments. This heading provided the positions, which the entity keeps in their trading books. The basic principles of the Trading Market Risk Management are based on: a. Independence of trading activities and balance sheet management. b. Overview of risk assumed. c. Definition of limits and allocations. d. Control and monitoring. e. Homogeneous and aggregated metrics. f. Consistent and documented methodology. Additionally, the Chapter 5 explains the metrics and processes used for the trading market risk control: Metrics: Value at Risk (VaR). Stressed VaR. Value at Earnings (VaE). Scenario Analysis. Trading Market Risk Limits Trading. Proceedings: Market data retrieval. Analysis of the metrics and trading market risk positions. Control of the excesses of limits and products authorized. Control of insurance operations. 4 In the case of internal Methodologies with Advanced Approach (AIRB), the institutions estimate the Probability of Default, Loss Given Default, Exposure at Default and Maturity Term.

9 2017 RISK MANAGEMENT ANNUAL REPORT 8 Control of assessment model. Control of long and short positions. Control of liquidity. Price control. Financial Settlement. The rest of the chapter includes quantitative information on this type of risk. Chapter 6 contains information very similar to the one presented in Chapter 5 but in reference to the structural risks. Structural risks consist of market risks inherent in the institution's balance sheet, excluding negotiation portfolios. This risk includes both losses from price variation affecting the sale and maturity portfolios available, as losses arising from the management of assets and liabilities. The main structural risks are the following: Structural Interest Rate risk. Structural Change Risk. Structural Equity Risk. Inflation risk. Market Liquidity Risk. Prepayment or Cancellation Risk. As part of the financial management of the institution, Chapter 6 examines the sensitivity of the financial margin and the equity value of the various items of the balance sheet against changes in interest rates. This sensitivity arises from gaps in the dates of maturity and modification of interest rates occurring in the different categories of assets and liabilities. The rest of the chapter discusses the quantitative information on this type of risk. Chapter 7 is very similar to the previous two chapters but deals with liquidity risk, which is fixed as the possibility of defaulting obligations on time or with excessive costs. The types of losses caused by these risk losses include enforced sales of assets or impacts on margin by the mismatch between cash outflows and inflows forecasts. This is the risk of loss of value of the buffer of liquid assets of the entity and is responsible for the variation of its operating value (derivatives and securities, etc.) which may involve additional collateral requirements and, therefore, worsening liquidity. Liquidity risk is classified into the following categories: a) Financing Risk. b) Mismatch Risk. c) Contingency Risk. The metrics that Banco Santander (Mexico) used for monitoring and controlling of liquidity risk are: Ratio of Structural Finance. Liquidity horizon for a local systemic crisis. Liquidity Risk Limits. Liquidity Gap. Available Liquidity. Concentration of Funding Sources. Stress Test. Liquidity coverage ratio (LCR) Net Stable Funding Ratio (NSFR)

10 2017 RISK MANAGEMENT ANNUAL REPORT 9 The rest of the chapter includes quantitative information on this type of risk. Chapter 8 describes the main policies and principles for the management of the operational risk, covering losses by failures or deficiencies in internal controls, errors in processing and storage operations or transmission of information, as well as adverse administrative and judicial resolutions, fraud or theft, and comprises, among others, technological and legal risks. For the identification and grouping of operational risks the different categories and business lines defined by both local regulators and the supervision of the institution they are used. The methodology is based on the identification and documentation of risks, controls and related processes also uses quantitative and qualitative tools such as self-assessment questionnaires, the development of historical databases and operating risk indicators, to name a few, both control and mitigation, and disclosure thereof. For the calculation of regulatory capital required for operational risk the Basic Indicator Approach as defined in the CUB, published by the CNBV it is used. Chapter 9 of this report describes the main policies and principles for capital management of the institution and how to calculate the capital requirement. Special mention is made to the internal methodology authorized for use by Banco Santander (Mexico) by the CNBV to calculate its capital requirement for credit risk. Capital management in the institution seeks to ensure the solvency of the company and maximize profitability, ensuring compliance with internal capital targets and regulatory requirements. It is an essential tool for making strategic decisions in their management using the established objectives in determining the Appetite Risk, planning and Capital budget, as well as the use of metrics that allow to evaluate the profitability and the creation of their business value. Capital management begins with the following key aims: 1. Capital Budget. 2. Planning Capital. 3. Establishment of Risk Appetite. 4. Minimum criteria. Capital policies that set the general guidelines are specified, which must govern the actions of the areas involved in the processes of management and control of capital. Autonomy of the Capital. Centralized Monitoring. Proper distribution of own resources. Strengthening Capital. Capital Preservation. Prudent management. Maximizing value creation. The rest of the chapter includes quantitative information on capital management and some metrics as the probability of default and the credit risk weights.

11 2017 RISK MANAGEMENT ANNUAL REPORT Introduction 2.1 Regulatory Environment During 2017 a number of amendments to the general provisions applicable to credit institutions (Circular Applicable to Credit Institutions, CUB) were made; mainly seeking stability and the correct functioning of the Financial System, also aiming to decrease cost of credit, enhance Bank s security and continue aligning the Mexican Regulation with international regulative standards (Basel) 5. Also in this year amendments were issued on: Credit Risk: Revolving Consumption Credit Score Methodology In order to better reflect the credit risk incurred by credit institutions: The rating methodology of the non-revolving and mortgage credit portfolios and their associated regulatory reports are updated by incorporating new dimensions of credit risk, such as the level of indebtedness of each client, their payment behavior in other financial and non-financial entities, as well as the specific risk profile of each product. A portfolio rating methodology for microcredits is established. The loss severity estimation is specified for the calculation of preventive reserves, when the collateral guarantees are recognized, in order to reduce the amount of preventive reserves derived from the credit portfolio rating, similarly, the term to constitute 100% of the amount of credit risk reserves that correspond to portfolios of non-revolving consumer, mortgage and microcredit is extended, in accordance with the new applicable methodology, also the time Financial Institutions should disclose such information in their financial statements and through other public communications is specified. Credit Risk: Agricultural loans credit score methodology The prices coverage that some borrowers have is recognized in the calculation of preventive reserves for credit risk for agricultural loans, in order to adequately reflect the risk incurred by the institutions. Counterparty Risk A weighted credit risk equal to 0% is established for the operations carried out by credit institutions with Banco de Mexico, which are subject to an additional capital requirement due to credit valuation adjustments for derivative transactions. Capital Risk In order to align the applicable treatment to the implicit support scenario with the international standards issued by the Basel Committee for Banking Supervision, and adequately reflect the risk incurred by credit institutions when they update the assumption of granting implicit support to securitization structures in which they act as originators or transferors of the underlying assets, and avoid excessive capital requirements when updating those assumptions, the obligation of maintaining capital for all the underlying 5 Reference: CNBV regulatory newsletter; released at

12 2017 RISK MANAGEMENT ANNUAL REPORT 11 assets of the current securitization schemes is limited only to the securitization structures for which implicit support had been granted. Clarifications are made in the capital requirement definition which credit institutions must have to support their credit risk; the treatment to be applied by credit institutions for the calculation of market risk capital requirements is modified for the investments they make in social equity of brokerage houses and securities deposit institutions in order to reflect their risk as any other similar instrument; regarding the use of internal models, credit risk measurement of portfolios granted to micro, small and medium enterprises is improved. Market risk The accounting criteria applicable to credit institutions held to maturity securities is adjusted extending the period by which they may be sold or reclassified before their maturity, without affecting the ability to use the securities category. Additionally, in order to achieve greater adherence and consistency with the international regulations established in the International Financial Reporting Standards, the requirements of isolated events that are outside the control of the credit institution are specified. Operational Risk The procedures and mechanisms that credit institutions use to identify any possible client identity supplanting are strengthened. Feasibility Plans It is specified that only Banks classified as Domestic Systemically Important Banks, will be required to update their contingency plans during March of each year, while the rest of the institutions must do it every two years. 2.2 Scope The information in this report, as well as including statistical data (unless otherwise stated) comprises the following institutions: a) Banco Santander (México), S.A., Institución de Banca Múltiple, Grupo Financiero Santander México. b) Santander Hipotecario, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada. Grupo Financiero Santander México. c) Santander Vivienda, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada, Grupo Financiero Santander México. d) Santander Consumo, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada, Grupo Financiero Santander México. e) Santander Inclusión Financiera, S.A. de C.V., Sociedad Financiera de Objeto Múltiple, Entidad Regulada, Grupo Financiero Santander México.

13 2017 RISK MANAGEMENT ANNUAL REPORT 12 It is important to recall that through December 2016, the Extraordinary Stockholders General Assemblies of Santander Hipotecario S.A. de CV. And Santander Vivienda S.A de CV. took place, in which the merge of both entities was agreed, Santander Hipotecario will be the merged company and Santander Vivienda the merger company. This report is prepared in accordance with applicable Mexican regulations in determining exposures, capital requirements for risks and reserve estimate. Statistical information as well as accounting financial statements come from reports regulatory sent to the CNBV and the Banco de Mexico, for the characteristics of the portfolio of the institution (credit by credit information). The CNBV, through its website, has recognized the high quality of the information sent by the institution, and recommends its use without restriction. 2.3 Risk Policy Framework in Banco Santander (Mexico) The internal manuals for Risk Management are technical documents that contain policies, procedures, data flow diagrams, models and methodologies necessary for the management and analysis of the different types of risk and requirements processing systems of information. The risk internal regulation of Banco Santander (Mexico) develops in the following types of documents: 1. Corporate Frameworks: reflected the general principles and define the framework for action to be adjusted to other more concrete documents. 2. Models: develop frameworks or particular aspects thereof; specify the principles, processes and responsibilities, governance and instruments of regulated activity. 3. Risk policies: set quantitative limits and qualitative criteria to be observed in the processes of risk decision. 4. Regulations: meets the inner workings of the committees and other joint decision or deliberation forums. 5. Procedures: detail the embodiment of a process or set of processes. 6. Guidelines: collect additional elements to the internal rules, necessary for a complete replication of the process or for a better understanding of them. The internal regulation of risk within Banco Santander (Mexico) provides documentation that Risk Management be developed in compliance with the principles described in Table 1A.

14 2017 RISK MANAGEMENT ANNUAL REPORT 13 Table 1A Principles that complies the documentation of Banco Santander (Mexico) Reflection of risk management All relevant activities of the risk function should be duly regulated. Internal risk regulations should reflect the way in which risk is managed in the entity, but should also be used to encourage the evolution of activities towards best practices. Responsibility of the regulations Governance of the regulations Coordination of the regulations Accessibility and knowledge of the internal regulations Use of reference documents Those responsible for the risk activities have to ensure that their activity is regulated in accordance with the risk policy model and in line with external regulations or standards. Control (validation) and governance procedures have to be established to enable authorities to be assigned to approve each document type at the pertinent level, including the due weighing up of opinions and consultation of all those involved. Producing consistent regulations, disseminating best practices, transferring knowledge and ensuring efficiency in the development of internal regulations requires extensive coordination in their development process, between both the Group's different units and the affected functions. The internal risk regulations will be accessible to all affected staff members, and the training activities necessary for awareness of these should be promoted. The regulatory development of those aspects for which there are reference documents has to be based, insofar as possible, on these, in order to add consistency to the Group's regulations and promote the use of best practices. The governance of the internal regulations of risks is carried out through the support of several committees: Board of Directors: responsible for approving and modifying the general risk policy. Comprehensive Risk Management Committee (CRMC): responsible for validating and ratifying frameworks, models and policies for comprehensive risk management, based on the objectives, guidelines and policies established by the Board of Directors. Risk Policy Committee: approver of the risk policy documents and its prior validation regarding risks or others that may have implications for the risk area. 3. Integral Risk Management 3.1 Basic Principles of the Integral Risk Management Risk management is considered by Banco Santander (Mexico) as a competitive element of strategic nature with the purpose of maximizing the value for the stockholder. This management is defined, from a conceptual and organizational sense, as a comprehensive management of the different risks assumed by

15 2017 RISK MANAGEMENT ANNUAL REPORT 14 Banco Santander (Mexico) for the development of its activities. Managing the risk inherent in the operations of the Bank is essential to understand and determine the behavior of its financial situation and to create long-term value; entirely, it is attached to the regulatory requirements established by the CNBV and Banco de Mexico. The Integral Risk Management is defined as the set of actions required for identification, decision, measurement, evaluation, monitoring and control of all risks. On a fist level, the Risk Map that the institution has defined includes the following types of risk: Credit Risk: this risk is caused by the possibility of losses arising from the total or partial failure of the institution financial obligations by its customers or counterparts. Counterparty Risk: is the risk that the counterparty to a financial contract will default prior to the expiration of the contract and will not make all the payments required by the contract. Counterparty risk applies to the following financial instruments: derivatives, repurchase transactions, and securities lending. Market Risk: risk incurred as a result of the possibility of changes in the market that affect the value of the positions in trading portfolios. Structural Risk: menace caused by the management of the different items of the balance sheet, including those relating to the sufficiency of own resources and those arising from the activities of insurance and pensions. Liquidity Risk: crisis of failing to meet payment obligations on time or doing so with an overcost. Operational Risk: risk of losses by deficiencies in internal controls, errors in processing and storage operations or transmission of information, as well as adverse administrative and legal Resolutions, fraud or theft; includes, among others, the technological and legal risks: Legal Risk: potential loss by failure to comply with the applicable legal and administrative provisions, the issuance of unfavorable administrative and judicial resolutions, and the application of sanctions, in connection with the transactions which the institution carries out. Technological Risk: potential losses from damage, interruption, alteration or failures derived from the use of hardware, software, systems, applications, networks and any other means of transmission in the provision of banking services to customers of the institution. Conduct Risk: risk occasioned by inadequate work placements and the relationship between the bank and his clients, as well as the treatment of products offered to their clients, also the customization of their products to their clients. Model Risk: acknowledge of losses originated by decisions made mainly by the outcome of the models, this comes because mistakes made in the inception, application and use of this models. Reputational Risk: damage made by the perception of the bank form the public opinion, clients, investors, or any other stakeholder. Risk Management at Banco Santander (Mexico) is governed by different principles, which are aligned with the strategy and business model of the institution: a) Incorporation of a Risk Culture.

16 2017 RISK MANAGEMENT ANNUAL REPORT 15 A strong risk culture, extending to all areas and employees and covers all types of risks is promoted. This culture includes a set of attitudes, values, skills and guidelines from the dangers integrated into all processes, including decision making change management and strategic planning and business. b) Involvement of senior management. There is a direct participation of the governing bodies and senior management in the development and implementation of risk culture, as well as in the management and control thereof. c) Independence of the risk function. The risk function operates independently to other competitions, covering all risks and providing adequate separation between the generating areas of risk and those responsible for its control and supervision. It has sufficient authority and direct access to the bodies responsible for setting and monitoring of the strategy and policies of management and Government risks. d) Definition of Risk Appetite. A key aspect of risk management is the definition of the risk appetite that determines the amount and type of risks considered reasonable to assume in the execution of its business strategy. The risk function boosts its definition, as well as its continuous control. e) Comprehensive Consideration of Risks. The identification and assessment of all risks that might impact on the income statement or capital position are basic premises to enable its management and control. The management and risk processes cover all activities and businesses. Risk management considers both the risks generated directly as those originating from outside the institution, but which may still affect it. f) Organizational Model and Governance. A model assigned to all risks, responsible for management and control while preserving the principle of independence and with clear and consistent reporting mechanisms. g) Decision in Collegiate Bodies. Decision-making through collegiate bodies is an effective tool to facilitate a proper analysis and different perspectives to be considered in risk management. The decision-making process includes a neat contrast of opinions provided to the potential decision impact and the complexity of the factors that may determine it. The risk governance model not only identifies the different bodies that compose it, but also defines the granting of faculties and powers of each of them. h) Anticipation and Predictability. Risk assessment is an eminently proactive vocation, in order to estimate the evolution of risks in different scenarios and time horizons. Therefore, it focuses on the future projection of all those variables that determine the results. Whenever possible, the intention is that the risk assessment should include its quantification or measurement. The quantification of the risk is based on widespread use of models. In cases where this is not feasible, risk assessment aims to identify the elements of greater incidence on the probability of occurrence of a loss event and its impact, in order to facilitate the implementation of mitigation measures and controls. i) Risk Limitation. All financial risks incurred are subject to objective, verifiable and consistent limits with risk appetite, both in regard to the types of acceptable risk and its quantitative level. The limits

17 2017 RISK MANAGEMENT ANNUAL REPORT 16 are allocated to the various types of risk, as well as the different activities and businesses. For non-financial and cross-cutting risks consistent tolerance level is set with its nature. 3.2 Adequate tools for Risk Management All risks in its various manifestations should have a responsible for control and management. Also, the structure of the risk function is proportional to the nature, scale and complexity of its activities. The institution has the following essential tools for a proper performance of Risk Management: Table 3A Tools for Risk Management Periodic plans of feasibility and, where appropriate, of resolution. A regular process for identifying and assessing all risks A periodic process simulation of the evolution of relevant risk factors and their impact on the capital and results Periodic (technological and operational) contingency and business continuity plans A uniform risk reporting framework with common standards and metrics Periodic planning processes of capital and liquidity

18 2017 RISK MANAGEMENT ANNUAL REPORT Management and Control of Risks The management and control of risks is structured in three lines of defense that developed three different functions: a) First Line of Defense: Risk Management from its generation. The first line of defense consists of lines of business or activities that originate the exposure to risk in the institution as part of its activity. The generation of risk in the first line of defense is set to appetite and defined limits. To serve its function, they have the means to identify, measure, manage and report the risks assumed. b) Second Line of Defense: Control and Consolidation of Risks, Monitoring its Management. The second line of defense is made up of teams specialized in risk control and supervision of the management of them. This line is responsible for the effective control of risks and ensures that they are managed according to the level of risk appetite defined by senior management; is responsible for the identification, measurement, management and reporting of the risks involved, without prejudice the needs of the first line for a proper management. Promotes the development of a common culture of risk, and provides guidance, advice and expert judgment in all matters related to risks, constituting the point of reference for the entity to these themes, as well as to propose methodologies of measurement and analysis. c) Third Line of Defense: Independent Review of Risk Activity. As a third line of Defense, are Internal Audit processes. Periodically evaluates that the policies, methods and procedures are appropriate and checks that they are effectively implemented in the operational management of the institution. The management and control of risks includes processes of different natures which, according to their scope and complexity, may differ in: (i) strategic management processes, which are those that form part of the definition, implementation and monitoring of the risk strategy; (ii) the decision processes are taking place to adopt and adequately implement concrete decisions that require management and risk control and (iii) instrumental processes are necessary to make possible the above. An overview of these processes is included in Table 3B.

19 2017 RISK MANAGEMENT ANNUAL REPORT 18 Table 3B: Risk Management Processes Strategic Management Processes Formulation and monitoring the Bank's risk appetite. Defining the types and levels of risk consistent with the objectives. Identification and implementation of strategies and activities to achieve and maintain the desired risk profile. Evaluation of the effectiveness of these deviations and the objectives pursued. Setting targets and metrics to control it and follow it. Decision Processes Origination: They occur before effectively take the risk. These processes determine whether to assume new risks. Anticipation: they are intended to prevent situations of increased level of risk and facilitate the adoption of corrective measures. Mitigation: They cover the decisions to reduce the consequences of the events of loss, both before and since such events occur. The key elements of mitigation processes are anticipation and early identification of loss events; the development of specific mechanisms for the management of these events and the agility in implementing these mechanisms. Instrumental Processes Identification of the risks associated with operational activity or business. Evaluation and measurement of risks, which aims to obtain an estimate of the likelihood of different scenarios of loss as well as the potential impact of each. Monitoring and control processes, ensures the continuous availability of updated information on the levels of risk assumed in the development of a business. Also cover policies and procedures compliance. The information, which includes the generation, dissemination and provision of relevant people the necessary information to know and assess the situation of the risks and be able to take decisions and actions needed. Governance Structure for Risk Management Banco Santander (Mexico) has a structure of agile and efficient government that, among other things, ensures: (i) participation in risk decisions and in monitoring and control of the governing bodies and senior management; (ii) coordination between the different lines of defense which set the functions of management and risk control; (iii) alignment of objectives, monitoring compliance and implementation of corrective actions and (iv) existence of an adequate environment management and risk control. To achieve these objectives, the scheme of the Committees Governance Model within the Bank is designed to ensure adequate: a) Structure: It implies, at least, the stratification according to the levels of relevance, balanced capacity of delegation and the elevation of incidents protocols. b) Composition: With members of sufficient level of dialogue and appropriate representation of the business and support areas. c) Operability, the frequency, level of minimum assistance and timely procedures.

20 2017 RISK MANAGEMENT ANNUAL REPORT 19 In Banco Santander (Mexico), risk decision-making bodies start from the Board of Directors towards the administrative units responsible for the management and control of each one of them. Board of Directors In terms of risks, among other things, the Board of Director is responsible for establishing the model of management and control of risks and to formulate the appetite for risk of the entity and to conduct a regular monitoring of the adequacy of the risk profile of the institution to the defined risk appetite. It establishes the minimum requirements of balance between profitability and risk of business or activities and makes decisions on operations or specific limits. Comprehensive Risk Management Committee (CRMC) The CRMC aims to manage the risks to which the institution is exposed, as well as monitor that the operations, complies with the objectives, policies and procedures for the Integral Risk Management (IRM) and the global limits of exposure to risk, that they have been previously approved by the Board of Directors. The functions of the Committee are: Propose to the Board of Directors for approval: Objectives, guidelines and policies for IRM, as well as any modifications made to them. Global limits of exposure to risk and specific risk exposure limits, considering: The Consolidated Risks, broken down by business unit or risk factor, cause or origin, as set out in Articles of the CUB and, where appropriate, risk tolerance levels. The mechanisms for the implementation of correctives actions. The cases or special circumstances that may exceed both the global limits of exposure to risk as a specific risk exposure limits. Approve: An exceptional specific limits adjustment and secondary of the risk appetite was made, when the Board had the faculties and approval com the Executive risk Committee, the risk levels tolerance (once a year), as well as the liquidity risk (article VIII). Specific risk exposure limits, when the Board has delegated authority to do so, the levels of risk tolerance and liquidity risk indicators (Article 81 fraction VIII of the CUB). Methods and procedures to identify, measure, monitor, limit, control, report and disclose the different types of risk to which the institution is exposed. Models, parameters, scenarios, assumptions, including those relating to stress testing established for liquidity risk (Annex 12-B CUB), to be used to carry out the assessment, measurement and control of risks to propose IRM. Methodologies for the identification, evaluation, measurement and control of the risks of new operations, products and services that are intended to offer the market. Corrective actions proposed by IRM as provided in section 69 of the CUB. Manuals for the CUB, according to the objectives, guidelines and policies established by the Board. These must be technical documents containing, among others, policies, procedures, data flow diagrams, models and methodologies necessary for the management of the various types of risk (Article 78 of the CUB). Technical Evaluation of the AIR (Article 77 of the CUB) for presentation to the Board and Committee. Report of Technical Evaluation (Article 77).

21 2017 RISK MANAGEMENT ANNUAL REPORT 20 Assign (remove), notifying the Board of Directors, the responsible for Comprehensive Risk Management Unit. Report to the Board at least quarterly: Risk profile of the institution. Exposure to risk assumed by the Institution. The adverse effects which could occur in the operation thereof. The non-compliance of the desired risk profile, limits of exposure to risk and levels of risk tolerance established. Corrective actions implemented (Article 69 of the CUB). Ensuring awareness by all personnel involved in taking risks: Desired risk profile. Limits of exposure to risk. Levels of risk tolerance. Report to the Board at least once a year: Business Continuity Plan. Effectiveness test of the Business Continuity Plan. Approve methodologies for estimating quantitative and qualitative impacts of operational contingency referred to in Article 74 fraction XI of the CUB. Adjust or authorize the excess on specific risk exposure limits: Exceptionally. Approval of the Board. According to the objectives, guidelines and policies for Integral Risk Management When the conditions and environment of the institution so require. Request to the board, the adjustment or the authorization to exceed, by way of exception, the global risk exposure limits. Executive Committee of Risks The Executive Committee of Risks is intended for all the Bank's risks, ensuring the proper identification, measurement, monitoring, control, reporting and risk mitigation, and the availability of means for adequate risk management. The Committee's functions are as follows: Propose to the relevant committees of Bank risk appetite. Approve the specific risks levels or secondary risk appetite when the conditions in the institution environment requires, this will be informed to the board of directors Propose the methodology of Risk Identification and Assessment (RIA) of the Bank. Suggest risk management models. Evaluate the procedures in risk according to the normative corporate models. Approve the creation and modification of Risk Committees according to the corporate governance Follow the Bank Risk in all areas. - Credit Risk: (i) Propose additional credit provisions required, (ii) approve credit operations as deemed appropriate and (iii) follow operations/customers whose size could have a significant impact on the Bank's results. - Market Risk: (i) Operational know as they consider appropriate, (ii) follow-up of limits whose size can have a relevant impact on the Bank's results.

22 2017 RISK MANAGEMENT ANNUAL REPORT 21 - Operational Risk: (i) Monitor the budget/size limits that may have a significant impact on the Bank's results. Take the necessary measures to comply with the recommendations of the regulator and the auditors. Approve the corresponding provisions models and monitor their proper implementation. Supervise and approve the monthly calculation of provisions, ensuring the sufficiency of provisions in accordance with the regulations, as well as follow up on the agreements or application plans that are defined in this regard, including those that refer to modify the final amount in cases that he considers it convenient. Committee of Risks Control The Committee of Control Risks has the power to monitor and control the risks of the Bank, giving a comprehensive, regular and adequate monitoring of all risks identified in the risk map of the general framework of risk, reporting and, if necessary, appropriate scaling the alerts to higher organisms. The Committee's functions are as follows: Review the determination of risk appetite and the defined strategy for its management. Monitoring methodology Risk Identification and Assessment and monitoring the resulting assessment. Ensure the implementation of Organizational Model Lines of Defense, at three levels: Risk Managers, Risk Drivers and Audit, clearly defining roles and responsibilities. Supervise the fulfillment of the normative model of risks and their specific principles, in particular to define, evaluate and follow up the policies of risk deemed appropriate. Validate the existence, updating and dissemination of Governance Risk Model, which defines the risk decision-making bodies, their powers, members and delegated powers. Assess scenarios and assumptions to be used in conducting stress tests. Follow up on recommendations from the audits of regulators and auditors. Inform to the Executive Committee of Risks about important deviations, identifying sources of concern. Committee of Information Management and Data Quality The Committee of Information Management and Data Quality is the body responsible for ensuring compliance and periodic review of Risk Information Framework and the implementation of the actions necessary to improve them, taking care to ensure the correct treatment of the information for the proper management and risk control of the unit, ensuring proper quality of data and processes necessary to their availability, extraction, aggregation and analysis. The Committee's functions are as follows: Promote the preparation of documentation that supports the government of the data and its elevation to the corresponding statutory governing bodies for approval and ensure compliance. Review and approve the relevant modifications in the data governance process. Approve data quality objectives and follow-up reporting on compliance to government bodies Approve certification reports, establish mitigation plans and send to the corporate counterpart committee for ratification. Propose, approve and supervise all activities related to the identification, evaluation and management of the quality of risk data and with the information and aggregation of risk data.

23 2017 RISK MANAGEMENT ANNUAL REPORT 22 Validate and communicate any limitation that prevents a complete aggregation of risk data in the reports. Follow the status and quality indicators of the risk data and other properties thereof. Assess the status of the risk information processes, reporting relevant incidents to the Risk Executive Committee and executing the necessary measures to ensure that the required standards are maintained. Ensure the execution of the measures determined by the highest administrative body in relation to the data aggregation processes and the presentation of risk reports, coordinating the necessary functions and proposing other actions that may be necessary. Propose and approve improvements and modifications applicable to the risk information model, governance of information and data and validate its application status and compliance with regulatory principles and requirements, in accordance with the regulatory risk model. Receive, prioritize and coordinate all requirements related to risk reports. Approve local taxonomies of risk and data reports and their modifications; as well as adhering to corporate taxonomies. Approve the certification procedure and the risk information model, governance of information and data according to the regulatory risk model. Review projects related to the aggregation processes and the generation of risk reports. Committee of Operational Risk The Committee of Operational Risk observe the identification, mitigation, monitoring and reporting of operational risk, survey the compliance with the Framework of operational risk limits and risk tolerance policies and procedures in this subject. Oversees the identification and control of current, emerging and operational risks, their impact on the risk profile and the integration of identification and management of operational risk in their decision-making processes. The Committee's functions are as follows: Promote and review the availability of the Framework and Model Operational Risk Management, policies that develop and follow its implementation and development in the Institution. Monitor the evolution of the operational risk profile through information provided by the established tools (loss database, self-assessment questionnaires, risk indicators, business environment, scenarios and metrics defined) as well as through other sources (customer claims, technological incidents, audit reports and supervisors, etc.) and check the evolution of the established metrics, raising, where necessary, appropriate alarms. Perform the monitoring of operational risk losses annual budgets. Review the main events of each period, determining if they fit into the categories of operational risk. In which case, analyze the causes and identify the controls set. Advise on issues appetite and tolerance for operational risk. Propose, approve or validate, as a result of the powers assigned, action plans, mitigation measures and monitoring plans and identified current controls. Recommend the beginning of thematic reviews on specific processes or sources of risk. Understand, assess and monitor the observations and recommendations made by supervisory authorities and by Internal Audit in relation to operational risk.

24 2017 RISK MANAGEMENT ANNUAL REPORT 23 Track changes and developments of the regulations related to operational risk, assess the issuance of comments by the Bank in this regard and further plans of action for its implementation. Contribute to the development and implementation of the culture of operational risk management in the organization, through training programs, meetings and other outreach initiatives. Monitor the implementation of programs and initiatives of a corporate nature and/or regulatory. Participate in the revision and issue the opinion of different versions of the plans, like the previous process to the presentation others committees if is the case, and the formal approval of the government. Assist the consultative committee regarding technical questions about the content plans Define steps to be taken along with a responsible in order to reduce the operational risk exposure for action drivers and issues identified by Operational Risk environment. Guarantee that the business continuity plans and procedures are developed and updated for Grupo Financiero Santander Mexico, as well as to ensure that the trials and drills as will be effective according to the corporate policy and local regulation, ensuring an effective response and continuity of the business in case any contingency will be presented. Committee of Capital The Capital Committee is responsible for the supervision, authorization and valuation of all aspects related to the capital and the solvency of the Institution. The functions of the Committee are the following: a) Supervise: The analysis of solvency and capital adequacy. Compliance with budgets, capital planning and stress test analysis. Monitoring of capital consumption, RORAC and EVA, of the institution and by businesses. Monitoring of all aspects related to the implementation of advanced models. Regarding capital management, the eventual decision to activate the Feasibility Plan in terms of solvency, as this is established corporately, as it will be responsible for submitting it to the CAIR. b) Authorize: Review and validation of capital planning and stress test exercises prior to their internal and corporate approval or presentation to the corresponding supervisory authority. Changes in capital models and methodologies, considered relevant for internal purposes, accompanied by the report of the independent validation area, previously presented in the Local and Corporate Models Committee for risks under the perimeter of competence of the General Risk Department. For the purposes of this framework, relevant changes are considered, those whose impact exceeds a threshold of 1% of the Group's capital consumption. Annually, all the changes made to capital models and methodology will be raised for consideration by CAIR. Identification of proposals. Capital objectives for the planning horizon contemplated in the Capital Self-Assessment Report.

25 2017 RISK MANAGEMENT ANNUAL REPORT 24 Optimization of capital consumption. Improvement of solvency ratios. Improvement of capital models and the integration of these in management. In terms of capital, this Committee coordinates the relationships with the supervisors and the flow of information (Capital, RORAC and EVA) to the market. 3.4 Management of Risk Information Risk management and control require high availability of hard data, ability to group and analyze these data as well as solid reporting procedures. The management of risk information in Banco Santander (Mexico) is governed by the following principles: a) Responsibility: The Board of Directors is ultimately responsible for ensuring the implementation of the framework for managing Risk Information. b) Technological Architecture: It has a technological architecture for each type of risk that ensures that risk information and baseline data provide answers to the general requirements established for the Institution and reporting risks. c) Reconciliation of risk data: The risk information is reconciled with the accounting data to ensure the accuracy of it, and, where appropriate, with other relevant sources that may exist. d) Data Availability: data are available ensuring an appropriate level of detail for certain users identified at all times through appropriate access credentials. The relevant users regarding risks have full access to risk data to ensure that they can be added, validate and reconcile properly with risk reports. e) Completeness and Exhaustiveness: Reports of risk management and aggregation criteria cover all material risks consistent with the risk map. f) Indicators of Data Quality: They are defined quality indicators covering aspects such as accuracy, integrity, completeness, tolerance and availability in both normal and stress situations. g) Data Quality Controls: There are controls over processes in order to ensure data quality at all levels. h) Promptness: The reports should be available in the manner and time established, taking into account the nature and volatility of the risk involved and the relevance of the report. i) Flexibility and adaptability: The risk management reports are prepared according to the needs of the organs and the key areas involved in risk management and monitoring. j) Forward-looking Approach and availability of documentation: The risk reports contain, where relevant, the likely path in the Bank's capital situation and risk profile thereof, and provide information on estimates and forecasts in different scenarios, analyzing and identifying stress levels and trends of emerging risks. k) Data analysis and Expert judgement: The reports are both descriptive and prescriptive and provide quantitative and qualitative data, including explanations, recommendations and conclusions. l) The above principles are developed through the implementation of various key processes in the Information of Risk Management: Data availability: The aim is to have a common infrastructure, accurate and reconciled on different variables to respond to multiple requests for information necessary. To do this, the information requirements are set; selected data needed to satisfy these requirements are identified; data source systems are extracted; the source data is transformed into the required data and data stored in repositories available for the exploitation and use thereof.

26 2017 RISK MANAGEMENT ANNUAL REPORT 25 Aggregation of Data: The aggregation process is driven by a particular data structure based on different criteria and rules that allow a precise and homogeneous grouping of data in order to generate different views of information, responding to needs analysis different users. Analysis and use of information: The data and risk information are available for use in a homogeneous, flexible and with sufficient granularity environment, also are easily understandable and accessible in a timely manner for use, analysis and distribution. The information is available for use in both the reporting and other requirements for the management processes and risk control. - Reporting and distribution to third parties: The process of reporting and distribution guarantees it is available to all relevant parties. That provision, its form and frequency depends on the relevance and materiality of informed risk and should be done on time and according to established schedules. The Committee of Information Management and Data Quality ensure adequate quality of the data and the processes needed for its availability, extraction, aggregation and analysis, and its main functions are: a. Promote the development of the documentation supporting the government data. b. Review and approve any significant changes in the process of government data. c. Approve the data quality objectives (criticality, indicators, tolerances, quality plans). d. Propose, approve and monitor all activities related to the identification, assessment and management of data quality and risk information and risk data aggregation. 3.5 Risk Appetite Risk appetite is the maximum level and type of risk the organization is willing to take, within its risk capacity to achieve its strategic objectives and the development of its business plan. The risk capacity is the maximum level and nature of risks that the company can assume without compromising its viability, determined by the level of sufficient resources (capital, liquidity, asset and liability management systems and capabilities) to develop the activity the entity to the demands of regulators, governments, shareholders, investors, customers, employees, suppliers and social community. The Risk Appetite Framework (RAF) is the set of instruments that articulate the risk appetite of the institution. The risk appetite is expressed, in general, aggregate and by type of risk, in Risk Appetite Statement (RAS). The RAS sets, using quantitative metrics and qualitative indicators, the criteria to be submitted to the Bank's risk exposure in both current conditions and under different future stressed scenarios. The criteria set by the RAS are taken into account and respected throughout the developing taken of the other elements that constitute the RAF, which are developed to the level of detail necessary, policies, limits and other criteria applicable in different lines of business and types of risk. The risk limits are all the quantitative and qualitative limitations that distribute and move the restrictions set in the RAS to the different business lines, specific categories of risk or any other relevant level of disaggregation. The risk appetite considered desirable risk profile of both the present,medium and long term. When analyzing the possible evolution of the risk profile, both considered the most likely circumstances as other unfavorable situations (stress scenarios). It incorporates quantitative metrics and qualitative indicators

27 2017 RISK MANAGEMENT ANNUAL REPORT 26 relating to key performance indicators, which are aggregated, understood by the entire organization and clearly reflect the reasons for taking or not taking risks in decision-making processes. Risk appetite is integrated into the management through a dual approach bottom-up and top-down: Top-Down Vision: The Board of Directors leads the fixing of risk appetite, ensuring its disintegration and translation of specific limits that are set at portfolio level, business unit or line. Bottom-Up Vision: the risk profile that contrasted with risk appetite is determined by the aggregation of measurements made at the portfolio level, unit or business line. The risk appetite of the entity arising from the consideration of the business objectives and their interaction with the potential risks to take and existing capabilities. The maximum management body, The Board of Directors, is responsible for determining and approving risk appetite; It promotes its articulation in the form of policies and limits to ensure its implementation, communication and monitoring. The Board of Directors and the Risk Management Authority, it is up to formulate the risk appetite of the entity, identifying its development elements and assign responsibilities for it, and perform periodic monitoring of the adequacy of the risk profile of the entity risk appetite defined. The Executive Risk Committee is responsible for ensuring the consistency of the actions of the Bank's risk appetite determined by the Board of Directors, and approves actions on the level of risk in light of the analysis and monitoring of risk appetite.

28 2017 RISK MANAGEMENT ANNUAL REPORT Credit Risk Management 4.1 Overview The credit risk arises from the possibility of losses derived from the total or partial failure to meet financial obligations to the institution by its clients or counterparties. The credit risk is caused by the possible failure to pay by the accredited both in lending operations that have involved a payment and those that do not involve any but whose performance is guaranteed by the Bank. Table 4A Causes of Credit Risk The credit risk is undoubtedly the most important risk in banking Possible Causes: Insolvency of accredited. Related-party transactions. Excessive concentration. Inadequate guarantees. Other causes. Segmentation from the point of view of credit risk management is based on the distinction between three types of customers: Individuals segment includes all natural person except for those with business people. Includes holdings of residential mortgage, credit card and non-revolving consumer portfolio. SME S, Companies and Institutions including legal entities and individuals with business activity. In addition to public sector entities and private sector entities nonprofit. Global Corporate Banking (GCB) is composed of corporate, financial and sovereign institutions, which make up a closed list reviewed annually. This list is determined by a thorough analysis of the company. The governance of the Credit Risk Management is a committee structure that are responsible, among other things, the following functions: The decisions on ratings, operations and risk limits, within the powers that have been granted by the bodies envisaged in the general framework of risk and credit risk and its monitoring. Validation and supervision of policies of credit portfolios. Validation and monitoring of annual plans portfolios. Monitoring the performance of exposures. These committees, in appropriate cases, will have representatives of the business functions and may delegate the functions they consider relevant in other organs, with the relevant regulations of these committees to establish the process of granting powers and duties of each of them, including qualitative and quantitative limits that define its scope and decision.

29 Presale Sale After-sales 2017 RISK MANAGEMENT ANNUAL REPORT Credit Risk Cycle The risk management process consists in identify, analyze, control and decide, where appropriate, the risks incurred by operations of Banco Santander (Mexico). During the process involves both business areas and senior management. Credit Risk through a cycle or life process, whose phases are valid for any operation, notwithstanding the important differences that can be seen in the cycles of the risks of different segments, specifically between Particular and Business. In the Credit Risk Cycle three phases differ: Presale, sale and after-sales. The process is constantly fed back incorporating the results and conclusions of the study phase to the sales risk and pre-planning. The following table lists the processes that take place in each of the mentioned phases. Study of risk and credit rating process Planning and setting limits Table 4B Credit Risk Cycle in the credit process Decision on operations Monitoring Measurement and Control Recovery management Risk Study In general, the risk assessment carry out in the analysis of the credit application consists to analyze the customer's payment capacity 6 to meet its contractual obligations with the Bank. This involves analyzing the credit quality thereof, its risk operations, solvency and profitability to obtain depending on the risk taken. The risk analyst assesses the credit quality of each customer through a rating/score of the customer and a valuation report associated with the rating/score that reflects those aspects that determine the score. The rating/score is the basic tool of risk management, and together with the associated evaluation reports are updated with a frequency that depends on the client's situation, at least once a year. All customers prior to the granting of a credit risk must be assigned an internal rating/score according to the rating model previously defined and authorized. The rating/score reflects the credit quality of a customer, and is built with both quantitative information (financial, external and internal, etc.) and qualitative (analyst expertise). This rating/score reflects the probability of customer default. 6 Includes confirmation that economic activity in the potential customer is not within the list of activities in which the Bank has decided not to establish business relationship (eg. trade and distribution of weapons, people whom deduct may be related whit criminal activities).

30 2017 RISK MANAGEMENT ANNUAL REPORT 29 To manage properly the credit risk must be reached a near vision to the client, both in quantitative and qualitative aspects, in order to meet their needs and anticipate risks that might affect the good end of the contracted operations. Customer allocation to a risk analyst has the primary goal that the analysts have an intimate knowledge of him. The ratings accorded to customers are regularly reviewed, at least once a year, incorporating new financial information and experience in the development of the banking relationship. The frequency of review is increased in the case of clients who reach certain levels in the automatic warning systems and in those classified as special monitoring. Similarly, the tools of rating are reviewed to be able to adjust the accuracy of the rating given 7. Against the use of ratings in the wholesale world and the rest of the companies and institutions, in particular the individuals segment dominated the scoring techniques, which almost always, automatically assigned a valuation of transactions that occur and have designed to identify the credit quality of customers, in addition to estimating the probability of default. This process is aided by origination tool for high-volume applications and seeks to discriminate in the best way possible to the good from the bad payers Planning and setting limits The commercial strategic planning is implemented through the Strategic Business Plan. This plan is the union of the business plan with the credit policy and the means required for their achievement on which the business budget is based and must be approved prior to the budget. The three elements are closely connected and feed each other: Business plan: set goals in exercise and specific action plan to be implemented to achieve the budget. Credit Policy: moved the risk appetite to each business line in the form of portfolio policies, policies for the granting, management and credit recovery and decision rules. Media Plan (infrastructure): lists the models, systems and resources required for the implementation of planned actions. The commercial and strategic planning should include safeguard, first of all, the principles established in the General Corporate Framework of Risks. It is also ruled by principles that are structured in the following categories: a) Principles of integration and consistency with other management tools. b) Principles concerning the scope of planning. c) Organizational and governance principles. Within the annual planning, the levels of risk the bank assumes limited in an efficient and comprehensive and budgets of each of the Bank's business are set out in terms of objectives and limits on portfolio level, within defined limits risk appetite and risk policies established, defining the scope of the entity's risk management, and media (models, resources, processes and systems) needed for the annual achievement of these objectives are set. 7 Banco Santander (Mexico) has an internal area of Risk Methodology, responsible for the development, review and calibration tools.

31 2017 RISK MANAGEMENT ANNUAL REPORT 30 The credit policies moved the risk appetite to each business line, setting the scope of the annual plan. The definition of the general, policies and portfolio approval policies, management and recovery of credit policies are the responsibility of the risk function, and its approval competence of the governing bodies established for the purpose of risk. The annual process of setting limits is a dynamic process that determines the willingness to take risks with each client. This limit is consistent with the budget, and with the risk appetite for which they have tools and/or processes that allow, among other things, define the limits (joint responsibility for the functions of risks and commercial), approving (according to the corporate governance and committee established) and control. The management limits are intended to avoid unexpected negative impacts on the income statement. Define the boundary of acceptable risk for the unit and its definition is not conditional on the budget for year. The indicators subject to define a limit, determinates an Alert threshold and a threshold Stop that are easily understood and measurable. At the wholesale level and other companies and institutions, an analysis is done at the client level. When certain features occur, the customer is the subject of establishing an individual limit (preclassification). The result of the pre-qualification is the highest level of risk that can be assumed with a customer or group of customers in terms of amount or period. In the corporate segment, a more simplified model for those customers who meet certain requirements (high knowledge, rating, among others) is used Decision on operations This process aims at the analysis and resolution of operations, approval risks being a prerequisite before any operation risk hiring, being the risk approval a prerequisite before hiring any risk operation. This process should take into account the defined policies of approval and take into account both risk appetite and those elements of the operation that are relevant to achieve the balance between risk and return. The staff of the business areas performing loans promotion does not participate the approval process. Also, it is strictly forbidden employees, officers and directors of the institution involved in approving loans in which they have or may have conflicts of interest. The decisions taken in the credit approval process should be duly documented in the minutes of the Committee session and/or official authority responsible for the decision, which must be jointly signed by the participating members. The loan approval is the responsibility of the Board, which delegated this function to the Committees. Credit Committees have as a priority that studied, discussed and appropriate decisions, allowing healthy growth and stability risks. In the area of smaller individuals and SME s it facilitates the management of large volumes of credit transactions with the use of automatic decision models that qualify binomial customer/operation. With them, the investment is organized into homogeneous risk groups from the classification that the model gives to the operation, according to the information on the characteristics of the operation and characteristics of the owner. In the Personal Risk assessment, analysis and approval it is done through an automatic decision model, which considers the assessment of minimum admission criteria, scores, limiting rules and calculation amount.

32 2017 RISK MANAGEMENT ANNUAL REPORT 31 In the field of business there are two types of decision: Automatic Decision, in which it is verified by the business area if the proposed transaction has no place (in sum, product, term and other conditions) within the limits allowed under the prequalification. Decision requires authorization from the analyst, although fit in amount, term and other conditions in the pre-settlement limits. This process applies to retail banking preclassification. In GCB, the management of the operations attends a global relation model using global systems for the production of the rating and the pre classifications of the clients; the operations authorization decisions are submitted to the local and global Credit Committees. The authorization of the pre classifications of the clients is delegated to the Global Account Officer (GAO's) for the administration of the credit limits in its different products. Although they are relevant in all phases of credit risk in the decision on operations plays an especially important role considering mitigation techniques. It is important to point out that in addition within the institution, is a continuous monitoring of the models of decision on operations, with the aim of ensuring that systems remain effective and robust. The aspects discussed in the follow-up to decision models are: Stability. Effect of changes in the composition of the target population as a result of commercial actions, adding new customers and current characteristics variation. Performance. Evaluation of the ability of the model of decision to discriminate between different risk profiles and predict its evolution. The findings of the follow-up decision models lead to actions whose main objective is to improve the quality of the final resolutions, through amendments to the decision models and improvements to the capture and quality of information Monitoring After the admissions process and decision, once the risk is incorporated in the portfolio, it is necessary to conduct a continuous process of risk assessment undertaken in order to anticipate situations of risk and possible deterioration of the measures and preventive and corrective actions. The risk monitoring allows evaluate the development of all the elements that can affect the quality of the risks contracted operations or in the effectiveness of the instruments and mechanisms used in risk management. The monitoring is based on customer segmentation and performed by risk teams, complemented by the work of internal audit. The function is specified in the identification and monitoring of special surveillance firms, regular reviews of credit ratings and scores initially assigned to customers, in addition to the continuous monitoring of indicators and metrics. The continuous monitoring aims the proactive and preventive advance through periodic review of all customers over the predefined actions associated with each situation and its implementation, in a shared manner between the business and risks functions. The system named companies in special surveillance (FEVE) distinguishes different degrees depending on the level of concern of the circumstances observed (extinguish, secure, reduce and follow). Including a FEVE position does not mean have been defaults, but the advisability of adopting a specific

33 2017 RISK MANAGEMENT ANNUAL REPORT 32 policy with it. Customers classified as FEVE are reviewed at least every six months or quarterly for more serious degrees. The revision of the allocated ratings is performed at least once a year, but if weaknesses are detected are performed more regularly. For risks of individuals and SME s of lower turnover, a monitor of key indicator is conducted in order to detect deviations in the behavior of the loan portfolio with respect to the forecasts made in the Strategic Business Plan. The process of managing customer base of the perimeters companies, SMEs and individuals can observe the portfolio from a global perspective to analyze the observed deviations from planning and risk factors, and project its impact on portfolio performance regarding the expectations about it and establishing action plans. The primarily responsible for the portfolio executive process is the portfolio manager of each of the segments. Within the portfolio management it has been identified the Commercial Strategic Plan as a key tool. This Plan is the conjunction of the business plan; credit policy and the means required for their achievement and consist in a policy-based management and strategic planning. This monitoring process through the Bank s Plan ensures that policies referred to therein are met, the business goals (budget) and recovery strategies. If significant deviations occur, the necessary measures are taken to bring them back. The portfolio management is a continuous process analysis in order to collect common elements of the environment and portfolio, and if necessary, modify the policy. Projective metrics and scenarios are used, analyzing deviations from planning and identifying sources of concern. Anticipation is the key element along the analysis of risks and possible impacts on profitability. The anticipation is focused on the identification of potential deterioration of the risk profile, adverse situations or business opportunities. Within portfolio monitoring, the portfolio manager carries out a follow up the evolution of the macroeconomic environment and the political and economics one of the country. Likewise, also it analyzes the commercial processing and risk (strategies, prices and offers, among others) of the competitors. On the other hand, performs the simulation of adverse scenarios. These scenarios are often historical or hypothetical, built based on regulatory and management information, for which projected risk parameters are calculated. This analysis of the environment and the market is performed in order to assess the financial situation of the entity under different circumstances; ensure that planning and strategies defined in the entity take into account the market situation; detecting whether the strategies defined are suited to the current macroeconomic conditions and establish the necessary preventive measures adapted where necessary to specific sectors. The portfolio manager, as appropriate, restates the definition of new strategies or adapts existing strategies. Another phase of portfolio monitoring is to analyze the portfolio in terms of both structure and indicators. The portfolio manager performs this analysis. To do this, evaluates the structure of the portfolio using different criteria (concentrations of term, of risk per customer in the case of companies- and sectorial, inter alia).

34 2017 RISK MANAGEMENT ANNUAL REPORT Measurement and Control In addition to monitoring the creditworthiness of customers, Banco Santander (Mexico) established control procedures necessary to analyze the current portfolio credit risk and its evolution through the various stages of Credit Risk. The function is developed evaluating the risks from different perspectives, establishing as the main elements control by geographical area, business areas, management models, products, etc. facilitating early detection of outbreaks of specific attention, and the development of action plans to correct any damage. Moreover, there is in this process a periodic review of risk limits, which are approved and reviewed at least once a year, unless significant changes occur in the economic environment and/or in the company and/or with the individual, or when required by the highest management body, it is promoted by the responsible for controlling these risks function or any function involved in the management of these limits (business function or risk). Each control shaft supports two types of analysis: Quantitative and Qualitative Analysis of the Portfolio The evolution of risk is controlled permanently and systematically regarding to budgets, limits and standards of reference, evaluating the effects to both exogenous future situations such as those arising from strategic decisions, in order to establish measures that put the profile and volume the risk portfolio within the parameters set. Assessing the control processes Includes the systematic and periodic review of the procedures and methodology developed through the entire cycle of credit risk, to ensure its effectiveness and validity. The existence and policy compliance is verified and they allow the execution of business plans defined under the established risk appetite. The Internal Audit is responsible for ensuring that the policies, methods and procedures are adequate, effectively implemented and reviewed regularly. It is verified that the methods, actions, and means related risk management is adequate, applied and perform their function efficiently within the expected standards Recovery Management The Credit Risk manifests after the granting of credit under a double circumstance: a) Default on the operation, as an objective and early sign of its possible future and final accident rates. b) Insolvency of the holder, observable by the change in his financial position and/or the appearance of signs on his credit behavior in public databases. The process of recovery management includes those activities designed to mitigate the consequences of loss events, both before they (management of irregularity or early default) occur as after such events occur (recovery of bad debts and foreclosed assets management). Recovery management through its focus on preventive management is linked to monitoring processes, to anticipate the event of default and taking with it the most corrective measures appropriate to each situation.

35 2017 RISK MANAGEMENT ANNUAL REPORT 34 Areas of recoveries are business areas and direct customer management, whose its creation of value is based on the effective and efficient management of the collection, either by regularizing outstanding balances or total recovery. It requires proper coordination of all areas of management and is subject to ongoing review and continuous improvement of processes and management methodology that underpin. A proper recovery management act in four main phases: early irregularity or default, recovery of bad debts, default recovery and management of foreclosed assets. The scope of this function begins even before the first default, when the client shows signs of deterioration and ends when the same debt has been paid or regularized. The recovery function aims to advance the event of default and focuses on preventive management. The recovery activity is structured based on the following four pillars or elements: Policy of risks recoveries. Strategies of Management. Implementation and monitoring of the business. Control and monitoring of integrated business risk. Recovery management is subject to political control and an environment defined by the risk function. As business activity, recovery management policies are subject to an environment defined by the risk function. Are particularly applicable risk policies that rules the key recovery management strategies (remove, nonrecourse, sales, portfolio and reconductions) or those that rules customer recovery management at different stages, depending on the status of their payments (irregular, doubtful or failed). Apart from measures aimed at adapting operations to the customer's payment capacity, deserves special mention recovery management, where alternatives to law for early payment of debt are sought. The main forms of recovery are presented: Cash collection: It should always be the first option for recovery. The regularization of debt by charging involves the total or partial cancellation of debt. Reconducting or Restructuring: These are the operations that due to financial difficulties of the customer, current or expected to meet their payment obligations to the Group in the contractual terms in force it is necessary to modify, cancel and/or formalizing a new operation with assumable conditions of the client. Reductions or Write-Offs: They are a finalist loan recovery strategy consisting of an agreement between the company and the customer, whereby the customer is exempt from payment of the amounts for interest, ordinary or remunerative and/or equity or principal. Usually performed in Exchange for the cancellation of the rest of the debt, thus giving a definitive solution to the issue in management, either, as according to term, offering the customer a reorganization of their payments with the entity so that allow or encourage meet their payment commitments. Nonrecourse: is the act of cancellation of all or part of the debtor's obligation to the entity by providing certain goods or rights other than those due as a result of a bilateral agreement. It is a strategy that arises when the client has a capacity of very impaired or no payment. Portfolio/Credit Sale: these are the transactions which are transferred by or transmitted to a third party (buyer) certain loans to the entity or entities of the Group have towards their customers, or cash flows of certain receivables that the entity has against its customers, for a specified price.

36 2017 RISK MANAGEMENT ANNUAL REPORT 35 Allocation: is consistently acted in the cancellation of the debtor's obligation to the entity, in whole or in part, by providing certain goods or rights other than those due as a result of a court ruling. While these strategies are defined by the function of recoveries, running at all times under the provisions of the respective policies regulating risk. 4.3 Risk mitigation techniques The credit risk is mitigated in general terms through the use of guarantees. A guarantee is defined as a measure of reinforcement added to a credit operation in order to mitigate the loss by failure to pay. The guarantee is an element for mitigating the severity of the operation in case of default. Its purpose is to reduce the final operating loss, among other cases, where the long-term operation increases the risk of damage to the customer or because of possible and relevant external events that could jeopardize the success of the operation and are hardly manageable by creditor. The guarantees accepted by the institution are classified: Personal Guarantees: Gives the creditor a right of personal nature or ability that targets the own assets of the guarantor. This kind of security will be provided by parties other than the debtor, and in the credit agreement itself or in a separate contract (reliable firm and credit derivatives). Real Guarantees: Those that are constituted on real assets (equipment or real state) or specific and certain rights. These are rights that secure the creditor the performance of the principal obligation through a special link of an asset. Because of this special relationship, in case of default of the secured obligation, the creditor can realize the economic value of the asset through a procedure regulated and charged with the proceeds being opposable preference in the collection in this way against other creditors. Admission and management of securities shall be governed in any case under the following criteria: a. Express, subsidiary, accessory and essential character of the securities The constitution of securities in contracts must be express, trying to set a clear and precise legal nature and scope. The guarantee is subsidiary because the creditor takes with it the right to demand payment, both the debtor and the guarantor, but the claim to it is subordinate to the former does not comply. The security is ancillary because it presupposes the existence of a valid principal obligation and current call. If he dies, the guarantee disappears. The admission of any operation is based on the debtor's ability to pay and in the economic sense of the operation; however, the guarantee is an essential element in reducing the cost of funds to the client. To the extent that the provision of guarantee reduces the eventual loss of all operations, facilitate access to financing on terms more favorable.

37 2017 RISK MANAGEMENT ANNUAL REPORT 36 b. Careful and Expert Assessment The valuation of the guarantees must use conservative criteria and suitable for the time horizon of the secured transaction and realized with processes that minimize the risk of valuation of them. The assessment should always be made in view of the purpose of the operation, according to objective criteria of truth and transparency, and respecting the rules that will result from implementing and caring for their formal and structural aspects. The time value of the security offered and its possible change in the nature or value risk reduction, amortization or disappearance, should be appropriate to the maturity and payment flows of the main transaction. In Table 4C key elements required for the valuation of securities are presented. Table 4C: Elements required for the valuation of the securities Real Estate Guarantees: They must be valued by an independent third party to the operation 8, with specific expertise in this subject, ensuring that assessments meet the legal requirements that exist in this regard, and they must contain: The legal purpose of the valuation and the valuation method used Registration of property ownership and characteristics of the guarantee. Load situation, reservations, liens, and limitations of domain. This reference is essential in assessing, for the property or rights where an organized and sufficiently liquid market exists. For those who are considered unusual by its nature, an independent evaluation by a third specialist with proven experience and credibility in the sector must be obtained that the case. Personal Guarantees: The updated documentation of guarantors that allows quantify its financial solvency is collected. In any case, joint obligors, guarantors or sureties should be equally valued by the current system of internal risk assessment according to their characteristics. c. Valuation Update The value of securities could be subject to significant changes over the life of credit operations. The proper management of guarantees requires full registration in the systems of the institution, allowing: Conduct joint evaluations of portfolios subject to certain guarantees, either to changes in actual market data or to possible future scenarios. Identify operations associated with certain safeguards and, where appropriate, implement concrete actions on them. Run processes of assessment indexes or other formulas that identify operations that exceed certain levels of alert. 8 Banco Santander (Mexico) has an internal area of Technical Evaluation of Real Estate Projects in charge of the valuation of real estate securities for commercial loans.

38 2017 RISK MANAGEMENT ANNUAL REPORT 37 d. Correct instrumentation of securities The correct implementation of the operation that gave rise to the guarantee is necessary and indispensable premise for its existence, so that all are extreme care to ensure that the guarantee is valid and fully effective. e. Cautions on the conservation and availability of security Guarantees can change its value by market conditions, but can also undergo significant changes in value for its own preservation. Therefore, it is essential to observe certain criteria about. In the case of security, the client must be agreed with the subscription of compulsory insurance to ensure the reinstatement of the asset value to events that could cause its impairment. In the case of security interests, to the extent that the business permits without altering its normal operation, must be deposited the guarantee in the bank itself or held by an independent third party, establishing safeguards that will strengthen the duties of conservation and maintenance of the item. f. Capacity of Execution and Clearing of Guarantee The possibility and feasibility of execution of the guarantee and their settlement should be considered. Among the aspects to be evaluated are: The full title of the total ownership of the domain is an essential element in the ability to liquidate the security in case of need. The order of priority in the implementation of the guarantee. The existence of prior rights on the guarantee prevents its correct valuation. The existence of a deep and liquid market where redeem the guarantee. Be careful with the securities on shares of companies whose law precludes negotiation or not quoted on organized markets. The feasibility and settlement in the case of special projects, where the guarantees on rights related to the project itself are subject to its feasibility. g. Security Blocking Blocking the guarantee involves limiting the right to dispose of assets or rights pledged as collateral security by the guarantor. The policy is limit or block the availability on the security, with greater emphasis on anything that may be subject to fraud. Therefore, unless authorized should: In the case of financial stocks, mark the values pertaining to the guarantee in the entity or released to the depository institution. In the case of property or rights on which there is a public record, make the appropriate entry or retention of title in the register against third parties. In the case of third party depositary of good, ensures the communication and decision by the third party in right of preemption on the goods provided as security, its duty of care and maintenance that affect them. In the case of financial assets, pledges and trusts are prior to the availability of resources, and in the case of mortgages may be delayed up to an average of 6 months, as recorded in the Public Registry of Property. h. Amendment of the Guarantee If at the request of the company or customer, the ability to modify the guarantee arises, the request is handled as a new guaranty claim and must be authorized by the committee with authority to do so.

39 2017 RISK MANAGEMENT ANNUAL REPORT 38 i. Execution of the Guarantee The failure of the secured obligation gives the entity the possibility of requiring the execution of the guarantee in accordance with the agreement in the contract. j. Extinction of the Guarantee The guarantee is void for the reasons specified in the instruments to which it is formalized, and the legally established causes. Generally, these causes are: By the extinction of the principal obligation for pay, compensation, confusion, forgiveness or other institutions that apply in each legislation. For the loss or destruction of the property contributed as guarantee. The course of the security period, regardless of subsisting or not an obligation or guaranteed. In the calculation of the regulatory capital, the mitigation techniques of the credit risk impacts on the value of the risk parameters and thus in the capital, distinguished by type of guarantees, including secured and personal. Personal guarantees impact on the value of the probability of default (PD) by replacing the PD of the counterparty to the transaction by the PD of the guarantor or credit derivative counterparty. When internal methodologies used, securities impact on the value of the loss given default (LGD). Mitigation consist in to associate to the operation guaranteed a specific LGD according to their security, taking into account also other factors such as the type of product, the balance of the operation and others. In the case of mortgages, the LGD of the operation will depend on the Loan to Value (LTV), plus the time that the operation carried on the balance sheet of the bank. If eligible financial guarantee, LGD zero is assigned to the part of the exposure covered by the security value after applying a regulatory haircut.

40 2017 RISK MANAGEMENT ANNUAL REPORT 39 Table 4D Loan portfolio covered by guarantees 9 Financial collateral 39,481 65,034 Non financial collateral 47,301 40,397 Total guarantees 86, ,431 Portfolio coverd with guarantees 59,593 63,815 Total loan portfolio 223, ,947 * It does not include loans to government agencies, parastatals, and productive state enterprises. Financial collateral 19,458 26,840 Non financial collateral 110, ,409 Total guarantees 129, ,249 Portfolio coverd with guarantees 63,944 62,524 Total loan portfolio 102, ,683 * It does not include loans to government agencies, parastatals, and productive state enterprises and comercial. Companies with annual sales equal or greater than 14 millions of UDIS* millions of pesos Concept Sep-17 Dec-17 Companies with annual sales of less than 14 millions of UDIS* millions of pesos Concept Sep-17 Dec-17 States and municipalities loans millions of pesos Concept Sep-17 Dec-17 Non financial collateral 18,999 28,468 Total guarantees 18,999 28,468 Portfolio coverd with guarantees 19,693 27,089 Total loan portfolio 20,350 27,968 9 Guarantee data used for the calculation of reserves.

41 2017 RISK MANAGEMENT ANNUAL REPORT Methodologies for calculating Reserves for Credit Risk Regulatory Framework In accordance with the provisions of the CUB to calculate the reserves for credit risk, institutions may use: a) The Standard Method by which the institutions in order to determine their reserves for the credit risk, must use the parameters and formulas established in the regulation to determine the probability of default (PD), the LGD AND Exposure at Default (EAD). b) Any of the Methods Based on Internal Ratings, foundation or advanced, provided they obtain prior authorization from the CNBV. Consumer Credit Portfolio, Mortgage Portfolio and Commercial Portfolio, the Internal Methodology with Advanced Approach (AIRB), according to the institutions will obtain the allowances using their own estimates of PD, LGD, y EAD. For Commercial Portfolio, the institution may use the Internal Methodology with Foundation Approach (FIRB), according to the allowances using their own estimates of PD for each borrower and using the LGD and EAD settled in the regulation Portfolios authorized to Banco Santander (Mexico) for the use of Internal Methodologies for the Calculation of Reserves for Credit Risk Since 2012, the CNBV authorized Banco Santander (Mexico) to use Internal Methodologies with Foundation Approach (FIRB) for calculating credit reserves and minimum capital 10 requirements for portfolios of Global Corporate Banking Firms and Banks and Financial Institutions. In October 2015, the CNBV authorized Banco Santander (Mexico) to use Internal Methodologies with Advanced Approach (AIRB) for calculating credit reserves and minimum capital 11 for Corporate and Real Estate Developers. Table 4E Internal Methodologies Outstanding at December 31, 2016 Foundation Approach Business Global Corporate Banking Banks Financial Institutions Advanced Approach Corporate Promoters Real Estate 10 The Chapter about Capital detailed the use of internal methodologies (FIRB) for the calculation of capital requirement for credit risk. 11 The Chapter about Capital detailed the use of internal methodologies (AIRB) for the calculation of capital requirement for credit risk.

42 2017 RISK MANAGEMENT ANNUAL REPORT 41 Business Global Corporate Banking (GCB). This portfolio segment consists of a closed list of companies and groups that is reviewed annually. This list is determined by a thorough analysis of the company (business, countries in which it operates, product types used and more). Banks Financial Institutions. They are all customers whose current exhibition, more lines or requested risks of the commercial portfolio by firm or economic group, exceed 8 million pesos. Corporate 12. They are all customers whose current exhibition, more lines or requested risks of the commercial portfolio by firm or economic group, exceed 8 million pesos. Exceptionally, individualized management are considered those that do not exceed 8 million pesos according to the above criteria, but that potential and foreseeable reach it in a maximum period of one year. Among the types of companies to find within this segment, the following customers are recognized: Juridical Persons and Natural Persons with business activity, including Agribusiness. Corporations that are not included in the Global Corporate Banking. Natural Persons who are shareholders or directors of the entities individualized or customers of Private Banking. Real Estate Companies (Property Developers) It comprising the operations financed construction projects for further promotion (vertical and horizontal housing, shopping malls, hotels, offices and more). It is important to note that, generally, the Bank's financing in this sector often have the mortgage to finance property, to win, therefore, especial importance the proper valuation of property and its tracking, because usually that property will own income generator intended for credit repayment, being, also, secondary source of repayment in the event of having to enforce the security. Natural Persons and Juridical Persons comprise the domestic segment of Real Estate Companies with business activity whose core activity is a source of Real Estate Risk (The credit risk which arises in lending transactions is maintained with clients whose main business is real estate activity). The real estate sector is a very broad activity that includes many activities and sub activities. In this sense, the different types of property risk identified in the institution are: Property Development: Development and construction of buildings/properties for resale, usually housing/residential but also other commercial uses (premises, offices, other). Properties that Produce Income: The construction or purchase of a property is financed by a loan whose repayment source consists in renting of the offices, premises or housing spaces. In the case of financing the purchase of a property already constructed it is normal that the rents are already in force. Others Minority Risks of Property: Included in this section all those real estate risks of different types to those detailed in the above and for which no study or specific referred 12 For Corporates, since 2012, the CNBV authorized Banco Santander to use models based in internal ratings by the Foundation Approach. Then, in October 2015, the CNBV authorized the use of an Internal Model with Advanced Approach.

43 2017 RISK MANAGEMENT ANNUAL REPORT 42 is necessary for being minority risks in the portfolios of the Retail Banking Industrialized Risk. While behind these businesses are real estate assets, it is usually business whose analysis for other types of expertise are required. Table 4F Gross exposures acordding to rating methodology December 2017 millions of pesos Loan Types Internal Methodology Standard Foundation Advance Method Approach Approach Total States and Munucipalities 27, ,968 Financial Institutions 13,181 2, ,551 Companies with annual Sales equal or greater than 14 millions of UDIS* 11,963 72, , ,947 Companies with annual sales of less than 14 millions of UDIS 84,343 4,654 14, ,683 Project Finance 20, ,047 Residential Mortgage 130, ,492 Non - revolving Consumer 52, ,492 Credit Card 54, ,372 Subtotal 394,858 79, , ,552 Interest Collected in Advance Financial Burder Leasing Operations Total 394,858 79, , ,870 * The information of companies loans includes loans to government agencies, parastatals, and productive state enterprises Principles of valuation system authorized for internal models applied in Banco Santander (Mexico) The valuation system of Banco Santander (Mexico) quantifies the probability of default of each counterparty (company or group) and is the basic tool of risk management of the Bank and its main objectives are: a) Report any risk decision (approval of limits and operations, risk policies, and monitoring of customer, among other). b) Estimate the fair price for each operation. c) Determine the reserves and equity consumption for each operation (in the case of approval of internal models). The resulting valuation calculates the probability of default, defined as arrears in the next 12 months. There is a one to one correspondence between rating and probability of default. Table 4G Characteristics of Valuation System of Banco Santander (Mexico) Predictive: It is a reflection on the probability of default (PD) of analyzed customer. Includes all the quantitative and qualitative aspects that PD defines. Homogeneous: Analysts use the same criteria wherever they are. It has a definite style used by all. Specific: It caters for the specificities of each company, mainly its sector, country, environment.

44 2017 RISK MANAGEMENT ANNUAL REPORT 43 Validated: It is officially accepted by regulators, internal and external audits, rating agencies. Efficient: The effort is proportional to the benefit received. Relevant: It provides useful information for decision-making. It addresses the most relevant points for each company from the point of view of risks. Among the general principles of the institution valuation system, are: a. Sectoral Approach: Industry knowledge is critical as much of the value of a company depends on its sector. The sector risk is a reference of the maximum value that can suck a company in this sector. b. Forward-Looking Approach: It is to measure the probability of default in the future. It required analyzing and assessing the perspectives of both the industry and the company. c. Comparable: Assessment must always be justified in comparison to other companies within and across sectors, domestic and abroad. d. Consistency in the Cycle: The assessment should be consistent throughout an economic cycle. It must take into account the current situation of the company, as the expectation of cycle change. e. Quantitative Approach: Each of the above must be accompanied by metrics and quantitative information regarding the client's financial statements, the economic sector. Competition and other macroeconomic variables. f. Knowledge-based Opinion: Valuation should therefore reflect the opinion of the Analyst Risk on the creditworthiness of the company, for which it will rely on the analysis of the company and its knowledge of the sector, the economic environment of the company, the financial characteristics business and possible uncertainties about its future performance Main Characteristic of Internal Methodologies with Foundation Approach Authorized by the CNBV to Banco Santander (Mexico) Since 2012, the CNBV authorized Banco Santander (Mexico) to use models based in internal ratings by the Foundation Approach in order to calculate loan loss reserves and capital requirements for credit risk of the following credit portfolios 13 : a. Business Global Corporate Banking (GCB). b. Banks Financial Institutions. 13 For Corporates, since 2012, the CNBV authorized Banco Santander to use models based in internal ratings by the Foundation Approach. Then, in October 2015, the CNBV authorized the use of an Internal Model with Advanced Approach

45 2017 RISK MANAGEMENT ANNUAL REPORT 44 The Internal Methodology with Foundation Approach is based on determining the probability of default by rating process that includes a quantitative or statistical module based on the financial reasons information of the customer (company in the case of GCB and the bank in case of the financial intermediation institutions (FII's bank)) and a qualitative or expert module, based on the opinion of the analyst, who rate the model variables according to their experience and according to the expert and financial analysis of the entity. The rating assignment process is schematically summarized as: Table 4H General Outline Rating The rating thus obtained is called rating adjusted or final rating, in the event that no further required adjustments (special cases holding company or support required external). Quantitative module is a linear regression transformed model whose variables are made for financial reasons. The list of financial ratios used in the model was proposed by analysts for admission of risks that based on his experience in analyzing counterparts, choose those they consider the most significant in predicting the probability of bankruptcy. The quantitative module is calibrated based on the market price of credit derivatives or credit default swaps. The probability of default implied premium quoted by the market is extracted and also builds a model relating said probability of default to customer balance information, so that from this information can obtain the probability of default even without liquid entities trading on these instruments. The main elements of the model are included in table s 4I y 4J. Table 4I Types of Financial Ratios Included in the Statistical Model GCB Resources Generation Size Profitability Solvency Liquidity FII s Banks Asset Quality Capitalization Transactions Liquidity

46 2017 RISK MANAGEMENT ANNUAL REPORT 45 After obtaining statistical rating, the analyst takes this information as a reference, but reviewed and adjusted to obtain the final rating, which is thus markedly expert. Sometimes also adjusts ratings in cases where the valued customer belongs to a group that receive explicit support. Table 4J Valuation Areas For Qualitative Model GCB Market Management Access to Credit Profitability Resources Generation Solvency FII s Banks Asset Quality Management/Regulation Reputational The ratings accorded to customers are regularly reviewed to incorporate new financial information available. The timing of the reviews increases when certain automatic warning systems are activated. Likewise, also reviewed the rating tools to go adjusting the accuracy of the rating given. Thus the calculation of the probability of default by the borrower meets all regulatory requirements, among which are: Use of information and techniques that consider the long-term experience in estimating the average PD in each classification. Allocations used not only expert judgment. Banco Santander (Mexico) executes a series of internal controls in order to ensure consistency of the concession process, the reliability of the data used, and in any case the proper management and control of the risks of all exposures. Conducting risk processes ensures that each step is done properly, data operations and market positions used are correct and that the generated data and information risk are reliable Main Characteristic of Internal Methodologies with Advanced Approach Authorized by the CNBV to Banco Santander In October 2015, the CNBV authorized Banco Santander to use models based in Internal rating in order to calculate the minimum capital requirements for credit risk by the advanced method (AIRB), as well as determine the allowance for credit risk of exposures to: a) Corporate. b) Real Estate Companies (Property Developers). The determination of the probability of default by determining rating is based on an automated module that collects the first intervention of the analyst and that may or may not be supplemented later. The automatic model determines the rating in two phases, a quantitative and a qualitative based on a corrective questionnaire, which enables the analyst to modify the automatic scoring by a limited number of rating points.

47 2017 RISK MANAGEMENT ANNUAL REPORT 46 The automatic evaluation is obtained from a multivariate linear regression model whose variables are composed of financial ratios and credit bureau data 14, plus the answers of a closed questionnaire, which the Analyst performs. The variables used were previously identified as the most predictive power failure capacity of a company. Automatic assessment provides a global credit rating ("rating") for the company, collecting thus quantitative and qualitative aspects. The algorithm for obtaining this score is made as the sum of the product of the score and the percentage weighting assigned to each of these areas. This is a client portfolio manager with sufficient experience and associated internal defaults; the estimate is based on that inner experience of the institution. The PD is calculated by observing the entries in delinquency of the portfolios and putting those entries in relation to the rating assigned to customers. The matrix of qualitative information that analyst rate, consists in a questionnaire with different areas of valuation: Product and Market. Profitability. Solvency Administration. Access to credit. When real estate companies are a special purpose vehicle (SPV) and concentrated real risk, there two types of slightly different rating models applied to automatic Rating Model described in previous paragraph. Rating SPV Model of Recent Creation Applies to property risk operations for which financing is provided a SPV. This is a project planning or construction stage where the repayment of the operation rests solely on the future cash flows to be generated by the real estate asset that guarantees the operation or lack of income. A manual model whose rating is obtained as a result of the analysis and rating of three areas of valuation, subjectively evaluated by each analyst of the Project: Product/demand/market; access to credit and professionalism of managers. Rating SPV Model Underway It is isolated projects where repayment of the operation rests solely on the cash flows generated by the property assets that guarantee the operation already in operation or operating stage and generate recurring income (at least one full year). A manual and expert model based on the knowledge and experience of the construction credit analyst is applied, with the main objective to establish the ability of the project/company to meet the payment obligations with the bank through the funds generated by the project. Rating assessment is done through six valuation areas: product/demand/market; management; access to credit; cost effectiveness; resource generation and solvency. Within the Internal Methodology with Advanced Approach, calculating LGD meets the following requirements: Calculate based on the internal experience of recovery flows in breach contracts. Be adjusted to the worst moment in the cycle, so it is considered as a severe downturn 14 Incorporate Credit Bureau data, gives the model a higher discriminating power and greater robustness, to include other aspects that are not collected, or do so with lower sensitivity, in purely financial information.

48 2017 RISK MANAGEMENT ANNUAL REPORT 47 Be consistent with the definition of default given by Basel and the CNBV. Comply with the requirements established by the CUB from the CNBV to reflect the severity of the loss, considering the unfavorable economic conditions 15. In this sense, the LGD is defined, as the expected percentage loss of such an operation would have for breach. The estimated LGD is, therefore, the expectation of the random variable percentage loss given default. The calculation is based on observing the recovery process credit operations and takes into consideration not only the accounting records of income and expenses associated with the recovery process, but also the time when these occur, to calculate their present value, and indirect costs associated with this process. To estimate LGD is used the recovery movements, expenses and nonrecourse or awards observed from the operations that have entered into a state of "default" within the observation period. The Recovery Unit is responsible for integrating information related to recovery flows of records that have fallen into arrears after it enters in default until the end of the recovery process marked by the normalization of the contract or the settlement thereof. The process involves discounting all flows of recovery to date when the breach occurred; the loss observed for each operation in default is defined by the following variables: Amount in debt at the time of default. Date default. Flows of recovery. Flow of expenditure incurred in recovery. Flow derived from nonrecourse in payment or award. The LGD finally assigned to each operation must be compatible with the requirements of the CUB, in the sense of reflecting the severity of loss given unfavorable economic conditions. This means that the expected loss should be conditional on the worst moments of the cycle in order to calculate a "downturn LGD" which will eventually be used for purposes of calculating regulatory principal. Calculating a "long-run LGD" or LGD cyclically adjusted, which is used for calculating economic capital and loss reserves estimation also it is included. In Banco Santander México most of credit contracts contain a Clause of Denunciation or Restriction of Contract that establishes "the Accredited is appropriate that the Bank remains authorized to restrict the amount of the credit or the term to use the same one, or both simultaneously, as well as to denounce the contract in any time, using simple communication in writing directed the Accredited, staying consequently, limited or extinguished as it is the case, the right of this to use the amount undrawn". This faculty of the Bank is realized in conformity by the established in the article 294 of the Ley de Títulos y Operaciones de crédito. For Corporates, Real-estate Companies and States, Municipal Governments and Public Organisms, Banco Santander México possesses an immaterial percentage of committed irrevocable credit lines. 15 For calculating loss reserves a Long Run LGD (average economic cycle referred to in the estimate) is applied while the capital requirement for the use LGD Downturn (estimate considering the worst moment of the economic cycle referred to in the estimation).

49 2017 RISK MANAGEMENT ANNUAL REPORT 48 In not retail portfolio only possesses available balances of credit assessed for some accredited in the portfolios of Financing Specializes and Global Corporate Banking being the latter considered for the Internal Methodology with Foundation Approach and others for Corporate and Real estate developers for the Internal Methodology with Advanced Approach. On not having possessed available balance material assessed in credit operations, the application of Credit Conversion Factor (CCF) corresponding to the Methodology by Foundation Approach of the Agreement of Basel will be considered. For the rest of the contingent off-balance sheet items, other than unused credit lines such as: financial guarantees, commercial guarantees, documentary credits, etc., conversion factors (CCF) established in the regulation apply Control of internal rating systems Banco Santander (Mexico) internal validation covers all model used in the risk function. The scope of validation includes not only the theoretical and methodological aspects, but also, technological systems and the quality of the data that enable and where their effective functioning is based and, in general, all relevant aspects of management (controls, reporting, uses, involvement of senior management, other). The result of the validation of the quality of a model is summarized in a final risk rating indicates the model according to the following scale: 1. Low: The behavior of the model and its use is appropriate. The quality of the information used in the development is good. The methodology used complies with the standards and best practices defined. Documentation, processes and regulations in relation to the model is clear and complete. Any deficiency is of little relevance and does not affect the performance of the model. 2. Moderate-Low: The behavior of the model and its use is appropriate. The assumptions considered in the development of the model are reasonable. There are areas for improvement, but they are not keys or relevant. Do not expect any problems in the implementation and use of the model. Changes in the model should be considered if the benefits outweigh the cost of change. 3. Moderate: The behavior of the model and its use is appropriate. The assumptions considered in the development of the model are reasonable. There are areas for improvement in the model. Corrections of deficiencies must be made in the medium term or must analyze the cost benefit changes. 4. Moderate-High: There are deficiencies in the model behavior or use. The assumptions of the model, the qualities of the sample information or predictions development thereof are questionable. Prior to the implementation or use of the model is highly recommended that some deficiencies are planned or remedied for its correction in the short term. Others alternatives in the development to mitigate risk model should be considered. 5. High: The behavior of the model is not suitable, and it is not being used for the purpose for which it was developed or model assumptions are incorrect. Some aspects need to be corrected immediately. It is recommended not to implement or use the model as it has been presented.

50 2017 RISK MANAGEMENT ANNUAL REPORT Counterparty Risk Within the set of credit risk, there is a concept, which, by its peculiarity, requires specialized management: Counterparty Risk. The counterparty risk of a transaction is the probability a counterparty do not comply in time or manner with its contractual obligations to the Bank during the life of the transaction. The financial instruments that have Counterparty Risk are the Derivative Instruments, Securities Lending and the Repos. The measurement and control of counterparty risk, is in charge of a specialized risk unit that is independent from the business units. The counterparty risk control is performed daily by a computer system, which identifies the credit line available with any counterparty, in any product and term. To control counterparty lines, the Equivalent Credit Risk (REC) is used. if such counterparty commits a default in any moment until the maturity date of transactions. REC takes into account the Current Credit Exposure, which is defined as the cost to substitute the transaction at market value provided that this value is positive for the Bank, and it is measured as the market value of the transaction ( MtM ). In addition, REC includes the Potential Credit Exposure or Potential Additional Risk ( RPA ), which represents the possible evolution of the current credit exposure until maturity, given the characteristics of the transaction and the possible variations in the market factors. REC calculation takes into account collateral received to mitigate risk. Usual mitigants are cash and bonds. Every month a "Backtesting" is done comparing the estimated exposure and the one actually observed. In addition to the Counterparty Risk, there is the Settlement Risk, which is present in every transaction at its maturity date, when the possibility that the counterparty does not comply with its payment obligations arises, once Banco Santander (Mexico) has complied with its obligations by issuing payment directions. For the process of control for this risk, the Deputy General Direction of Financial Risks oversees on a daily basis the compliance with the limits on counterparty credit risks by product, term and other conditions stipulated in the authorization for financial markets. Likewise, it is the responsible for communicating on a daily base, the limits, consumptions and any incurred deviation or excess. On a monthly basis, a report is presented to the Integral Risk Management Committee. The aggregated Counterparty Risks, Issuer Risks and Sovereign risk are presented. In addition, excesses to established limits are presented to the Corporate Banking Credit Committee and Commercial Credit Committee. Expected Loss at month end for current transactions in financial markets under several stress scenarios are presented to the Integral Risk Management Committee. Currently, we have approved lines of Counterparty Risks in the Institution for the following segments: Mexican Sovereign Risk and Domestic Development Banking, Foreign Financial Institutions, Mexican Financial Institutions, Corporations, Companies Banking-SGC, Institutional Banking, Large Enterprises Unit, Project Finance. Equivalent Net Credit Risk of the lines of Counterparty Risk and Issuer Risk of Banco Santander (Mexico) for the last quarter:

51 2017 RISK MANAGEMENT ANNUAL REPORT 50 Table 4K Equivalente net credit risk millions of american dollars Segment Oct-17 Nov-17 Dec-17 Average Sovereign Risk, Development Banking and Financial Institutions 17,826 18,970 18,517 18,438 Corporates 1,060 1, ,052 Companies The equivalent credit risk lines maximum gross counterparty risk of the Bank at the last quarter, which corresponds to derivatives transactions, is distributed depending on the type of derivative: Table 4L Equivalente gross credit risk millions of american dollars End of fourth Type of Derivative quarter of 2017 Interest Rate Derivatives 16, Exchange Rate Derivatives 40, Bonds Derivatives - Equity Derivatives TOTAL 57, The expected loss at the end of the fourth quarter and the quarterly average of the expected loss of the lines of Counterpart risk and issuer risk of Banco Santander (Mexico) are: Table 4M Expected loss of the lines of counterparty millions of american dollars Segment Oct-17 Nov-17 Dec-17 Average Sovereign Risk, Development Banking and Financial Institutions Corporates Companies Segments of Mexican financial institutions with foreign financial institutions are very active counterparties with whom Banco Santander (Mexico) has current positions of financial instruments with Counterparty Credit Risk.

52 2017 RISK MANAGEMENT ANNUAL REPORT 51 Respect to total collateral received for derivatives transactions as of the year end: Table 4N Total collateral received for derivatives transactions Cash collateral 92.80% Collateral refer to bonds issued by the Mexican Federal Government 7.20% Regarding the management of securities, collateral, in the case of instruments derivatives, the transactions subject to collateral agreements are valued according to the frequency indicated in the collateral agreement; all agreements have now established daily basis. In this assessment, the agreed parameters are applied in the collateral agreement so that the amount to give or receive from the counterpart is obtained. These amounts (margin calls) are requested by the party entitled to receive collateral, usually on a daily basis, as stipulated by the agreement collateral. The counterpart that receives delivery of the collateral requirement checks assessment, and may arise discrepancies in this process. On the other hand, the correlation might exist between increased exposure to a client and its creditworthiness is analyzed by the admission area and limited by the amount of counterparty credit line and/or REC amount of specific approvals, established in the authorization line process; among many aspects Admission verifies that transactions in derivative for corporate, companies and individuals be hedging purposes and not speculative. Regarding the correlation between the collateral received and the guarantor in derivatives transactions, it is confirmed that to date, government bonds and/or cash as collateral are received only, which means that there is practically no risk of adverse effects because the existence of correlations. Faced with the possibility of a drop in the credit rating of Banco Santander (Mexico) and the possible effect it would have on a real increase in supply guarantees, it is estimated that the impact of collateral that the Bank would have to provide if one reduction in its credit rating would not be significant. This is because some insignificant percentage of collateral agreements is conditional on the rating of bank. 4.6 Information regarding securitization exposures To fulfill the obligation set forth in Article 88 of the CUB, Banco Santander (Mexico) reported that they have no significant position in this type of transaction. 4.7 Exposures by Credit Risk In this subsection information on exposures to credit risk it is shown in the following breakdowns: General profile of bank exposures Exposures by type of portfolio and calculation methodology for regulatory capital Exposures by remaining term Exposures and reserves by State

53 2017 RISK MANAGEMENT ANNUAL REPORT 52 Exposures and reserves by economic activity (in the case of commercial loans) Overview Table 4O Loan portfolio evolution millions of pesos 4% dic-16 mar-17 jun-17 sep-17 dic-17 It does not include: Interest Collected in advance Financial Burden Leasing Operations Table 4P Companies rating distribution 68% 28% 2% 2% Óptimo (9) Muy Bueno (7-8) Bueno (5-6) Deficiente (3-4)

54 2017 RISK MANAGEMENT ANNUAL REPORT Exposure by Type of Portfolio Table 1 Type of Portfolio Total Loan Portfolio Balance at the end of quarter Quarter average monthly balance Performing Nom Performing Performing Past quarter Nom Balance at the Balance Performing end of quarter (September) States and Munucipalities 27,968 23,229 27, Financial Institutions 16,551 15,018 16, Companies with annual Sales equal or greater than 14 millions of UDIS 212, , , ,696 1,541 2,723 2, Companies with annual sales of less than 14 millions of UDIS 1 103, ,560 98, ,247 3,487 2,883 3, ,753 Project Finance 20,047 19,828 20, Residential Mortgage 130, , ,372 1, ,791 1,934 1, Non - revolving Consumer 52,492 52,557 47, ,505 2,151 4,595 4, ,475 Credit Card 54,372 54,675 49, ,685 2,541 7,475 7, ,959 Subtotal 618, , ,167 2,161 8,713 13,511 20,051 20, ,935 Interest Collected in advance -527 Financial Burden Leasing Operations -154 Total 617,870 1/ It does include loans to government agencies, parastatals, and productive state enterprises. 2/ Register during the reported quarter Gross Exposures December 2017 millions of pesos Credit Status Nom Impaired Impaired Allowance for Loan Losser Variation Write Offs 2 Table 2 Companies with annual sales equal or greater than 14 millions of UDIS* millions of pesos Concept Sep-17 Dec-17 Total Loan Portfolio Performing Loans (Non Impaired) 220, ,686 Performing Loans (Impaired) 2,661 1,696 Non Performing Loans (Non Impaired) 9 24 Non Performing Loans (Impaired) 723 1,541 Total 223, ,947 Exposure at Default Performing Loans (Non Impaired) 222, ,984 Performing Loans (Impaired) 2,661 1,696 Non Performing Loans (Non Impaired) 9 24 Non Performing Loans (Impaired) 723 1,541 Total 225, ,245 Allowance for Loan Loss Balance 2,919 2,724 Exposure at Default According to Risk Rating Methodology Standard Methodology Performing Loans (Non Impaired) 11,101 11,994 Performing Loans (Impaired) 8 26 Non Performing Loans (Non Impaired) 9 17 Non Performing Loans (Impaired) Total 11,167 12,106 Internal Rating Methodology Performing Loans (Non Impaired) 211, ,990 Performing Loans (Impaired) 2,652 1,670 Non Performing Loans (Non Impaired) 0 6 Non Performing Loans (Impaired) 675 1,472 Total 214, ,139 * It does not include loans to government agencies, parastatals, and productive state enterprises.

55 2017 RISK MANAGEMENT ANNUAL REPORT 54 Table 3 Companies with annual sales of less than 14 millions of UDIS* millions of pesos Concept Sep-17 Dec-17 Total Loan Portfolio Performing Loans (Non Impaired) 97,300 98,663 Performing Loans (Impaired) 1,680 1,247 Non Performing Loans (Non Impaired) Non Performing Loans (Impaired) 3,206 3,487 Total 102, ,683 Exposure at Default Performing Loans (Non Impaired) 100, ,213 Performing Loans (Impaired) 1,693 1,260 Non Performing Loans (Non Impaired) Non Performing Loans (Impaired) 3,154 3,442 Total 105, ,246 Allowance for Loan Loss Balance 3,153 2,883 Exposure at Default According to Risk Rating Methodology Standard Methodology Performing Loans (Non Impaired) 81,816 84,131 Performing Loans (Impaired) 1, Non Performing Loans (Non Impaired) Non Performing Loans (Impaired) 1,310 1,465 Total 84,426 86,838 Internal Rating Methodology Performing Loans (Non Impaired) 18,322 17,081 Performing Loans (Impaired) Non Performing Loans (Non Impaired) Non Performing Loans (Impaired) 1,844 1,978 Total 20,816 19,408 * It does not include loans to government agencies, parastatals, and productive state enterprises. Table 4 States and municipalities loans millions of pesos Concept Sep-17 Dec-17 Total Loan Portfolio Performing 20,350 27,968 Non Performing Total 20,350 27,968 Exposure at Default 20,350 29,469 Allowance for Loan Loss

56 2017 RISK MANAGEMENT ANNUAL REPORT 55 Table 5 Financial institutions loans millions of pesos Concept Sep-17 Dec-17 Performing Loans Total Loan Portfolio 13,951 16,551 Exposure at Default 13,951 16,551 Allowance for Loan Loss Balance Exposure at Default According to Risk Rating Methodology Standard Methodology 11,106 13,181 Internal Rating Methodology 2,845 3,370 Total 13,951 16,551 Table 6 Mortagage loans millions of pesos Concept Sep-17 Dec-17 Total loan portfolio Performing 123, ,952 Non performing 5,153 5,540 Total 128, ,492 Allowance for loan loss 1,853 1,934 Table 7 Non revolving consumer millions of pesos Concept Sep-17 Dec-17 Total loan portfolio Performing 50,363 50,341 Non performing 2,013 2,151 Total 52,376 52,492 Allowance for loan loss 4,608 4,595 Table 8 Credit cards loans* millions of pesos Concept Sep-17 Dec-17 Total loan portfolio Performing 50,714 51,729 Non performing 2,506 2,643 Total 53,220 54,372 Allowance for loan loss 7,547 7,475 *It does not include cards issued to legal entities

57 2017 RISK MANAGEMENT ANNUAL REPORT Remaining Term Exposure Table 9 >10 years 22% 1 year 22% Loan Portfolio 618,552 mdp 10 years 12% 5 years 15% 3 years 28% September 17 % December 17 % sep 17 vs dec17 1 year 143,808 23% 134,692 22% -9,115 3 years 173,377 28% 171,856 28% -1,520 5 years 93,501 15% 99,154 16% 5, years 76,080 12% 75,975 12% -105 >10 years 127,184 21% 136,875 22% 9,691 It does not include: Interest Collected in advance Financial Burden Leasing Operations Table 10 Companies with annual sales equal or greater than 14 millions of UDIS Total loan portfolio millions of pesos Remaining term Sep-17 Dec-17 Up to 1 year 83,905 71,490 More than 1 year and up to 3 years 39,557 40,507 More than 3 years and up to 5 years 40,693 42,844 More than 5 years and up to 10 years 33,866 33,431 More tha 10 years - - Revolving 25,681 24,673 Total 223, ,947 * It does not include loans to government agencies, parastatals, and productive state enterprises.

58 2017 RISK MANAGEMENT ANNUAL REPORT 57 Table 11 Companies with annual sales of less than 14 millions of Total loan portfolio millions of pesos Remaining term Sep-17 Dec-17 Up to 1 year 26,312 24,907 More than 1 year and up to 3 years 29,091 28,883 More than 3 years and up to 5 years 20,022 23,151 More than 5 years and up to 10 years 4,844 5,004 More than 10 years 22,173 21,738 Revolving Total 102, ,683 * It does not include loans to government agencies, parastatals, and productive state enterprises and comercial. Table 12 Mortgage loans Total loan portfolio millions of pesos Remaining term Sep-17 Dec-17 Up to 1 year More than 1 year and up to 3 years More than 3 years and up to 5 years 1,962 2,066 More than 5 years and up to 10 years 16,779 17,665 More than 10 years 109, ,954 Total 128, ,492 Table 13 Non revolving consumer Total loan portfolio millions of pesos Remaining term Sep-17 Dec-17 Up to 1 year 2,469 1,618 More than 1 year and up to 3 years 25,482 21,858 More than 3 years and up to 5 years 24,361 28,920 More than 5 years and up to 10 years More than 10 years 0 0 Total 52,376 52,492

59 2017 RISK MANAGEMENT ANNUAL REPORT Exposure by State Table 14 Companies with annual sales equal or greater than 14 millions of UDIS* Total loan portfolio by state millions of pesos Sep-17 Dec-17 State Non Non Performing Total Performing Performing Performing Total Ciudad de Mexico 63, ,194 63, ,704 Nuevo Leon 23, ,728 19, ,034 Jalisco 11, ,976 12, ,846 Sinaloa 5, ,176 5, ,747 Veracruz 6,252-6,252 5, ,699 México 15, ,714 9, ,109 Quintana Roo 1, ,966 2, ,535 Chihuahua 4, ,459 5,992-5,992 Querétaro 2, ,352 2, ,403 Coahuila 6, ,644 7, ,377 Other Satates 82, ,240 76, ,500 Total 222, , ,382 1, ,947 * It does not include loans to government agencies, parastatals, and productive state enterprises. The allocation of entities is aligned to the reports sent to the CNBV. State Table 15 Companies with annual sales of less than 14 millions of UDIS* Total loan portfolio by state millions of pesos Sep-17 Dec-17 Performing Non Performing Total Performing Non Performing Total Ciudad de Mexico 21, ,122 22,828 1,805 24,634 México 5, ,315 5, ,407 Nuevo León 5, ,857 5, ,623 Jalisco 9, ,949 10, ,233 Veracruz 2, ,115 2, ,280 Sinaloa 1, ,607 1, ,978 Coahuila 2, ,327 2, ,112 Chihuahua 2, ,366 2, ,536 Guanajuato 1, ,858 2, ,710 Baja California 6, ,023 5, ,267 Other Satates 40,262 1,640 41,902 39,779 1,125 40,904 Total 98,980 3, ,441 99,910 3, ,683 * It does not include loans to government agencies, parastatals, and productive state enterprises. The allocation of entities is aligned to the reports sent to the CNBV.

60 2017 RISK MANAGEMENT ANNUAL REPORT 59 Table 16 Mortgage loans Total loan portfolio by state millions of pesos Sep-17 Dec-17 State Non Non Performing Total Performing Performing Performing Total Ciudad de Mexico 28, ,966 28, ,210 México 14, ,065 14, ,320 Jalisco 10, ,531 10, ,520 Nuevo León 11, ,531 11, ,622 Baja California 5, ,751 5, ,772 Querétaro 5, ,761 5, ,076 Veracruz 4, ,943 4, ,983 Guanajuato 4, ,334 4, ,407 Puebla 3, ,062 3, ,137 Chihuahua 3, ,771 3, ,815 Other Satates 31,414 1,755 33,169 31,773 1,857 33,631 Total 123,731 5, , ,952 5, ,492 The allocation of entities is aligned to the reports sent to the CNBV. Table 17 Non revolving consumer Total loan portfolio by state millions of pesos Sep-17 Dec-17 State Non Non Performing Total Performing Performing Performing Total Ciudad de Mexico 7, ,164 7, ,204 México 5, ,845 5, ,870 Veracruz 4, ,643 4, ,668 Jalisco 3, ,889 3, ,900 Nuevo León 2, ,129 2, ,073 Tamaulipas 2, ,258 2, ,269 Puebla 2, ,428 2, ,458 Baja California 1, ,594 1, ,586 Chihuahua 1, ,761 1, ,778 Guanajuato 1, ,693 1, ,710 Other Satates 16, ,973 16, ,976 Total 50,363 2,013 52,376 50,341 2,151 52,492 The allocation of entities is aligned to the reports sent to the CNBV.

61 2017 RISK MANAGEMENT ANNUAL REPORT Estimates of Credit Risk by State Table 18 Credit card* Total loan portfolio by state millions of pesos Sep-17 Dec-17 State Non Non Performing Total Performing Performing Performing Total Ciudad de Mexico 14, ,832 11, ,777 México 5, ,439 5, ,138 Jalisco 3, ,660 4, ,292 Nuevo León 3, ,280 3, ,772 Veracruz 2, ,756 2, ,039 Tamaulipas 1, ,518 1, ,814 Puebla 1, ,576 1, ,788 Guanajuato 1, ,571 1, ,697 Chihuahua 1, ,537 1, ,767 Baja California 1, ,363 1, ,526 Other Satates 14, ,687 15, ,762 Total 50,714 2,506 53,220 51,729 2,643 54,372 *It does not include cards issued to legal entities The allocation of entities is aligned to the reports sent to the CNBV. Table 19 Companies with annual Sales equal or greater than 14 millions of UDIS* Allowance for loan losses and by state millions of pesos State Sep-17 Dec-17 Ciudad de Mexico Nuevo León Baja California México Jalisco Veracruz Sinaloa Campeche Quintana Roo Chihuahua Other Satates 769 1,114 Total 2,919 2,724 * It does not include loans to government agencies, parastatals, and productive state enterprises. The allocation of entities is aligned to the reports sent to the CNBV.

62 2017 RISK MANAGEMENT ANNUAL REPORT 61 Table 20 Companies with annual sales of less than 14 millions of UDIS* Allowance for loan losses and by state millions of pesos State Sep-17 Dec-17 Ciudad de Mexico 503 1,019 Yucatán Sinaloa Baja California Nuevo León Veracruz Jalisco México Sonora Tamaulipas Other Satates 1,577 1,082 Total 3,153 2,883 * It does not include loans to government agencies, parastatals, and productive state enterprises. The allocation of entities is aligned to the reports sent to the CNBV. Table 21 Mortgage Loans Allowance for loan losses and by state millions of pesos State Sep-17 Dec-17 Jalisco Ciudad de Mexico México Nuevo León Baja California Quintana Roo Veracruz Puebla Querétaro Sonora Other Satates Total 1,853 1,934 The allocation of entities is aligned to the reports sent to the CNBV.

63 2017 RISK MANAGEMENT ANNUAL REPORT 62 Table 22 Non Revolving Consumer Allowance for loan losses and by state millions of pesos State Sep-17 Dec-17 Ciudad de Mexico México Veracruz Jalisco Nuevo León Tamaulipas Puebla Baja California Guanajuato Chihuahua Other Satates 1,489 1,494 Total 4,608 4,595 The allocation of entities is aligned to the reports sent to the CNBV. Table 23 Credit Card Loans* Allowance for loan losses and by state millions of pesos State Sep-17 Dec-17 Ciudad de Mexico 2,196 1,607 México Jalisco Nuevo León Veracruz Tamaulipas Puebla Guanajuato Baja California Chihuahua Other Satates 2,159 2,322 Total 7,547 7,475 *It does not include cards issued to legal entities The allocation of entities is aligned to the reports sent to the CNBV.

64 2017 RISK MANAGEMENT ANNUAL REPORT Exposure of Corporate Portfolio by Economic Sector Table 24 Companies with annual Sales equal or greater than 14 millions of UDIS* Total loan portfolio by economic sector millions of pesos Sep-17 Dec-17 Economic sector Non Non Performing Total Performing Performing Performing Total Professional, scientific and technical services 23, ,795 31, ,854 Construction 25, ,036 23, ,484 Wholesale trade 30, ,895 22, ,394 Transportation 11, ,867 12, ,760 Retail trade 17, ,661 17, ,931 Agriculture, animal breeding and production 9, ,307 10, ,976 Nonmetallic mineral products manufacturing 4,975-4,975 5,341-5,341 Mass media information 5,295-5,295 5, ,801 Food industry 7,327-7,327 6,373-6,373 Basic metal industry 4, ,198 5, ,370 Chemical industry 7, ,537 6, ,242 Other manufacturing industries 2,012-2,012 2, ,091 Temporary accomodation services 2, ,378 2, ,699 Metal products manufacturing 3,732-3,732 4, ,241 Others 67, ,685 54,308 1,082 55,390 Total 222, , ,382 1, ,947 * It does not include loans to government agencies, parastatals, and productive state enterprises. The sectorization is aligned to the reports sent to the CNBV. Table 25 Companies with annual sales of less than 14 millions of UDIS* Total loan portfolio by economic sector millions of pesos Sep-17 Dec-17 Economic Sector Non Non Performing Total Performing Performing Performing Total Professional, scientific and technical services 16, ,250 16, ,482 Construction 16,363 1,503 17,866 15,641 1,876 17,517 Retail trade 8, ,015 9, ,525 Wholesale trade 10, ,599 10, ,873 Agriculture, animal breeding and production 4, ,311 4, ,875 Beverage and tobacco industries Business support services 10, ,354 9, ,992 Transportation 3, ,545 4, ,073 Food industry 1, ,824 1, ,787 Machinery and equipment manufacturing Chemical industry 2, ,972 3, ,056 Other manufacturing industries 1, ,678 1, ,512 Temporary accomodation services Health care and social assistance services Plastic and rubber industry 1, ,116 1, ,185 Others 18, ,229 19, ,175 Total 98,980 3, ,443 99,910 3, ,683 * It does not include loans to government agencies, parastatals, and productive state enterprises. The sectorization is aligned to the reports sent to the CNBV.

65 2017 RISK MANAGEMENT ANNUAL REPORT Estimate for Credit Risk in Corporate Portfolio by Economic Sector Table 26 Companies with annual Sales equal or greater than 14 millions of UDIS* Allowance for loan losses millions of pesos Economic sector Sep-17 Dec-17 Professional, scientific and technical services Construction Retail trade Wholesale trade Clothing Industry 8 12 Transportation Nonmetallic mineral products manufacturing Agriculture, animal breeding and production Mass media information Food industry Chemical industry Basic metal industry Other manufacturing industries 9 18 Metal products manufacturing Temporary accomodation services Others 1,745 1,018 Total 2,919 2,724 * It does not include loans to government agencies, parastatals, and productive state enterprises. The sectorization is aligned to the reports sent to the CNBV. Table 27 Companies with annual sales of less than 14 millions of UDIS* Allowance for loan losses millions of pesos Economic sector Sep-17 Dec-17 Construction 1,080 1,103 Professional, scientific and technical services Nonmetallic mineral products manufacturing 4 4 Retail trade Wholesale trade Agriculture, animal breeding and production Paper industry 10 9 Other manufacturing industries Business support services Food industry Transportation Machinery and equipment manufacturing Beverage and tobacco industries 5 5 Plastic and rubber industry Temporary accomodation service Others Total 3,153 2,883 * It includes Project Finance. It does not include loans to government agencies, parastatals, and productive state enterprises. The sectorization is aligned to the reports sent to the CNBV.

66 2017 RISK MANAGEMENT ANNUAL REPORT 65 Table 28 Impaired Loans December 2017 millions of pesos Loan Allowance for Portfolio loan losses Impaired September ,672 10,506 Increase by new origination + 9,271 3,992 Increase/decrease by balance variation -/+ -3,847-2,214 Decrease because rating improvement - -3, Decrease because of write offs - -2,803-1,796 Decrease beause of payoffs Impaired December ,224 10,049

67 2017 RISK MANAGEMENT ANNUAL REPORT Management of Trading Market Risk This chapter provides information on the activities subject to trading market risk and its evolution in the last year. Different metrics and methodologies employed in the institution are also described. 5.1 Activities Subject to Trading Market Risk The perimeter of identification, measurement, control and monitoring function of Market risk covers those operations where equity risk is assumed. The measurement of market risk quantifies the potential change in value of the positions taken as a result of changes in market risk factors. The risk arises from changes in risk factors: interest rate, exchange rate, equity, credit spread and volatility of each of the above, and liquidity risk of the various products and markets in which it operates Institution. Trading activities include both the provision of financial services to customers, in which the entity is the counterparty, as buying and selling activity and proper positioning in financial instruments. This heading provided the positions which the entity keeps in their trading book. Table 5A: Trading Market Risk function of the variable that generates Interest Rate Risk: The possibility that variations in rates may adversely affect the value of a financial instrument. Equity Risk: The possibility that variations in the price of a stock may adversely affect the value of one share certificate and / or a financial instrument. Credit spread risk: The possibility that changes in credit spread curves associated with issuers and types of debt could adversely affect the value of a financial instrument. Volatility Risk: The possibility that variations in the listed volatility of market variables may adversely affect the value of a financial instrument. Cancellation or prepayment risk: The possibility of early termination without negotiation, on transactions whose contractual relationship permitted explicitly or implicitly, to generate cash flows that must be reinvested at an interest rate potentially lower. When significant risks are identified, they measured and allocated limits in order to ensure an adequate control. Global risk measurement is done through a combination of methodologies applied to trading books. 5.2 Basic Principles on the Trading Market Risk Management a. Independence of trading activities and balance sheet management. The management and control of the trading books and balance are clearly differentiated Procedures for each of the activities and processes already exist. b. Overview of risk assumed. Aggregate overview of all the risks assumed by the institution, in trading activities and in the management of balance, for effective, efficient and consistent management of the Trading Market Risk and Structural Risk. c. Definition of limits and allocations. The Board of Directors is responsible for setting limits of risk which the institution is willing to take, according to risk appetite. The limits clearly define the types of activities, segments, products, risks that can be incurred and decisions can be taken regarding risks.

68 2017 RISK MANAGEMENT ANNUAL REPORT 67 g. Control and supervision. Control mechanisms considered all the risks and its comparison with the structure of limits. h. Homogeneous and aggregated metrics. They identify and define the appropriate metric for management and control of Trading Market Risk and Structural Risk. Evaluation of Trading Market Risk and Structural Risk assumed is based on a process of measuring them. The measures take into account all relevant risk components in their life cycle. i. Homogeneous and documented methodology. The valuation of the instruments and their risks is a central element in the key processes of management and risk control. El adecuado desarrollo de la función de admisión y control de Riesgos de Mercado de Negociación se encuentra dentro de una estructura de órganos de gobierno ágil y eficiente que asegura la participación de todas las partes implicadas y hace compatible el adecuado desarrollo de la función. The adequate development of the design and control of market risk management is found within a governance structure that is agile and efficient, allowing for the participation of all involved. To ensure proper management of Trading Market Risk, there is a Committee of Risk Control with the following terms: a. Propose methodology applicable of Trading Market Risk, including one that corresponds to calculation models of Trading Market Risk and valuation of financial products subject to market valuation. b. Understand and analyze Trading Market Risk exposures of the Institution. c. Supervisar el diseño y funcionamiento de los modelos internos de Riesgos de Mercado de Negociación. Supervise the design and functioning of the internal models of market risk management d. Control measures of Trading Market Risk. e. Develop proposals for Trading Market Risk limitis, new products, and underlying terms for its approval. f. Accept the proposed modifications of Trading Market Risk limits, in terms of deadlines, products and underlying. g. Review the regulations applicable to Trading Market Risk and formulate proposals for improvement. The area of Trading Market Risk Management Unit within Risk Management has the responsibility to recommend administration policies Trading Market Risk of the Institution, establishing parameters for measuring risks and delivering reports, analyzes and evaluations to the senior management, Committee of Integrated Risk Management and to the Board of Directors. 5.3 Key processes in the Trading Market Risk Management The admission and control of Trading Market Risks is based on the following key processes: a. Definition of Limits, Products and Underlying. Fixing Trading Market Risk limits, it is essential to maintain risk levels within the risk appetite of the institution. This limits admission includes both the underlying process of setting annual limits, as well as the approval of amendments to the previously established limits and approval of new products and underlying.

69 2017 RISK MANAGEMENT ANNUAL REPORT 68 b. Definition, Capture, Validation and Distribution of Market Data. Market data are the basis for Trading Market Risk management. Decisions on sources of information capture, calculation methodologies or processed data on the use of approximations when there is no specific information corresponding to the risk function. c. Measurement, Analysis and Control of Trading Market Risks. Agrupa todas aquellas funciones que tienen como material de trabajo las métricas de Riesgos de Mercado de negociación utilizadas con el objetivo de conocer y anticipar los riesgos. Group all these functions that have as work materials the metrics of market risk that are used to identify and anticipate risks. d. Calculation, Analysis, Explanation and Reconciliation of Management Results. Reconciliation of operating results, besides being the essential element in the evaluation of the management of risk takers, is a piece of information needed to understand the Trading Market Risk is being taken in the different activities. e. Consolidated information. The consolidated information allows to manage the level of Trading Market Risk assumed by the institution and transform isolated measures of risk and return on consolidated figures that incorporate diversification effects. The consolidation process includes the calculation and analysis of the consumption of regulatory capital in accordance with the provisions of the equity framework. 5.4 Control of Trading Market Risk A. Metrics de Trading Market Risk Value at Risk (VaR) It is the standard used by the market to measure, using statistical techniques, the potential maximum loss in market value under normal conditions, can generate a certain position or portfolio for a given degree of statistical certainty (confidence level) and a defined time horizon. The VaR provides a universal measure of the level of exposure of the various portfolios of risk and allows comparison of the level of risk assumed among different instruments and markets by expressing the level of each portfolio through a unique figure in economic units. The VaR is calculated using historical simulation with a window of 521 working days (520 percentage changes) and a one-day horizon. The calculation is based on the number of simulated losses and profits as 1% percentile with constant pesos and with pesos decreasing exponentially with a factor of decay that is reviewed annually, reporting the measure that is more conservative. A confidence level of 99% is assumed. Stressed VaR It consists in obtaining a weighted daily VaR at 99% confidence level and considering a time series of 260 data that takes into account a period of turbulence in the relevant markets for the trading portfolio of the institution. Value at Earnings (VaE) Statistical measure complementary to VaR to measure the benefit that could be obtained under normal market conditions in a time interval and confidence level.

70 2017 RISK MANAGEMENT ANNUAL REPORT 69 Scenario Analysis It is to define alternative performance of different financial variables and obtain the impact on results when applied to trading activities. These scenarios can replicate past events (such as crises) or, conversely, may identify feasible alternatives that do not correspond to past events. Three types of scenarios are defined as a minimum: probable, possible and remote, getting along with the VaR a more complete spectrum of the risk profile. Trading Market Risk Limits It refers to the thresholds defined by the institution, according to the level of disaggregation of risk appetite, with the aim of controlling and managing the different factors of market risk to which the products and underlying the trading book are exposed. The limits are used to control the Trading Market Risk of the Institution, from each of their portfolios and books. The structure of limits applies to control exposures and establish the total risk granted to the business units. These limits are set for VaR, Loss Trigger, Stop Loss, equivalent volume of interest rate, equity equivalent volume and open currency positions. Also, it has a structure of limits for sensitivities Market Risk factors noted above. B. Process control of Trading Market Risk a) Data collection The data corresponding to the position of the trading book are found on the institution electronic platform and from there travel to market risk calculation engine. Additionally, the function of market data through the tool of prices, sends those prices to the mentioned calculation engine. With exposures and prices, the compute engine Market Risk generates the following information: Positions Metrics, considering the different types of sensitivities. Risk Market Metrics, considering VaR and Stressed VaR. b) Analysis of the metric and positions of Trading Market Risk The Market Risk function performs a daily analysis of the metric and its variation on the previous day. It performs an analysis of sensitivities by position, to identify the products in which the variation occurs in order to determine the causes of the changes in the various metrics used. On the other hand, the Market Risk function performs an analysis of VaR and Stressed VaR in a daily basis, additionally, comparing them in order to observe how responsive the positions and changes to these two scenarios. In the case that there are 20 consecutive exceptions that occur for which the VaR percentile is greater than the Stressed VaR, the Market Risk function analyzes the vectors of loses and gains in light of the metrics that have been calculated in order to identify positions and market movements that have been generated. The analysis performed aims to identify and remove the causes of exceptions into two basic categories: Market Movements: in this case the revision of the window used for calculating the Stressed VaR may become necessary.

71 2017 RISK MANAGEMENT ANNUAL REPORT 70 Significant changes in the composition of the portfolio: in this case the function of market risk analyzes, together with the business functions, if new positions are permanent or is it specific operations, in order to decide whether to revise the window used for calculating the Stressed VaR. In the event that it is necessary to check the window marked (the window review occurs, at least, on a quarterly basis), the market risk function performs simulations that include long periods (performed in 2008 to the date of execution of VaR) in order to verify which is the suitable window. c) Control of the excesses of limits and products authorized If as a result of the analysis of the level of VaR excesses occur within the limits of market risk or hiring a product term or unauthorized underlying is detected, the Market Risk function release such excess to the business functions involved, who develops an action plan that details the actions to take to reduce the levels of risk assumed. d) Control of insurance operations Financial risk function conducts a monthly control to confirm that all operations of fixed income underwriting and equities in which the business functions have been involved, have their proposed model and resolution insurance operations in markets. e) Assessment Model The control objective is to ensure models of product assessment mitigate the risk of erroneously rating or no rating certain operations. Monthly, it verifies that the parameters of the assessment models are within the recommended values. f) Control of Long and Short Positions The aim is to control long and short positions (no net) for products and underlying that are traded on the negotiating table. To this end, quarterly, the Market Risk function reviews the consumption and liquidity levels with the business function for fixed income products, equities and foreign exchange. g) Control of Liquidity The control objective is to establish limits and control the liquidity of the positions held by the tables to cover the risk of losses because they cannot cover or break a position within a specified term. h) Control of prices The aim of control is to ensure correct capture and validation of market prices for its use in the various systems, in order to cover the risk of improper valuation of products and perform transactions with different prices to market prices. The price control is regulated in the data processing market. i) Financial Reconciliation The aim of surveillance is to ensure that risk and estimated results are correct, ensuring consistency of information between the accounting and management systems.

72 2017 RISK MANAGEMENT ANNUAL REPORT 71 C. Data of the reported period a. VAR The Value at Risk for the close of the fourth quarter 2016 (unaudited) amounted to: VaR at the end of the fourth quarter of 2017 VaR (Thousand of % mexican pesos) Trading Desks 128, % Market Making 134, % Propietary Trading 16, % Risk factor Interest rate 125, % Foreign exchange 25, % Equity 5, % * % of VaR with respect to Net Capital Table 5B The Value at risk corresponding to the average of the fourth quarter of the last year (unaudited) amounted to: Table 5C Average VaR fourth quarter of 2017 VaR (Thousand of % mexican pesos) Trading Desks 114, % Market Making 117, % Propietary Trading 27, % Risk factor Interest rate 129, % Foreign exchange 43, % Equity 5, % * % of VaR with respect to Net Capital

73 2017 RISK MANAGEMENT ANNUAL REPORT 72 b. Sensitivity Analysis The measure of sensitivity Trading Market Risk is a measure of the variation (sensitivity) of the market value of the financial instrument in question, to changes in each of the risk factors associated with it. The sensitivity of the value of a financial instrument to changes in market factors, is obtained by full revaluation of the financial instrument. The following sensitivities are listed under each risk factor and the associated historical consumption of trading book. 1. Sensitivity to Risk Factor Equity ( Delta EQ ) The EQ Delta shows the change in the portfolio's value in relation to changes in the prices of equities. The EQ Delta calculated for the case of derivative financial instruments considered the relative change of 1% in the prices of the underlying assets in equities, in the case of equities, this considers the relative variation of 1% of market price title. 2. Sensitivity to Risk Factor Foreign Exchange ( Delta FX ) The FX Delta shows the change in the portfolio's value in relation to changes in asset prices exchange rate. The FX Delta calculated for the case of derivative financial instruments considered the relative change of 1% in the prices of the underlying assets of the exchange rate, In the case of currency positions, this considers the relative variation of 1%of the corresponding exchange rate. 3. Sensitivity to Risk Factor Volatility ( Vega ) Vega sensitivity is the measure resulting from changes in the volatility of the underlying asset (the reference asset). Vega risk is the risk that a change in the volatility of the underlying asset value, that results in a change in the market value of the derivative. The calculation of Vega sensitivity, considers the absolute change of 1% in the volatility of the underlying asset value. 4. Sensitivity to Risk Factor Interest Rate ( Rho ) This sensitivity quantifies the change in value of financial instruments for the trading portfolio in the face of a parallel increase in the interest rate curves of a basis point. The table below presents the sensitivities described above corresponding to the position of the trading portfolio, as of the end year of the fourth quarter:

74 2017 RISK MANAGEMENT ANNUAL REPORT 73 Table 5D Sensitivity analysis millions of pesos Interest rate sensitivity(1pb) Vega risk factor Delta risk factor Pesos Otras Divisas EQ FX IR EQ FX (1.39) (0.32) On the basis of the aforementioned. This reflects a prudent management of the Bank s portfolio with respect to risk factors. c. Stress Test Also, monthly simulations of gains or losses of portfolios by revaluations of them under different scenarios (Stress Test) are performed. These estimates are generated in two ways: Applying to market risk factors observed percentage changes in certain period of history, which includes significant market turbulence. Applying Market Risk factors changes depending on the volatility of each of these. Then different scenarios are shown stress test considering various scenarios calculated for the trading book of the institution. Probable scenario This scenario was defined based in the movements derived from a standard deviation, with respect to risk factors that have an influence over the valuation of financial instruments. Specifically: Risk factors of Interest Rate ( IR ), volatility ( Vol ) and rate of Exchange ( FX ) were incremented in a standard deviation. Risk factors with respect to stock market ( EQ ) were decreased in a standard deviation. Possible scenario Under this scenario, as requested in the official letter, risk factors were modified in 25%. Specifically: Risk factors: IR, Vol and FX were multiplied by 1.25 that means, they were incremented in 25%. Risk factor EQ was multiplied by 0.75 that means, it was decreased in 25%. Remote scenario Under this scenario, as requested in the official letter, risk factors were modified in 50%. Specifically:

75 2017 RISK MANAGEMENT ANNUAL REPORT 74 Risk factors IR, Vol and FX are multiplied by 1.50, that is, they were incremented in 50%. Risk factor EQ was multiplied by 0.5, that is, it was decreased a 50%. The following table shows the possible income (loss) for the trading book of the institution, according to each stress scenario at the end year of the fourth quarter: Table 5E Possible lncome (loss) Stress test millions of pesos Risk profile Stress all factors Probable Scenario 0.34 Remote Scenario Possible Scenario d. Backtesting The overall objective of the backtesting is to contrast the goodness of the VaR calculation model. That is, accept or reject the model used to estimate the maximum loss on a portfolio for a certain level of confidence and a time horizon determined. On a monthly basis, these backtesting are conducted to compare the daily gains and losses which would have been observed if the same positions had remained, considering only the change in value due to market movements, against the calculation of value at risk and therefore to calibrate the models used. These reports, even if they are made monthly, include daily tests. 5.5 Derivates Financial Instruments The Global Corporate Banking offers its customers, derivative products in order to mitigate the financial risk. Derivatives are financial instruments or contracts whose value depends mainly on the behavior of the price of one or more underlying assets: Swaps: A contract through which two parties agree to exchange a series of cash flows at a future date. There are various types of swaps: Interest Rate, Foreign Exchange, UDIs, Equity swaps. Forwards: A forward contract whose settlement is deferred until a later date specified therein. Unlike futures contracts, they are not traded on a market. They are private agreements between two financial institutions or between a financial institution and one of its corporate clients. Futures: A futures contract is a kind of forward contract, but standardized and negotiable on a regulated market. This type of contract has margins and capital that supports its integrity and includes details such as quantity, quality, delivery date, delivery method, among others. All positions handled in these contracts, are between a participant on one side and the clearing on the other.

76 2017 RISK MANAGEMENT ANNUAL REPORT 75 Options: It is a standardized contract in which the buyer pays a premium and acquires the right, but not the obligation, to buy (call) or sell (put) an underlying asset (which can be shares, stock market indices, etc.) an agreed price (strike or exercise price) at a predetermined future date at a set period (maturity). The Bank may enter into derivatives transactions with the following financial intermediaries: Decentralized agencies, credit institutions and brokerage firms authorized to operate as participants and / or intermediaries in the derivatives markets. It can also operate with domestic and foreign companies with no legal impediment and that demonstrate high moral and financial solvency, which satisfy the minimum requirements of process analysis and risk assessment. To celebrate derivatives transactions, customers must have a credit line with or without guarantees for the operation and shall not in any case exceed the ceiling of the authorized line. To assess exposure to credit risk of derivatives is taken into account implied volatility in the value of the instruments, in order to determine the maximum possible loss that can assume the counterparty (REC) and relate to the amount total credit line. Derivatives operations conducted with clients and intermediaries shall be documented by establishing framework contracts. Derivative financial securities are valued at reasonable value, according to the accounting rules established in the Circular Letter for Credit Institutions issued by the National Banking and Exchange Commission, in Principle B-5 Derivative Financial Instruments and hedging Transactions and the provisions in Principle A-2 Application of specific rules, and the provisions in the specific rule included in Bulletin C-10 of the Financial Information Rules. A. Methodology of Valuation 1. Trading Purposes a. Organized Markets The valuation is made at the relevant market closing price. Prices are provided by the supplier of prices. b. Over the Counter Market Derivative financial instruments with optionality: In the majority of the cases, a general form of the Black & Scholes model is used. Such model assumes that the underlying product follows a lognormal distribution. For exotic products or when payment depends on the trajectory of any market variable, MonteCarlo simulations are used. In this case, it is assumed that logarithms of the different variables follow a multi-varied normal distribution. Derivative financial instruments without optionality: The valuation technique is to obtain the present value of the estimated future flows In all cases the institution carries out the valuation of its positions and registers the corresponding value. In some cases, a different calculation agent is designated, and such calculation agent may be the counterparty or a third party. 2. Hedging Purposes In the performance of its commercial banking activities, the institution has tried to cover the evolution of the financial margin of structured portfolios that are exposed to adverse movements

77 2017 RISK MANAGEMENT ANNUAL REPORT 76 in interest rates. The ALCO, the body responsible for the management of long-term assets and liabilities, has constituted the portfolio via which the Bank achieves such hedge. An accounting hedge is defined as a transaction that complies with the following conditions: a. A hedge relationship is designated and documented from the beginning in an individual file, where its objective and strategy is established. b. The hedge is effective for the compensation of variations in the reasonable value or in the cash flows attributed to such risk, according to the risk management documented at the beginning. The Management of Banco Santander (Mexico) performs derivative transactions for hedging purposes with swaps. Derivatives for hedging purposes are valued at market value, and the effect is recognized depending on the type of accounting hedge, pursuant to the following: a. In the case of fair value hedges, they are valued at market value for the risk covered, the primary position and the hedging derivative instrument, and the net effect is registered in the statement of income of the corresponding period. b. In the case of cash flow hedges, the hedging derivative instrument is valued at market value. The effective portion of the hedge is registered in the comprehensive income account, within the stockholders equity, and the ineffective portion is registered in the statement of income. The Institution ceases the recording of hedges at the maturity date of the derivative, or when such derivative is sold, cancelled or exercised; when the derivative does not reach a high efficiency in compensating the changes in the reasonable value or the cash flows of the covered item, or when Banco Santander (Mexico) decides to cancel the hedge. It shall be fully evidenced that the hedge fulfills the objective for which derivatives were contracted for. This effectiveness requirement assumes that the hedge must comply with a maximum range of deviation with respect to the initial objective of 80% to 125%. In order to demonstrate the efficacy of hedges, two tests are to be carried out: a) Forward-looking Test: it is demonstrated that, in the future, the hedge will be within the aforementioned range of deviation. b) Retrospective Test: This test reviews if, in the past, from its initial date to now, the hedge has been maintained within the allowed range of deviation. In the cases of Fair Value Hedges and the Cash Flow Hedges, they are retrospective and forward-looking efficient and within the allowed maximum range of deviation. B. Overview of the Position The most relevant reference variables are Exchange Rates, Interest Rates, Stocks, baskets and market indexes. The frequency with which financial products trading and hedging purposes are valued is daily.

78 2017 RISK MANAGEMENT ANNUAL REPORT 77 At the end year of the fourth quarter, the institution has no situation or contingency such as changes in the value of the underlying asset or the reference variables, that may cause the use of the derivative financial instruments to be different to their original intended use, a significant change in their scheme or the total or partial loss of the hedge, requiring the Issuer to assume new obligations, commitments or variations in its cash flow or affecting its liquidity (day trade calls), nor contingencies or events known or expected by the Management that may affect future reports. Type of Derivative Table 5F Summary of derivative financial instruments million of mexican pesos as of December 31, 2017 Underlying Purpose of Derivative Notional amount Actual Quarter Fair Value Previous Quarter Forwards Bonds Trading Forwards Foreingn Currency Trading 231, ,199 Forwards Equity Trading 15, Futures Foreingn Currency Trading 6, Futures Market Index Trading Futures Interest Rate Trading 5, Futures Equity Trading Options Equity Trading Options Foreingn Currency Trading 227, Options Market Index Trading 20, Options Interest Rate Trading 243, Swaps Cross Currency Trading 896,310-5,219-4,135 Swaps Interest Rate Trading 5,346,429-2,330-1,802 Swaps Equity Trading 1, Forwards Foreingn Currency Hedging 53,823 1,669 2,504 Swaps Cross Currency Hedging 66,611 2,226 4,015 Swaps Interest Rate Hedging 6,

79 2017 RISK MANAGEMENT ANNUAL REPORT 78 The institution, at the execution of transactions of OTC derivative financial instruments, has Collateral formalized agreements with many of its counterparties, which function as market value guarantee of the derivative transactions, and it is determined based on the exposure of the net position on risk with each opposing party. The managed Collateral consists mainly in cash deposits, whereat there is not a deterioration situation. There are no derivative financial instruments whose underlying assets are treasury shares or securities representing them during the quarter. Tabla 5G Number of expired derivative financial instruments and closed positions Description Maturities Closed Positions Caps and Floors Equity Forward OTC Equity OTC Fx 1,832 0 Swaptions 1 0 Forward IRS CCS 92 43

80 2017 RISK MANAGEMENT ANNUAL REPORT Structural Risk Management This chapter provides information on the activities subject to Structural Risks and expose its evolution during the last year. Different metrics and methodologies employed in the institution are also described. 6.1 Activities subject to Structural Risk The perimeter of identification, measurement, control and monitoring function of market risk covers those operations where equity risk is assumed. The measurement of market risk quantifies the potential change in value of the positions taken as a result of changes in market risk factors. The risk arises from changes in risk factors: interest rate, exchange rate, equity, credit spread and volatility of each of the above, and liquidity risk of the various products and markets in which it operates the institution. The structural risks consist of market risks inherent in the balance sheet of the institution, excluding trading portfolios. This risk includes both losses from price changes affecting the portfolios available for sale and held to maturity, as well as losses from the management of recorded assets and liabilities (banking book). The main structural risks are the following: Structural Interest Rate Risk: It arises from mismatches between maturities and repricing of assets and liabilities in the balance. Structural Exchange Rate Risk: Exchange rate risk is a result of operating in a currency other than the Mexican Peso. Structural Risk in the Equity Portfolio: Includes investments through equity to non-consolidated financial and non-financial, such as portfolios available for sale consist of equity positions. Inflation Risk: The possibility that changes in inflation rates may adversely affect the value of a financial instrument or portfolio. Market Liquidity Risk: The possibility that the institution is unable to reverse or close a position in time without impacting the market price or in the cost of the transaction. Prepayment or Cancellation Risk: The possibility of early termination without negotiation in transactions whose contractual relationship so permits, explicitly or implicitly, to generate cash flows must be reinvested at an interest rate potentially lower. When significant risks are identified, they measured and allocated limits in order to ensure proper control. The overall measurement of Structural Risk is made through a combination of methodology applied to the Portfolio of Management Balance-Sheet. 6.2 Basic Principles on the Structural Risk Management a. Independence of the Trading Activities and Balance-Sheet Management. The management and the control of trading books and balance-sheet portfolios are clearly differentiated. There are procedures for each of the activities and processes. b. Overview of risk assumed. There is an aggregate overview of all the risks assumed by the institution, in trading activities and in the management of balance-sheet, for effective, efficient and consistent management of the Trading Market Risk and Structural Risk. c. Definition of limits and allocations. The Board of Directors is responsible for setting risk limits that the Institution is willing to assume, according to risk appetite. The limits clearly define the types of activities, segments, products, risks that can be incurred and decisions can be taken regarding risks.

81 2017 RISK MANAGEMENT ANNUAL REPORT 80 d. Control and supervision. The mechanisms of control that considers all the risks and compares these with the structure of limits. e. Homogeneous and Aggregated Metrics. They identify and define the appropriate metric for management and control of Trading Market Risk and Structural Risk. The evaluation of the Trading Market Risk and Structural Risk assumed is based on a measurement of the same process. The measures take into account all relevant risk components in their life cycle. f. Homogeneous Methodology and documented. The valuation of the instruments and their risks is a central element in the key processes of management and risk control. The proper development of the function of admission and Structural Risk control is within an agile and efficient structure of governance bodies that ensures the participation of all parties and makes compatible the appropriate function development. To ensure proper management of structural risks, there is a Committee of Risk Control with the following terms: a. Propose a methodology of Structural Risks applicable, including that corresponds to calculation models of Structural Risk and valuation of financial products subject to the market assessment. b. Understand and analyze exposure to Institutional Structural Risks. c. Supervise the design and operation of internal models of Structural Risks. d. Control of Structural Risk Measures. e. Develop proposals for Structural Risk limits, new products, and underlying terms for its approval. f. Admit the proposed amendments to Structural Risk limits, in terms of deadlines, products and underlying. g. Review the regulations implementing to Structural Risks and formulate proposals for improvement. The area of Structural Risk Management within the Unit of Integrated Risk Management, is responsible for recommending policies of structural risk management of the Institution, establishing risk measurement parameters, and providing reports, analyzes and evaluations to the Senior Management, Integrated Risk Management Committee and the Board of Directors. 6.3 Key Processes in the Structural Risk Management The admission and control of structural risks is based on the following key processes: a. Definition of limits, products and underlying. a. The fixing of the Structural Risk limits is key to maintaining the risk levels within the risk appetite of the institution. This admission of the limits includes both the process of setting annual limits, as well as the approval of amendments to the previously set limits and approval of new products and underlying. b. Definition, capture, validation and distribution of market data. a. Market data are the basis for the management of Structural Risk. Decisions on sources of information capture, calculation processed data methodologies on the use of the approximations when there is no specific information corresponding to the risk function. c. Measurement, Analysis and Control of Structural Risks. a. It brings together all those functions whose work material Structural Risk metrics used in order to understand and anticipate the risks. d. Calculation, Analysis, Explanation and Reconciliation of Management Results. a. Reconciliation of operating results, besides being the essential element in the evaluation of the management risk-taking areas, is a key piece of information to know the structural risks that are being made in the different activities.

82 2017 RISK MANAGEMENT ANNUAL REPORT 81 e. Consolidated information. a. The consolidated information to manage the level of structural risks assumed by the institution and transform isolated measures of risk and return on consolidated figures that incorporate diversification effects. 6.4 Control of Structural Risk Banco Santander (Mexico) commercial banking activity generates significant account balances that are recorded on the balance sheet. The Committee of Asset and Liabilities (ALCO) is responsible for determining the risk management guidelines of financial margin, equity value and liquidity, whose must to be followed in the different commercial portfolios. Under this approach, the Corporate Finance Department is responsible for implementing the strategies defined in the Committee of Assets and Liabilities in order to change the risk profile of the trade balance by following established policies, for which it is essential to take the information requirements for interest rate risk, exchange rate risk and liquidity risk. A. Structural Risk Metrics As part of the financial management of the institution, the sensitivity of financial margin and equity value of the different balance-sheet, against changes in interest rates, is analyzed. This sensitivity arises from gaps in maturity dates and modification of interest rates occurring in the different categories of assets and liabilities. Sensitivity to Net Interest Income (NIM) The sensitivity of the Net Interest Income measures the change in the expected accruals for a specific period (12 months) given a shift in the interest rate curve. The calculation of this sensitivity is done by simulating the margin both for a scenario of changes in the rate curve as well as the current situation, the sensitivity being the difference between the two margins calculated. As part of the control system of structural risk derived from changes in the interest rate set a limit of sensitivity of the Net Interest Income to one year. In case of exceeding this limit occur, those responsible for risk management must explain the reasons for it and facilitate action plan to correct it. Sensitivity to Market Value Equity (MVE) The Sensitivity of Market Value Equity is a measure of the sensitivity of the financial margin and measures the interest risk implicit in the equity value (own resources) on the basis of the incidence that has a variation of interest rates at current values assets and liabilities. The analysis is based on the classification of each item sensitive to interest rates over time, according to their date of redemption, expiration, or contractual modification of the interest rate applicable. As part of the control system of Structural Risk deriving from changes in the interest rate set a limit on the MVE. In case of exceeding this limit occur, those responsible for risk management must explain the reasons for it and facilitate action plan to correct it. Treatment of liabilities without defined maturity The volume of account balances without specific maturity is divided between stable and unstable balances. This separation is obtained using a model based on the relationship between the account balance and fluctuating averages. From this monthly cash flows are obtained.

83 2017 RISK MANAGEMENT ANNUAL REPORT 82 The model requires different inputs among which are: own product parameters, parameters of customer behavior, market data and historical data from its own portfolio. B. Data from the reporting period This sensitivity is derived from the difference between maturity dates of assets and liabilities and the dates interest rates are modified. The analysis is performed from the classification of each item sensitive to interest rate throughout time, according to their repayment, maturity or contractual modification of the applicable interest rate: Table 6A Sensitivity analysis millions of pesos Sensitivity NIM Sensitivity MVE Oct-17 Nov-17 Dec-17 Promedio Oct-17 Nov-17 Dec-17 Promedio Balance MXN GAP 33% 37% 49% 40% 51% 50% 44% 48% Scenario N/A N/A Balance USD GAP 67% 62% 66% 65% 24% 17% 26% 22% Scenario N/A N/A Using simulation techniques, the predictable change of the net interest income and the market value of equity are measured in different interest rate scenarios, and their sensitivity under extreme movement of such scenarios, as the end of year: Scenario Total Derivatives Table 6B Non Derivatives Scenario Total Derivatives Non Derivatives Balance MXN GAP , ,593 Balance USD GAP Thousand of millions pesos Sensitivity NIM & MVE. Derivatives and non derivatives Sensitivity NIM Sensitivity MVE The Committee of Assets and Liabilities adopts investment and hedging strategies to maintain these sensitivities within the target range.

84 2017 RISK MANAGEMENT ANNUAL REPORT Structural Risk in the Equity Portfolio At ended December the Bank has equity positions in its banking book. These positions are maintained as shares and registered in the account: Permanent Investments in Shares. This position is valued at its fair value using market values. If the market value cannot be obtained reliably, or if it is not representative, taking into account the event that there is no frequent activity in the market in which it negotiated the title, an insignificant volume is traded or its price is suspended, the fair value is determined based on the equity method and/or based on the acquisition cost adjusted by updating factors, or to last determined fair value. In the case of equity securities valued at acquisition cost, they are adjusted to net realizable value when it is less than the updated cost. This value shall be determined based on formal valuation techniques. The amount by which the value of debt and equity is reduced, should be recognized against income for the year. If at a later date to the value of a security was decreased, there is certainty that the issuer will cover a larger amount than in books, it may make a new estimate of its value. The effect of this revaluation should be recognized in the results when it happens. Under no circumstances should this reassessment may exceed book value at that date would have the title if it had not been adjusted for the decrease decrement. Table 6C STOCK POSITION December 2017 VALUE OF THE TOTAL POSITION IN BALANCE millions of pesos CONCEPT BALANCE VALUE FAIR VALUE MARKET VALKUE CAPITAL GAIN MAID UNREALISED GAIN REVALUATION PROFITS UNREALISED POSITIONS HELD FOR PROFIT Publicly Traded Positions 2,560 2,560 2, Publicly No-Traded Positions POSICITIONS HELD FOR OTHER REASONS Publicly Traded Positions Publicly No-Traded Positions 25,345 25,345 25,345 The capital requirement for the equity position of Banco Santander (Mexico) at the end of year amounted to $80 Millions of pesos.

85 2017 RISK MANAGEMENT ANNUAL REPORT Liquidity Risk Management 7.1 Activities subject to Liquidity Risk Liquidity risk is defined as the possibility of failing to meet payment obligations on time or to do so at excessive cost. The types of losses that are caused by this risk include forced sales of assets or impacts on margin mismatch between the forecasts of cash outflows and inflows. It is the risk of loss of value of the buffer of liquid assets of the entity and the change in value of the operations of the entity (derivatives and guarantees, among others) which may involve additional collateral requirements and thus worsening liquidity. Additionally, it includes the risk of being unable to meet payment obligations as a result of timing differences in cash flows, cash unforeseen needs, inadequate liquidity structure of assets and liabilities or concentration in finance providers. Under this, the Liquidity Risk is classified into the following categories: a. Financing Risk: It identifies the possibility that the entity is unable to meet its obligations as a result of an inability to sell assets or obtain financing. The funding liquidity risk arises from the time lag in the cash flows or unforeseen cash requirements, either by improper design of active and passive operations, or unforeseen liquidity needs. b. Mismatch Risk: It identifies the possibility that the differences between the structures of maturities of assets and liabilities generate an additional cost to the entity. c. Contingency Risk: Refers to extraordinary liquidity needs and identifies the possibility of not having elements of management adequate for obtaining liquidity as a result of an extreme event involving major needs of financing or collateral to obtain the same. 7.2 Basic Principles on Liquidity Risk Management Admission, control, consolidation and Liquidity Risk reporter contemplate and safeguard the principles established in the framework of the Integrated Risk Management and is governed by the following principles: Financial Autonomy Banco Santander (Mexico) independently handles its liquidity, which means that the Bank must capture and manage its own financial resources and maintain liquidity levels required internally at the entity level and by supervisors and regulators. Using homogeneous and aggregated metrics The assessment of the risks taken is based on a process of quantifying or measuring of them. The measures take into account all relevant components and dimensions of risk throughout their life cycle. The company ensures the identification, definition and knowledge of the appropriate management metrics and control of liquidity risk. The determination of the maturity of the derivative financial instruments is a key element in the processes of Liquidity Risk, particularly for those without a contractual behavior defined and/or dependent on the behavior of customers. Therefore, all flow calculation methodologies are homogeneous, are adequately documented and approved by the relevant bodies and are subjected to appropriate validation processes.

86 2017 RISK MANAGEMENT ANNUAL REPORT 85 Establishment and adaptability of limits Setting limits is to meet, efficiently and comprehensively, levels of Liquidity Risk that Banco Santander (Mexico) is willing to assume, according to the risk appetite set by its board of directors, and according to the capacity of managers, the infrastructure available for the management and control, knowledge of the liquidity of the products and information available at appropriate times. Additionally, agile mechanisms of modification of boundaries can adapt to extreme or adverse market situations, as well as responding to normal opportunities. Regulatory Environment Banco Santander (Mexico) must meet not only the requirements set by the regulator, but also must meet the requirements of the corporation so that it can adequately respond to the scrutiny supervisor on a consolidated basis. 7.3 Key Process in Liquidity Risk Management The model of Liquidity Risk in Banco Santander (Mexico) is based on the following key processes: a) Admission Setting limits and approval of new products and specific operations. Prior to admission of Liquidity Risk, the financial management function defines the perimeter of trading activity and balance sheet management of the entity, that is, the determination of the geographical segments, business and associated portfolios. b) Provisioning of Information As a preliminary step to the realization of control the risk of liquidity, information is collected on the principal items of the balance sheet of the entity (Expiries, stock of liquid assets, issues, commitments, among others). In this process, the function of Liquidity Risk obtains information from market data provided by market data function, which performs the following steps: Capture: obtaining market variables. Calculation: modification, transformation and interpolation of data captured from information systems. Validation: filtering the data according to defined quality requirements. Certification: generation of end of day prices and official data used in the process. Dissemination: setting the certified data available to different systems c) Liquidity risk control Measurement, analysis and control of liquidity risk is to ensure that the level of balance sheet liquidity is consistent with the approved limits and risk appetite established by the governing body of the entity. This process aims: Understand, analyze, control and monitor continuously the situation, evolution and trends in liquidity risk generated by the balance, reporting periodically to the address and requesting measures to be taken. Conduct analysis and control liquidity risk in the different axes, and levels and defined metrics. Understand, analyze, control and monitor the possible concentrations in funding sources or suppliers.

87 2017 RISK MANAGEMENT ANNUAL REPORT 86 Monitoring and analysis of Liquidity Risk excess, regarding the approved limits, notifying the excesses of risk-taking functions and requesting, where appropriate, actions that serve to its regularization. Respond in a timely manner to the requirements set by regulators, filling information Liquidity risk of the entire balance sheet. 7.4 Liquidity Risk Control As already mentioned, the liquidity risk is associated with the ability that Bank Santander (Mexico) has to finance its commitments undertaken, at reasonable market prices and to carry out its business plans with stable sources of funding. The factors that influence can be external (liquidity crisis) and internal due to excessive concentration of maturities. Bank Santander (Mexico) hits a coordinated management of the maturities of assets and liabilities, monitoring the maximum gap profiles. This surveillance is based on analysis of maturities of assets and liabilities both contractual and management. The Bank performs a control for maintaining sufficient liquid assets to ensure survival horizon for a minimum of days faced a liquidity stress scenario without resorting to additional sources of funding. Liquidity risk is limited in terms of a minimum of days established for local and foreign currencies in consolidated form. A. Liquidity Risk Metrics Structural Finance Ratio. After analyzing the components of the balance sheet, for those whose treatment is affected by variations and balances, the institution calculates the ratio of structural finance in order to measure the excess or deficit of liquidity structural in the balance. The structural liquidity analysis allows to determine how are funding the structural needs and if there is a high reliance on the use of instruments considered volatile or highly correlated with market variables. Liquidity Risk Limits. The limits of liquidity risk refer to those minimum thresholds defined by the entity in order to control and manage the risks relating to liquidity, balance sheet structure to which the entity is exposed. Liquidity Gap. Shows the liquidity risk profile or mismatches in the cash flows, assuming a normal course of business and stable market conditions. It consists of the contractual gap, coupled with the best estimate available of the flows that could affect the liquidity situation of the entity from the trade balance, other balance sheet items and other inputs and outputs known. Liquidity Available. It is defined as the amount of the public debt plus cash and other liquid assets without pledged and which can become almost immediately liquidity by direct sale on the market, without significantly affecting its price or to serve as collateral in operations of temporary assignment of assets (or other financing collateral) with reasonable haircuts. Concentration of Funding Sources. Shows the main funding sources or suppliers, volumes and terms of financing. The analysis of this information allows evaluate possible concentrations and effects faced possible changes in the sources or suppliers or its availability to provide it.

88 2017 RISK MANAGEMENT ANNUAL REPORT 87 Stress Test. Metrics by which the time horizon of liquidity stress scenarios is obtained, such as wholesale liquidity metrics (wholesale stress scenario), and stressed liquidity metrics (applying stress scenarios of local crisis, global crisis and idiosyncratic crisis). This metric provides information about how long the entity could survive without requesting funds to markets and what is the quantity and minimum time to obtain funds to cover the liquidity needs. Liquidity Coverage Ratio (LCR) The LCR shown resistance to short-term of the liquidity risk profile of the Bank, ensuring that it has sufficient high-quality liquid assets to overcome an episode of significant stress for 30 calendar days. The severity of stress period stated in the CUB issued by the CNBV. Net Stable Funding Ratio (NSFR) The NSFR is set as a long-term financing ratio which is facing structural funding needs against financing sources of a stable entity. This requires banks to maintain a stable funding profile in relation to the composition of its assets and off-balance sheet activities. B. Data from the reporting period Structural Gap Table 7A Million pesos STRUCTURAL GAP Total 1D 1S 1M 3M 6M 9M 1A 5A >5A Structural GAP 202,158 40, ,843 11,895 32,613 38,345 29,174 26, , ,623 Non Derivatives 187,149 40, ,373 11,201 32,017 38,228 28,747 26, , ,665 Derivatives 15, , , LCR Y NSFR Table 7B

89 2017 RISK MANAGEMENT ANNUAL REPORT 88 Structural Finance Ratio Table 7C STRUCTURAL FUNDING RATIO dic-17 Structural Funding Ratio 118% Structural Funding Ratio 759, Clients funds 518, Issuance 125, RRPP 116,133 Structural financing needs 645, Lending 605, Investments in group companies Reserve Requirements 28, Other financing needs 11,648

90 2017 RISK MANAGEMENT ANNUAL REPORT Operational Risk Management 8.1 Overview The Operational Risk is the risk of loss due to failures or deficiencies in internal controls resulting from errors in processing and storage operations, or in the transmission of information, inadequate or failed internal processes, people and internal systems or from external events as well as adverse administrative or legal resolutions, frauds or theft and includes, among others, Technological Risk and Legal Risk. This risk is inherent in all products, activities, processes and systems and is generated in all areas of business and support. Therefore, all employees are responsible for managing and controlling operational risks generated in its scope, from branches to support functions every employee of Santander is bounded to comply operational risk management. In terms of operational risk, Banco Santander (Mexico), aligned with the corporate methodology, has policies, procedures and methodologies for identification, control, mitigation, monitoring and disclosure of operational risks which are reviewed yearly In order to identify and group the operational risk use is made of distinct categories and business lines defined by the regulatory authorities, both local and as per the supervision of the institution. The methodology is based on the identification and documentation of risks, controls and related processes and uses quantitative and qualitative tools such as risk control self-assessment process, the development of historical databases and operational risk indicators, among others, for both the control and mitigation and disclosure requirements. Among the operational risks, is technological risk, which is defined as the potential losses from damage, interruption, alteration or failures derived from the use or reliance on hardware, software, systems, applications, networks and any other distribution channel of the information in providing banking services to customers of Banco Santander (Mexico). The Bank has adopted a corporate model for technological risk management, which is integrated into the processes of service and support of computer areas to identify, monitor, control, mitigate and report risks to Information Technology. This is designed to prioritize the establishment of control measures that reduce the likelihood of risks materializing. Another operational risk is legal risk, which is defined as the potential loss due to noncompliance with legal and administrative provisions, issuance of adverse administrative and judicial decisions and sanctions, related to bank operations. In fulfillment of the steps outlined in the administration of risks, the following functions have been developed: a) Establish a 3 Line of Defense Model for Operational Risk Management. b) Establish policies and procedures to identify, analyze, control and report Operational Risk, which are reviewed on periodically basis. c) Analyze the amount of direct or/and potential losses, resulting from the materialization of the latent operational risks. d) Disseminate within managers and employees, legal and administrative provisions applicable to operations. e) Mandatory annual training regarding Operational Risk for all employees. f) Perform internal legal audits at least once a year.

91 Millions 2017 RISK MANAGEMENT ANNUAL REPORT 90 For the calculation of regulatory capital required for operational risk since November 2016, the Alternate Standard Approach defined in CUB is used. Thus, to calculate the capital requirement for its exposure to operational risk, just as in the standard method, for each line of business a percentage was established on the income, but it determines that for the commercial and retail banks the income shall be substituted by the amount of loans and total amount each line of business. Operational losses were, during 2017, below the budget; as a result of an improvement of the control environment, strengthening of policies and recoveries through the year. Figure Operational Risk Losses Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Budget Losses Santander Mexico has no appetite to have more than 2% of the gross margin of operational losses. For 2017 the ratio stayed monthly below 1% Figure 2 Operational Risk Losses between Gross Margin Ratio 2.0% 1.5% 1.0% 0.5% Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Ratio Alert Limit

92 2017 RISK MANAGEMENT ANNUAL REPORT Operational Risk Control Operational risk management is developed taking the following elements: a. Identify the operational risk inherent in all activities, products, processes and systems. b. Define the operational risk profile specifying unit strategies and time horizon, through the establishment of appetite and risk tolerance, and budget monitoring. c. Promote the involvement of all employees in operational risk culture. d. Measure and evaluate the Operational Risk continuously and consistently with regulatory standards. e. Deploy control procedures. f. Monitor, verify and suggest mitigation measures that minimize operational risk. g. Identify the real operational risk exposure of Santander Mexico. h. Produce regular reports on the exposure to operational risk and level of control of both internally and to the market and regulators bodies. For each of these elements, Banco Stander (Mexico) should define and deploy systems to monitor and control operational risk exposures, integrated in the daily management of the bank, taking advantage of existing technology. Table 8A Properties model management and control of operational risk implemented in Banco Santander (Mexico) Promotes the development of operational risk culture Allows a comprehensive and effective operational risk management (identification, measurement, assessment, control, mitigation and information). Improves the coordination between departments to identify, communicate risks and boost efforts for the control. Operational risk information helps to improve the processes and controls, reduce losses and income volatility. Deliver information to the General Management for decision making. Facilitates the establishment of limits for operational risk appetite.

93 2017 RISK MANAGEMENT ANNUAL REPORT Capital 9.1 Overview Capital management in the institution seeks to ensure the solvency of the company and maximize profitability, ensuring compliance with internal capital targets and regulatory requirements. It is an essential tool for making strategic decisions using their management objectives established for determining risk appetite, planning and capital budgeting, and the use of metrics to evaluate the profitability and value creation business. To carry out this management is part of the following key objectives: 1. Capital Budget: It is held annually determining a set of target values for each of the months of the following year, which ensure that capital levels are adequate at all times with the risk profile of the entity and regulatory minimum requirements. 2. Capital Planning: It is made considering applicable regulatory requirements, and in it the sufficiency of current and future capital is analyzed by capital projections under different macroeconomic scenarios. 3. Establishment of Risk Appetite: Budget processes and capital planning must be aligned and coordinated with the establishment of risk appetite. 4. Minimum Criteria: In preparing proposals for capital targets should be considered: 9.2 Function of Capital All material risks to which the institution is exposed and are consistent with its risk profile referred. They are consistent with the budgets, strategic plans and business results forecasts, and liquidity and ability obtain funding from various sources, taking into account the correlation and dependency thereof. Incorporate risk factors external to the entity, arising from the regulatory, legal environment, economic or business. All applicable regulatory requirements are met. To be considered plausible stress scenarios in addition to the regular scenarios. That the objectives include at least quality and composition of capital (equity mix), ratios or levels of solvency, dividend policy and target values metric of profitability of invested capital and creating value by product segments, business and/or units. Capital policies set general guidelines that should govern the actions of the areas involved in the processes of management and control of equity Capital Strategic Policies Autonomy of Capital: Banco Santander (Mexico) is endowed with the capital required to autonomously develop their activity and meet regulatory requirements on capital and liquidity. Central Monitoring: The capital management model ensures a comprehensive view, so that the control exercised primarily by Banco Santander (Mexico) is complemented by the monitoring provided by the corporate unit.

94 2017 RISK MANAGEMENT ANNUAL REPORT 93 Proper Distribution of own Resources: Banco Santander (Mexico) should monitor their adequate capitalization (including its subsidiaries) and the adoption of balanced approach in the allocation of own resources to optimize the relationship between solvency and profitability. Reinforcement of Capital: Regardless of the need to operate with an adequate level of own funds (capital available) to meet legal and regulatory requirements, It ensures proper composition promoting the choice of computable elements of the highest possible quality (according to their ability to absorb losses, the retention time in the balance sheet of the entity and priority in the authorization) in order to guarantee its stability. Capital Preservation: The capital is a very scarce resource that must be used in the most efficient way possible. In this regard Banco Santander (Mexico) has mechanisms for continuous monitoring of capital consumption optimization. Sound Management: The capital management is based on ensuring the solvency based on an acceptable level of profitability on invested capital. This management is based on equity targets consistent with the risk profile of the institution limiting the levels and types of risks that the institution is willing to take on the development of its activity and ensuring the maintenance of adequate capitalization. Maximizing Value Creation: Investment decisions are aimed at optimizing the creation of value on invested capital, enabling management to align the business with capital management from analysis and monitoring of a set of metrics that relate the capital cost of resources to the benefit obtained by reversing the investment of them, that make it possible to compare performance on a standardized basis of operations, clients, portfolios and businesses. Stress Test: Banco Santander (Mexico) periodically performs stress tests under adverse scenarios to assess that capitalization remains solid and above risk appetite limits, approved and established by the corporate governance entities Management and Control Policies Objective of analysis and derivative actions: The main objective of the monthly monitoring and measurement metrics, is to help senior management in the process of making strategic decisions on solvency, capitalization and profitability of business. Minimum Frequency: At least once a month takes place a process of control and monitoring of the evolution of the different metrics of capital through various reports that are distributed to senior management and internal and corporate areas. Content of the Analyses: The causes of the variations in the amounts and/or deviations from budget or for business, changes in markets or economic variables, changes in the methodology of the models or parameters, changes in legislation or otherwise nature are studied Specifically, the main analyzes carried out with recurring basis are: Analysis of solvency and its evolution, comparing domestic capital base with regulatory capital requirements. Development of key capital metrics and analysis of the major monthly variations. Analysis of the volume of required capital and risk weighted assets based on risks other than credit risk.

95 2017 RISK MANAGEMENT ANNUAL REPORT 94 Analysis of the impact produced by recalibration, methodological changes in the patterns and changes in legislation. Analysis of the composition of capital in order to maintain a strong capital level, both in amount and composition thereof Organizational Structure and Governance Model The proper development of the function of capital, both in terms of decision-making and in terms of supervision and control, it needs a structure of agile and efficient governance organs to ensure the participation of relevant stakeholders, and ensure the necessary involvement of senior management. Table 9A Banco Santander (Mexico) Structure for Capital Management Comprehensive Risk Management Committee (CRMC): CRMC is responsible for submitting to the Board of Directors the following aspects of equity: a. Communications with the controller information on aspects relating to solvency and capital; evolution of figures of capital, return on capital, adjusted for risk; compliance with capital and budget plans associated with the implementation of internal models. b. Application for approval of objectives, guidelines, policies of capital: Minimum level of solvency of the entity. Minimum requirements for return on equity of business or transactions.