Banking group Santander revealed a 40 per cent drop in UK profits but hailed success in increasing support to small and medium sized firms.

The group’s UK arm, which swallowed the branch and savings business of Bradford & Bingley in 2008, loaned £4.3 billion to small and medium businesses in the year to December 31. That was higher than its £4 billion target in the Project Merlin deal with the Treasury.

The improvement followed the opening of five new corporate lending centres, bringing its total to 28, as well as the hiring of an additional 200 SME business advisers and the roll-out of mentoring services.

But in the first of the results from the UK banking sector, Santander’s bottom-line profits fell 40 per cent to £993 million after it put aside £538 million to deal with claims from mis-sold payment protection insurance.

Excluding PPI, underlying profits were down six per cent to £1.5 billion as margins were squeezed by the costs of regulation, including the Government’s bank levy, higher lending costs and limited demand for loans.

Amid expectations of a difficult year for the UK economy, the firm warned that the margin squeeze was likely to intensify in 2012.

Chief executive Ana Botin described the results as a solid performance in the face of challenging conditions and warned 2012 was likely to be “a tough year for the UK banking industry”. She added: "Economic prospects have deteriorated markedly even in recent months, whilst increased regulatory burdens and funding costs will increase results further."

Santander said net customer lending of £4.2 billion was driven by growth in SME loans and mortgages, suggesting that demand for personal loans had been weak.

The lender, which writes one in six UK mortgages, said the number of homes it repossessed rose to 10.5 per cent to 965, although this still represented a tiny fraction of its stock.

The group expanded in the UK following the acquisition of Bradford & Bingley's branches and savings book, Alliance & Leicester and Abbey National and it is in the process of buying 318 branches from Royal Bank of Scotland.

It plans to invest £490 million over the next three years in IT systems.

Meanwhile, gross lending by building societies and other mutuals in 2011 rose by 16 per cent in 2011 to £23.6 billion, bucking the trend across much of the rest of the market, according to the Building Societies Association.