Santander signBanking group Santander has revealed a 40% drop in UK profits but hailed its success in increasing support to small and medium sized firms (SMEs).

The group's UK arm loaned £4.3 billion to SMEs in the year to December 31, which 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% to £993 million after it put aside £538 million to deal with claims from mis-sold payment protection insurance (PPI).

Excluding PPI, underlying profits were down 6% 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. And amid expectations of another difficult year for the UK economy, the business warned that the margin squeeze was likely to intensify in 2012.

Chief executive Ana Botin described Tuesday's 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 about one in six UK mortgages, added that the number of homes it repossessed rose to 10.5% to 965, although this still represented only a tiny fraction of its stock.

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

It plans to invest £490 million over the next three years as it invests in IT systems to help it improve customer service and expand.