Spain's largest bank, one of the institutions hardest hit in the scandal, said it was offering the compensation to private customers. It made no mention of institutional investors.
The bank has been sued in Miami by investors who say it didn't adequately scrutinize the investments made with Madoff.
The lawsuit, filed in federal court Monday, claims Banco Santander was negligent, contending there was a "plethora of red flags" that should have alerted the bank that Madoff was running what the lawsuit says was Ponzi scheme. The suit seeks class-action status.
A New York-based lawyer for Madoff didn't immediately return a call seeking comment.
The bank said in a statement Tuesday that it acted with "due diligence" when one of its funds, Optimal Strategic US Equity, commissioned Madoff to handle investments by some Santander clients.
The bank says it is offering to give clients back their initial investment, in the form of preferred securities, but not interest accrued through Madoff funds.
These preferred securities will have an annual coupon of 2 percent, the bank said.
"The Group has taken this decision in view of the confluence of exceptional circumstances in the case at hand and on the basis of exclusively business considerations, namely the Group's interest in maintaining its business relationships with those clients," the statement said.