Annual Report UBank Ltd.

Transcription

1 Annual Report 2009

2 2 / Annual Report The Board of Directors Report to Shareholders General Meeting 115 Management Review of the Bank s Financial Position and Operating Results 135 Certifications of the General Manager and the Chief Accountant 138 Report of the Board of Directors and Management Regarding internal control over financial reporting, and auditor s report to the shareholders of Regarding internal control over financial reporting. 142 Financial Statements as at December 31, 2009 This is a translation from the Hebrew and has been prepared for convenience only. In case of any discrepancy, the Hebrew will prevail.

3 Annual Report 2009 Contents

4 4 / Annual Report 2009 Description of the General Development of Bank s Business 6 History of the Bank 6 Profit and Profitability 8 Developments in Balance Sheet items 11 Holdings Structure Chart 12 Significant Investee companies 12 Information about the Parent Company 12 Description of the Bank s Operational Segments 13 Distribution of Dividends 13 The Bank s Rating by a rating company 13 Human Resources 15 Restrictions and Supervision of the Bank s Activities 16 Significant Agreements 16 Information Systems 18 Legal Proceedings General Environment and Influence of External Factors on the Bank s Activity 19 Economic Developments in Updates in legislation in respect of the Banking system in Description of the Bank s Business according to Operational Segments 59 Fixed assets and Facilities 59 Taxation Additional Information 59 Risk Management Policy 95 Accounting Policy on Critical Matters and Critical accounting estimates 99 Contribution to the Community and Donations 99 Disclosure with Regard to the Bank s Internal Auditor 101 The Approval Process for Financial Report 102 Report on Directors with Accounting and Financial Expertise 103 Operation of the Board of Directors and Changes in Board Membership 103 Members of the Bank s Board of Directors 106 Members of the Bank s Management 107 Assessment of Controls and Procedures with Regard to the Disclosure in the Financial Report 108 Details of the Amounts and Benefits paid to the Recipients of the Highest Salaries in the Bank 112 Auditing Accountants Remuneration

5 Annual Report 2009 The Board of Directors Report to the Shareholders General Meeting

6 6 / Annual Report 2009 At the board of directors meeting which was held on March 23, 2010 it was resolved to approve and publish the consolidated financial statements of UBank Ltd (hereinafter referred to as the Bank ) and its consolidated subsidiaries for the year ended on December 31, The financial statements have been prepared in accordance with the Supervision of Banks directives and guidelines. Description of the General Development of the Bank s Business History of the Bank The Bank was incorporated in Israel in 1934 under the name Bank Eretz Israel le Toelet Ha ashrai Ltd. In 1965 the Bank was acquired by Baron Rothschild who named it Israel General Bank Ltd. In 1978, the Bank s shares were issued to the public on the Tel Aviv Stock Exchange. In 1996, the Bank was acquired by the Investec World Banking Group and in 1999 the Bank s name was changed to Investec Bank (Israel) Ltd. On December 22, 2004 ownership of the Bank was transferred to The First International Bank of Israel Ltd (hereinafter referred to as FIBI ). Upon the acquisition of the Bank by FIBI, and following the acceptance in full of a purchase offer made to the public, the Bank became a private company fully held by FIBI. Following the change of ownership, the Bank s name was changed in March 2005 to UBank Ltd, which acts as a separate and independent bank, specialising in the personal banking and capital market segments. Profit And Profitability Net profit in 2009 amounted to NIS 65.6 million, compared with NIS 65.3 million in 2008, an increase of 0.5%. Net profit in the fourth quarter of 2009 amounted to NIS 9.8 million, compared with NIS 19.7 million in the corresponding quarter last year, a decrease of 50.2%. The decrease derives mainly from a decrease in the profit from financing operations. Profit from ordinary operations before taxes totalled NIS million in 2009, compared with NIS million in 2008, an increase of 5.8%. The increase derives mainly from an increase of 10.5% in profit from financing operations (NIS 15.3 million), which was offset Partially by an increase 4.9% in operating and other expenses (NIS 8.4 million). See itemisation in the income and expenses analysis below. Provision for taxes on profit from ordinary operations totalled NIS 43.4 million in 2009 and represented 39.5% of the profit before tax, compared with a provision of NIS 39.4 million in 2008 that represented 38.0% of the profit before tax. The increase in the effective rate of provision for taxes derives from a decrease in receipt of dividends, which is taxes at lower tax rate, an increase in profit fax rate for 2009, from 15.5% to 16% and the expected gradual influence of the decrease in the statutory tax rate on the deferred taxes balances (according to the Economic Efficiency Law), which were partially offset by decrease in the companies tax rate. The return on equity of the net profit totalled 13.1% compared with 15.0% in The return on equity of the profit from ordinary operations before taxes reached approx. 21.9% compared with approx. 23.9% in 2008.

7 The Board of Directors Report 2009 / 7 Net profit per NIS 1 par value of share capital amounted to NIS 21.0 in 2009, compared with NIS 20.9 in Income and Expenses (): Change % Profit from financing operations Operating and other income (0.3) Operating and other expenses Of which: other expenses Of which: salaries expenses (4.4) Profit from financing operations before provision for doubtful debts totalled NIS million in 2009, compared with NIS million in 2008, an increase of 10.5%. The increase derives mainly from an increase in the operating return on the available-for-sale securities portfolio, locally and abroad, and an increase in profit realization in the available-for-sale securities portfolio in the amount of NIS 20.8 million. Profits in the available-for-sale securities portfolio in 2009 are offset by other that temporary impairment of NIS 13.7 million. (An other than temporary impairment was recorded in 2008 in the amount of NIS 15.4 million of which were NIS 5.4 million in mortgage-backed bonds). In addition increase derives from a range of activities in the area of the finance division, including being a market-maker for government bonds and other trading activities, which are part of the routine activity of the Bank. Provision for doubtful debts amounted to an income in the amount of NIS 3.9 million in 2009, compared with an income in the amount of NIS 4.4 million in The income in both years derives mainly from a decrease in the specific provision due to repayment of debts. Operating and other income amounted to NIS million in 2009, compared with NIS million in 2008, a decrease of 0.3%. The decrease derives mainly from a decrease in income from foreign dealing room commissions, a decrease in income from management fees of the mutual funds of the Bank a decrease in income from dividend. The decrease was partially offset by an increase in income from the activity in the Various spheres of the capital market and an increase in the Bank s Severance Pay Fund. Due to the new Bank Commission s Law, Management fees from mutual funds and distribution fees were reclassified from other income to operating commissions. Operating and other expenses amounted to NIS million in 2009, compared with NIS million in 2008, an increase of 4.9%. Salaries and related expenses in 2009 amounted to NIS 75.8 million compared with NIS 79.3 million during the corresponding period the year before, a decrease of 4.4%. The decrease is due mainly to the reallocation of salaries of the Bank s computer unit employees transferred to Mataf ( Computerization and Financial Operations - a subsidiary company of the First International Bank of Israel), in light of the conversion of the computer systems completed in January In addition, losses in the Severance Pay Fund in 2008 were recorded in this item. This decrease is partially offset by the increase in the provision for bonuses related to performance in 2009 and an increase in the number of employees employed in the Bank (an increase of 2.6%), due mainly to the opening of branches for affluent customers. Maintenance expenses and depreciation of buildings and equipment in 2009 amounted to NIS 21.9 million, compared with NIS 19.4 million during the corresponding period last year, an increase of 12.9%. The increase derives too mainly from an increase in expenses due to the opening of the new branches.

8 8 / Annual Report 2009 Other expenses amounted to NIS 80.8 million in 2009, compared with NIS 71.4 million in the corresponding period the last year, an increase of 13.2%. The increase is due mainly to an increase in computerization expenses after the abovementioned conversion of the systems, as a consequence of reallocation of salaries of the Bank s computer unit employees transferred to Mataf, and a rise in the overall payment for computer services to Mataf. (For further information on the subject of the computer services agreement with Mataf see the chapter dealing with Information Systems on page 16). This increase was partially offset by a decrease in expenses for professional services, marketing and publicity. The rate of cover of operating expenses by operating income was 69.5% in 2009, compared with 73.1% in Total income (Nis million) profit from financing operations and operating income operating income The Bank s share in profits (Losses) from equity basis companies amounted to a loss of NIS 0.8 million in 2009, compared with a profit than 0.9 million in Developments in Balance Sheet items The total balance sheet as at December 31, 2009 amounted to NIS 9,218.2 million, compared with NIS 8,498.1 million as at December 31, 2008, an increase of 8.5%. Cash and deposits with banks amounted to NIS 2,827.8 million at the end of 2009, compared with NIS 2,701.8 million at the end of 2008, an increase of 4.7%. Investment in securities amounted to NIS 2,498.2 million at the end of 2009, compared with NIS 2,930.7 million at the end of 2008, a decrease of 14.8%. The investment consists of: - Government bonds and Makam in the amount of NIS 2,060.9 million. - Foreign banks bonds ( Eurobonds ) in the amount of NIS million, of 20 different issuers. - Banks in Israel bonds in the amount of NIS million. - Government owned companies bonds in the amount of NIS 12.3 million. - Corporate companies bonds in the amount of NIS million of approx. 28 different issuers*. * of which a non material investment in mortgage-backed bonds in the amount of approx. NIS 1.2 million, rated AAA, issued by the Federal Home Loan Mortgage Corporation (FHLMC - Freddie Mac ) for a duration of 4.0 years.

9 The Board of Directors Report 2009 / 9 Following information regarding the duration and rate of the decrease of fair value of available for sale bonds, directly realized in the capital reserve and not recorded in profit and loss, as at (in NIS million): Rate of decrease Duration of decrease (in months) Up to Over 12 Total Up to 16.8% (4.8) (0.8) - (6.6) (12.2) Following information regarding the duration and rate of the decrease of fair value of available for sale bonds, directly realized in the capital reserve and not recorded in profit and loss, as at (in NIS million): Rate of decrease Duration of decrease (in months) Up to Over 12 Total Up to 20% (24.9) (2.8) (2.9) (0.5) (31.1) 20% - 40% (3.2) (15.4) (0.3) (4.1) (23.0) Over 40% (1.4) (1.4) (7.8) (4.7) (15.3) Total (29.5) (19.6) (11.0) (9.3) (69.4) The decrease of fair value of bonds for December 31,2009 consists of: Government bonds, government bonds traded abroad or bonds of government owned companies in the amount of NIS 4.3 million. The entire rate of decrease of government bonds is up to 20% and up to 6 months. A decrease of NIS 3.1 million in the fair value of foreign bank s bonds, rated A- and up (except for one bond that is rated BBB +) as at the balance date. (See also the report of existing credit exposures to foreign financial institutions). The decrease consists NIS 0.5 million up to 6 months and the rest is over 12 months. The entire rate of fair value decrease is up to 20%. Corporate bonds in the amount of NIS 4.8 million, consists of NIS 0.8 million between 6-9 months, and the rest is over 12 months. The entire rate of the decrease is up to 20%. The negative capital reserve of the Bank significantly decreases in 2009 from NIS 69.4 million as at 31 December 2008 to NIS 12.2 million as at 31 December The date excludes the effect of a positive capital reserve and tax. The capital reserve of the Bank as at 31 December, 2009 is negative in the amount of NIS 4.3 million, including the effects mentioned above (see note 3 Securities). When examining the need to make a provision for impairment, in accordance with the accounting policy for critical matters and critical accounting estimates, and in view of the fact that there were no material changes concerning the bond issuers mentioned, Bank Management is of the opinion that there is no need to make a provision for impairment of an other than temporary nature regarding these decreases in value, in the financial statements as at 31 December The examining of impairment was made according to the circular of the Banking Supervision department that was published on See the section dealing with impairment of assets in the Accounting Policy on Critical Matters. Credit to the public amounted to NIS 2,021.8 million at the end of 2009, compared with NIS 1,931.6 million at the end of 2008, an increase of 4.7%. The average balance in 2009 was NIS 1,804.7 million compared with an average balance of NIS 1,950.6 million in 2008, a decrease of 7.5%. The decrease derives mainly from short term credit for activity in the capital market.

10 10 / Annual Report 2009 Other assets amounted at the end of 2009 to NIS million, compared with NIS million at the end of 2008, an increase of 294.6%. The increase derives mainly from an increase in the net clearing balance in connection with securities activity with the Stock Exchange. Deposits of the public amounted to NIS 7,127.8 million at the end of 2009, compared with NIS 6,820.2 million at the end of 2008, an increase of 4.5%. The average balance in 2009 was NIS 6,736.6 million compared with an average balance of NIS 6,265.9 million in 2008, an increase of 7.5%. The increase derives mainly from short term deposits from activity in the capital market. Deposits from banks amounted to NIS 72.9 million at the end of 2009, compared with NIS million at the end of 2008, a decrease of 71.1%. Movement in this item derives mainly from daily interbank activity. The Bank s equity amounted to NIS million on December 31, 2009, compared with NIS million on December 31, The ratio of equity to total assets stood at 5.9% at the end of 2009, compared with 5.3% at the end of The capital to risk assets ratio according to proper Conduct of Banking Business Directive 311 amounted to 20.2% on December 31, 2009, compared with 24.9% on December 31, The capital to risk assets ratio that is required by the Bank of Israel is 9%. The capital to risk assets ratio, as of 31 December, 2009 calculated in accordance with the provisional directive working Framework for Capital Measurement and Adequacy (Basel II), is 16.7%.

11 The Board of Directors Report 2009 / 11 Holdings structure chart* UBank Ltd UBank Financial Asset Management Ltd Capital 100% UBank Mutual Funds Ltd Capital 100% UBank Trust Company Ltd Capital 100% UBank Underwriting & Consulting Ltd Capital 100% UBank Investments and Holdings Ltd Capital 100% Manif Financial Services Ltd Capital 19.6% * Significant companies.

12 12 / Annual Report 2009 Significant Investee Companies A. UBank Asset Management Ltd. (hereinafter referred to as the Company ) engages in providing investment portfolio management services for private and institutional customers. Until 31 December, 2009 The company wholly owned UBank Mutual Funds Ltd., which engages in managing various mutual funds. On 31 December, 2009 the entire holding was transferred to (for further information, see note 5). The total assets under management at the responsibility of both companies in 2009 is approx. NIS 1.4 billion, of which approx. NIS 0.7 billion represents investment portfolio management and approx. NIS 0.7 billion represents mutual fund management. The Company ended 2009 with a loss of NIS 0.2 million, compared with a loss of NIS 1.0 million in 2008 (excluding the results of UBank Mutual Funds Ltd.). B. UBank Mutual Funds Ltd. ended 2009 with a net Profit of NIS 0.2 million compared to NIS 1.2 million in C. "Ubank Trust Company Ltd." (henceforth: "the Company") is engaged mainly in providing trust services for mutual funds, and in addition, as a trustee for bonds series of spc and advanced fincial instruments and holding assets of individuals etc. The net profit of the Company for 2009 totaled about NIS 13.0 million, compared with NIS 13.5 million in D. UBank Underwriting & Consulting Ltd. engages in underwriting issues and financial counselling. The company s net profit amounted to less than 0.1 million in 2009, compared with a loss of less than 0.1 million in As of 31 December, 2009 the Board of directors of the company is considering how the operations of the company are to continue. E. UBank Investments and Holdings Ltd. (henceforth: the company ) is engaged mainly in renting premises, equipment and furniture for the Bank and connected companies. The net profit of the Company for 2009 amounted to NIS 0.8 million, compared to NIS 4.4 million in Information about the Parent Company The FIBI Group is one of the five largest banking groups in Israel. The Group operates in a number of financial activity sectors: commercial banking, private banking, mortgages, activity in the various layers of the capital market, international financial activity, leasing financing, factoring, credit cards and various financial services. In addition to Ubank, the FIBI Group owns three commercial banks in Israel - Otsar Hahayal Bank, Poaley Agudat Israel Bank and Massad Bank Ltd. - and 2 subsidiaries in abroad, FIBI Bank (UK) plc headquartered in London and FIBI Bank (Switzerland) headquartered in Zurich. The Group operates through 175 branches and extensions in Israel, out of which 85 branches and extensions attributed to the Parent Company. Description of the Bank s Operational Segments The following is a short description of the segments of the Bank s business activities: The Private Banking segment - includes all the Bank s private customers and their businesses. These are both private customers belonging to the personal banking division and also private customers in the capital market division, whose principal operations are in securities. In addition, the segment includes the activity of the Asset Management company of the Bank, the Fund Management company and the Bank s Trust company customers except from trust services for mutual funds area. The Corporate banking segment - includes all the institutional customers whose principal engagement is in the financial sphere, such as: groups engaged in insurance, pensions and provident spheres, mutual funds,

13 The Board of Directors Report 2009 / 13 portfolio managers and the like. These customers are attributed to the capital market division. In addition, the sector includes the customers of the Trust company of the Bank in the area of trust services to mutual funds. The Financial segment - this segment includes the activities of the dealing rooms, liquidity unit and the assets and liabilities management department of the Bank. The Bank has no significant activity in the households, small business segments and commercial Banking Segment. For detailed information, including a financial analysis, see the section that discusses the description of the business of the Bank according to operational segments. Distribution of Dividends In December 2007 a dividend in the amount of NIS 100 million was declared and distributed. During 2008 and 2009 there was no distribution of dividends. In March 2010 a dividend in the amount of NIS 75 million was declared and distributed. The Bank s rating by a rating company The Midroog company rated the Bank s deposits as Aa3 and the short-term deposits with a rating of P-1. Human Resources Description of the Organizational Structure and the Number of Staff employed Five managers are directly subordinate to the Bank s General manager, as follows: The manageress of the Personal Banking division, to whom the Bank s branches are subordinated (including the business and current account). The average number of employees in the personal banking division in 2009 amounted to 96 (in ). The manager of the Capital Market division to whom the Israeli securities and foreign securities trading departments, the Israeli securities and foreign securities back-room systems, the mutual funds operations department and the banking team that provides services for the customers of the division, are all subordinate. The average number of employees in the Capital Market division in 2009 amounted to 83 (in ). The manager of the Financial division to whom the assets and liabilities department, the liquidity unit and the dealing room, are subordinate. The average number of employees in the Financial division in 2009 amounted to 13 (in ). The manager of the Central Services division, to whom the following departments are subordinate: Human resources and administration, credit and risk management, Regulation and processes, the legal department, planning and marketing and computerization liaison officer. The number of workers employed at the Headquarters Division amounted in 2009 to 55 employees on average (in employees). The main decrease in the number of workers employed derives from the reallocation of the Bank s computer unit employees to Mataf following the conversion of the computer systems completed in January 2009 (for further information see the chapter dealing with Information Systems on page 16). The manageress of the Chief Accountant division, to whom the following departments are subordinate: accounting, international and reconciliations and bookkeeping and payments. The average number of

14 14 / Annual Report 2009 employees in the Chief Accountant division in 2009 amounted to 18 (in ). In addition, internal audit services rely for the most part on the internal auditing system of FIBI. For additional information see the section that deals with disclosure with regard to the Bank s internal auditor. In respect of information systems services, see details in the section that deals with information Systems. Set out below are data as to the number of employees at the Bank and its subsidiaries at the end of the year and the monthly average during the year: As at year end: Permanent Staff Other Staff* The Bank Subsidiaries Total Total Permanent Staff Other Staff* Total Permanent Staff Other Staff* Total Monthly average: * Includes hourly staff, staff from manpower agencies and outsourced staff. Changes in Manpower 9% of the bank s employees started working for the Bank during Turnover of employees on that scale allows the organization an influx of new manpower and does not affect the work routine, as a result of learning processes and temporary inefficiency on the part of the recruited employee, and training processes and close management during the first period on the part of the managers doing the recruiting. Contracts of Employment All of Ubank s employees are employed under personal contracts of employment. These agreements afford the Bank maximum flexibility of employment, while providing a swift response to the needs and conditions of the market and the Banks business activity. For information on employees rights on retirement - see details in note 11. Training The improvement of the level of professionalism in the Bank is a result of quality and focused recruitment, but also of a personal and organizational training program that matches the needs of the Bank, and is defined in the annual work program. The training program in the Bank includes professional teaching and training in different fields of routine banking activity. The training program is derived from various changing factors such as: the business policy of the Bank, developments expected in the market in general, and in the banking sector in particular, regulatory changes and so forth. The integration of UBank into the First International Bank Group has given the Bank s employees opportunities to use the training system developed by the First International Bank, courses, study days, supplementary learning and training. The training program provides opportunities, as a motivating factor for employees, an opportunity for the development of personal skills and allows for the personal development of employees in different subjects. In parallel, the Bank encourages personal and professional development by means of, among others, participation in funding academic studies meeting the Bank s requirements, and by assisting with vacation days during examinations.

15 The Board of Directors Report 2009 / 15 Remuneration programs for employees In accordance with the directives of the Supervisor of Banks from April 2009, the Board of Directors of the Bank discussed remuneration policy and the methodology for its implementation, with the aim of finding a balance between the desire to encourage motivation, creating identification of long-term interests among the managers with the Bank, retaining and rewarding managers and the desire for achievement, together with the need to prevent exaggerated risk-taking. The policy relates to all Bank employees and is a part of Group policy that was put together with the participation of the parent company, in accordance with the directive of the Supervisor of Banks. The policy is still in the final stages of formulation and awaits the approval of the Bank of Israel. Code of Ethics During 2009 the writing of the Bank s Code of Ethics was completed, with the aim of promoting ethics and social responsibility and incorporating appropriate norms of behavior among the Bank s employees and its managers. The writing of the Code of Ethics was done with the participation of the Banks employees. Ethics institutions were created and activities were carried out to incorporate the Code of Ethics, including: lectures directed to all employees and the distribution of the Code of Ethics brochure to each and every employee individually. Restrictions and Supervision of the Bank s Activities In Proper Conduct of Banking Business Regulation Limitations on the Indebtedness of a Borrower and a Group of Borrowers, there are restrictions, according to which the Bank is not allowed to extend credit to a single borrower, to a group of borrowers and to the six largest borrowers including groups of borrowers (as defined in the Regulation) in amounts that exceed 15%, 30% and 135% of its shareholders equity, respectively. The Bank reached an agreement with certain borrowers and certain groups of borrowers in respect of the said Regulation, that their credit facilities will only be exercised if that does not result in the exceeding of the restrictions that are described above. In Proper Conduct of Banking Business Regulation Activity on the Future Contracts and Options (MAOF) Market there are restrictions, according to which the total amount of the liabilities of a banking institution vis-à-vis the MAOF clearing system (after allowed deductions) shall not exceed 30% of the Bank s equity. In light of the high volume of activities of the customers of the capital market segment on the MAOF market, the Bank examines the said restriction on a current basis. In Proper Conduct of Banking Business Regulation Supplementary Provision for Doubtful Debts, it is stipulated that an additional provision for doubtful debts is to be made in respect of the concentration of debt in sectors. The Bank is exposed to such concentration in the financial services sector. This concentration follows the business policy of the Bank according to which the capital market customers segment is among the main segments of activity. The Bank is meticulous in implementing the restriction. In 2008 and 2009 no exception occurred to the sector concentration limit. In addition, see details on the subject of the reform in the capital market, in the chapter that deals with operational segments with reference to the activity of UBank Mutual Funds. Other than what is described above, there are no other restrictions and supervision that are specific or relating to the Bank in the period under review or which are expected to have a significant effect on the activities of the Bank in the future.

16 16 / Annual Report 2009 Significant Agreements a. Agreement for the transfer of factoring operations: On January 25, 2007 an agreement was signed between the Bank and Otsar Hahayal Bank Ltd. (hereinafter referred to as Otsar Hahayal ) (fully owned by a controlling shareholder of the Bank) for the transfer of the Bank s operations in the area of factoring services to Otsar Hahayal, including transferring the expertise acquired by Ubank in the sphere. Pursuant to the agreement, from February 1, 2007 Ubank will cease giving its customers factoring services in new transactions and will refer such customers to Otsar Hahayal (hereinafter referred to as the existing customers ) to obtain services. Furthermore, the Bank shall be entitled to refer Otsar Hahayal new customers who wish to receive factoring services from it in the future (hereinafter referred to as the new customers ). In return for the transfer of the above activity, The Bank is entitled to annual payments deriving from the profits of Otzar Hachayal from factoring activity of existing customers and new customers, after offsetting provisions for doubtful debts in respect of existing clients up to the total of the profits, all in accordance with definitions and formulas for calculation determined in the agreement. The period of the agreement is fixed for eight years. Since it came into effect, its influence on the results of the Bank s activity has not been material. b. Computer services agreement For detailed information see a chapter regarding the information system. c. See additional relevant information in the following notes to the financial statements: - With regard to agreements relating to the change of control in the Bank - see note 16(E). - With regard to the Bank s liabilities to the MAOF clearing house - see notes 15(C)(2) and 15(C) (3). - With regard to the Bank s liabilities to the Stock Exchange clearing house - see note 15(C)(4). - With regard to the collateral agreement with Euroclear - see note 15(C)(5). - With regard to the indemnification of office holders - see note 15(C)(8). - With regard to the commitments between the Bank and FIBI - see note 15(C)(10). - With regard to pledges - see note 15(D). - With regard to the extension of the rental of buildings - see note 15(c)(11). Information Systems a. Computerization: As part of the FIBI Group, steps are taking place to take advantage, in various areas, of the Group s size. One of the areas is integrating Ubank s computer system with the Group s systems, while preserving the relative advantage of the Bank. Within this framework, the two banks computer infrastructures were amalgamated and the computer systems supporting the various applications were converted. The responsibility for data security was transferred to Mataf ( Operational & Financial Computerization - a subsidiary of FIBI). Most of the process of amalgamating applications in the framework of which the computer applications of UBank and First International Bank Ltd. were unified, was completed by and as at the bank works with FIBI s computer infrastructures. The new computer systems integrate special-purpose systems together with the branch system, such as: the mutual fund operating system, the trusteeship management system, systems supporting dealing room activities, the financial risk management system and so on.

17 The Board of Directors Report 2009 / 17 During the migration of systems to the new computer applications, problems arose in a number of areas, which necessitated concentration of inputs and investment of resources. These matters were dealt with by the Bank in cooperation with Mataf and with the help of other external suppliers. The Bank has made preparations to deal with completing adaptations required to the needs of users and customers, Special emphasis has been placed on the implementation of controls for purposes of financial reporting and for the management of exposures and risks. However, the Bank is aware that management and financial reports are produced on the basis of new computer systems in which work process are taking place for the first time in UBank in Both the systems, and the way in which they are operated, are based on that existing in the FIBI Group, which is following up the process from the beginning until the completion of its integration. For purposes of the Board of Directors and Management s signature on the Report on Internal Control over Financial Reporting for the 2009 financial statements, the Bank performed a full mapping out of the control environment over financial reporting, while testing for operational effectiveness towards the end of the year. During the preparation of the financial statements, the Bank verified that key controls in financial reporting processes are carried out also at present. The Bank examines every improvement required in the various systems, both for operating and controlling business activity and in the areas of online banking in order to make it easier for customers. In this framework substantial improvements and changes have been integrated in 2009 in a number of applications, and the Bank has defined and characterized additional requirements which are in advanced stages of treatment. In accordance with the principles of the undertaking between the Bank and Mataf, Mataf bore the costs of the process of unifying applications between the banks. The Bank pays Mataf for ongoing computing services the same amount of computer costs (including depreciation) that the Bank had in 2005 and, in addition, it bears its share in development of regulatory and Group applications as will be agreed upon, with the addition of an agreed increase. Recently, a new model of the undertaking that will begin in 2010 was approved, which is based on the relative share of the Bank in all computer activities carried out in the FIBI Group. Mr. Amnon Beck, Mataf s CEO, serves as manager of information technologies of the Bank as of b. Providing of Computer Services: As a separate matter from the question of the systems themselves and as part of the strategy of the FIBI Group, computer services, including operations and programming, are provided by means of the subsidiary company - Mataf. The services are provided directly by the staff of Mataf. As part of this strategy, the employees of the Bank s computer department became employees of Mataf in As a result, all of the Bank s computer services, including operational services and programming services, are provided to the Bank by the Mataf company.

18 18 / Annual Report 2009 Legal Proceedings Set out below are details of five actions for material amounts, exceeding 1% of the Bank s equity, against the Bank and its consolidated companies. In the view of Management, based on legal opinions, appropriate provisions have been made in the financial statements, if required, to cover any damage resulting from the said actions. In the Bank s view, based on the opinion of its legal advisers (and in the view of consolidated companies based on their legal advisers opinion), the probability of a risk exposure occurring to the Bank is low, in all five actions specified below: 1. On July 25, 2002 an action was brought in the Tel Aviv District Court against a company which shares were traded in the stock exchange ( the company ), UBank Trust Co. Ltd. - a wholly owned subsidiary of the Bank ( Trust Company ), Poalim Capital Markets & Investments Ltd., directors of the company, its controlling shareholders, the parent of the company, and the accountants who audited the company accounts. The total damage alleged by the Plaintiff is approx. NIS 32,000 (The quoted amount of the suit is NIS 36.7 million). Together with the action an application was filed in Court to recognise it as a class action on behalf of all the holders of the debentures that the company issued, in an estimated amount of approx. NIS 34.2 million. After several delays in proceedings in the class action caused by the need to complete the process of liquidating the company, the Trust Company submitted a response to the petition for approval of the claim as a class action. The evidence in the case was heard, and we are waiting for a hearing on the case and the summing up. In the opinion of the Trust Company and its legal advisors, the Trust Company has valid claims, both against the suit being admissible to be judged as a class action, and also on the matter of the law-suit against the Trust Company. 2. On July 27, 2003 two customers brought a claim in the Tel Aviv District Court for the award of declaratory judgment to the effect that one of the customers does not owe the Bank money and that the pledge of shares of a Stock Exchange listed company that serves as collateral for both customers debts, which the Bank is seeking to realize, is invalid. The value of the dispute according to the statement of claim amounts to approx NIS 25.6 million. The claim is at the pre-trial stage. 3. On December 22, 2005 a claim was brought in the Tel Aviv District Court against UBank Trust Co. Ltd. ( the Company ) which was corrected to approx. NIS 30.6 million on September 15, 2009 by three Plaintiffs, which are related companies. The Plaintiffs held debentures for which the Company served as trustee. Because of financial difficulties the issuer of the debentures did not discharge its debts to the debenture holders. The company has submitted an amended defense plea. In the opinion of the Trust Company and its legal advisors, the Company has a good defense against the lawsuit. 4. In October 2006, judgment was given by the Jerusalem District Court, according to which the counterclaim submitted by a customer of the Bank, for a declaratory judgment that his losses in the amount of NIS 10.1 million resulted from the Bank s errors and negligence, was dismissed. The customer filed an appeal against the verdict with the Supreme Court. 5. On , a lawsuit was submitted to the Tel-Aviv District Court in Tel- Aviv against the Bank by a customer in the sum of NIS 7.6 million. It was claimed that the Bank was negligent in honoring checks amounting to NIS 5.0 million. The checks were forged by an employee of the customer; the Bank has submitted a defense plea and a third party declaration against the employee.

19 The Board of Directors Report 2009 / 19 General Environment and Influence of External Factors on the Bank s Activity Economic Developments in ended in a positive trend of development in the Israeli economy and the worldwide economy. The global economic crisis, that began developing in the second half of 2007 up to the third quarter of 2008, led to a deep recession that has been much shorter than earlier expectations: in the last quarter of 2008 and the first half of Beginning in the third quarter of the year there were signs of recovery from the global recession. In the Israeli economy, green shoots of the recovery were seen earlier - from the second quarter of If in the first months of 2009 the estimate was for negative growth in Israel of about 1.5%, the estimate at the end of the year for growth in GDP for 2009 is a positive rate of 0.5%. All in all, the Israeli economy has suffered less than other countries from the global crisis - the global rate of growth in 2009 is (0.8%) and in developed countries (3.2%). In 2010, according to the forecast of the International Monetary Fund, worldwide growth should reach 3.9%, in developed countries - 2.1%, and in the U.S.A - 2.7%. The International Monetary Fund estimate for Israel is for growth of 2.5%, but the Bank of Israel expects a more rapid growth of 3.5%. Economic analyses indicate the unorthodox macro-economic intervention in the monetary, physical and financial fields as the reason for the relatively rapid global economic improvement in the state of the economy. Against this background, there is uncertainty regarding continuation in the trend of ending the economic crisis, due to the fact that policy makers are declaring their intention of ending their policy of macro-economic support. Moreover, intervention by governments has created a difficult fiscal situation with a real potential for financial crisis in several countries. In Greece, Portugal and Spain, the rating and rating forecast have been decreased, out of concern over debt repayment ability. Fiscal incentives and the ever-growing burden of deficit funding, have increased government debts tremendously and reached all-time records. All of the above, and uncertainty regarding the degree of stability of many financial institutions worldwide, cast a cloud over the trend of recovery that as stated has clearly been observed and is still continuing since the second half of The ending of the recession in the Israeli economy, that as mentioned started earlier, seems much more established and less fragile compared to worldwide trends, even though global trends have a significant effect on Israel. The fiscal situation in Israel is also much better than in the rest of the world. The budget deficit has grown much more moderately, and the debt-to-gdp ratio maintained its stability. Trends in Israeli capital market have been much more positive compared to those in global capital markets. Trends in the labor market are much more positive - the increase in the unemployment rate has been much more moderate and ever since the third quarter of 2009 is in decline, compared to a worldwide increase. The estimate of growth in GDP in Israel for 2009 was as mentioned 0.5%. In the second half of the year, it reached 2.9% in annual terms and, in the last quarter of the year, more than 4.0%. Production of the business sector decreased in 2009 by 0.4%. Most prominent is the decrease in exports, excluding diamonds, of 10.8%. Imports, excluding defense imports and diamonds also recorded a significant decrease of 13.4%. Private consumption increased by 1.1%, which means a decrease in consumption per capita (the standard of living) of 0.6%. Excluding the effect of private vehicles, the increase in private consumption is 2.1%, and without a decrease in consumption per capita. Investment in fixed assets excluding ships and aircraft dropped by 6.6% and public consumption excluding defense imports grew by 2.5%. The trend of recovery starting in the second quarter of the year began with private consumption, but from the third quarter of the year, there also was an increase in exports and investments, and the rate of growth of imports also accelerated. The rate of unemployment, following the economic crisis, increased in 2009 and reached 7.7% of the work force, after reaching a relatively low rate in 2008 of 6.1%. During the second half of 2009, a decrease in the unemployment rate began and the assessment is that in 2010 it will reach 7.0% of the work force. The deficit in the government budget has also risen following the crisis, and its effect on revenues from taxes, and reached 5.15% of GDP. That is a lower rate than the budget estimate for 2009 that forecast a deficit of 6.0% of GDP. In 2010, a further decrease in the deficit is expected, of up to 4.0% of GDP. The debt-to-gdp ratio has remained more or less stable, and has not exceeded the level of 80%, despite the

20 20 / Annual Report 2009 increase in the deficit and the need to finance it by raising funds from the public. This is due to the effect of the increase in prices of production and the strengthening of the shekel last year. The current account surplus in the balance of payments increased significantly in 2009 and reached $7.2 billion compared with $2.1 billion in The main factor in the increase in the surplus is the sharp decrease in commodity prices, especially fuel prices, in comparison with the averages of 2009 and In addition, as mentioned, the decline in imports has been stronger in comparison with the decrease in exports of commodities and services. The expectation is that recovery in economic activity, together with a rapid increase in imports in comparison with the increase in exports, will reduce the current account surplus to $ billion in 2010, and that has significant consequences on the strengthening or weakening of the shekel in the year to come. Inflation in Israel during 2009 reached 3.9%, similar to the inflation rate in 2008 of 3.8%. In comparison with developed countries, where inflation during the last year was close to zero, that is considered a high rate of inflation, but in comparison with emerging and developing countries, where it reached 5.2%, it is a relatively low inflation rate. It exceeds the target range for inflation and has been affected this year by price increases that resulted from involvement by government - V.A.T, water tariffs, cigarettes, and tax on fuel. After deducting these price increases, inflation reached 2.8%, slightly lower than the top end of the inflation target. Housing and energy items had the most effect on the increase in prices last year. It should be mentioned that the increase in prices of housing of home-owners, which is not part of housing prices measured in the Consumer Price Index, amounted to about 18% from the beginning of the year. The most prominent increase in housing prices was affected by the sharp decrease in the interest rate, resulting in a decrease in the cost of mortgages. The public tended to shift towards investment in real estate, against a backdrop of a lack of attractive investment alternatives. At the same time, the decrease in the interest rate had no affect on the growth of the housing supply, where starts and completions of residential construction reflected a decline as well as the number of houses for sale. In 2010, a decrease is expected in inflation to reach the inflation target range of 1%-3%, with the factors that accelerated it in 2009 not expected to continue having an effect in During the first third of the year, the Bank of Israel interest rate was in an unprecedented downward trend, reaching 0.5%, with the purpose of moderating the effect of the deep global crisis on the financial and non-banking markets in Israel, against the backdrop of weakness in overseas markets and the enhanced risks of heavy recession. Similar action was taken by central banks around the world. With the accumulation of indicators pointing to a continuous and significant recovery, the interest rate began to climb again starting from September The pace of the increase in the interest rate is slow and precedes increases in interest rates around the world, which are expected to begin only in the middle of 2010, with the establishing of the trend for ending the recession, which is at this stage, as mentioned, not yet certain. Until February 2010 the interest rate increased by only 1.25%, reflecting a still considerable real negative interest rate of about 2.5%. Towards 2010, a positive interest-rate gap began to develop again between Israel and the rest of the world when comparing central bank interest rates. However, the positive gap on long-term bonds is on a decreasing trend. The ending of the crisis for the economy should bring about the continuation of adjustment of the interest rate to the ongoing establishment of the new domestic economic environment. Despite that, the pace of adjustment depends on developments in the global economic environment that do not match developments in the Israeli economy. Under current trends, it is very likely that this process will not be completed during The management of monetary policy of close to two years by the Bank of Israel is not only executed through interest rate decisions, but also through intervention by the Bank of Israel in the foreign exchange market. The increasing current account surplus in the balance of payments and positive capital movements into the economy, reflect among others the gap in the depth of the economic crisis between Israel and the rest of the world (in the world the crisis is relatively deeper). This situation led the Bank of Israel to intervene in the foreign exchange market and purchase dollars in considerable amounts, in order to prevent excessive strengthening of the shekel that could seriously harm the export sector and deepen the recession. During 2009, the shekel strengthened against the dollar at an aggregate rate of 2.1%. These trends, perhaps with a lower intensity, are expected to continue during 2010, against the background of the expectation of a current account surplus and positive capital movements in the coming year also. To that should be added the positive interest rate gap that has increased during recent months and should continue to rise also in The strengthening trend of the shekel is one of the factors that are supposed to stabilize inflation in 2010 within the inflation target range, even though the level of interest rates will continue to be relatively low, and may push inflation upwards.

21 The Board of Directors Report 2009 / marked the ending of the crisis affecting capital markets in Israel and around the world. After the sharp decrease in the markets in the last quarter of 2008, the fear of collapse of the world economy declined and negative trends became more moderate. Price increases in 2009 were a natural reaction to the sharp decreases at the peak of the crisis. The Tel-Aviv 25 index increased by approx. 75% in 2009, and at the end of the year reached a level higher than on the eve of the crisis in September The index increased by close to 95% from the low point of November Increases focused on stocks included in sectors that had been eroded due to negative developments in these sectors overseas - banking, insurance and real estate. A prominent increase of approx. 150% was registered in the Tel-Aviv 75 index, caused by a jump in the prices of several stocks connected to drilling for gas along the coast of Israel. Sharp increases have characterized most stock indices, among them the Yeter 50 and Real Estate 15, that have more than doubled, and the Tel-Tek 15 index that increased by approx. 85%. These indices stood out in 2008 with sharp decreases of approx. 65%-80%. In stock markets abroad, despite the problematic start to the year, stocks of the S&P 500 ended 2009 with the best return since 2003, 23.5%, of which, since the low point in March, the index added about 67% to its value. The Dow-Jones increased this year by 18.9% and the NASDAQ index increased by 43.9%. Europe also registered increases: the French CAC-40 index increased by 22.3% and the German DAX index by 23.9%. In Japan, the Nikkei index increased by 19% and in Honk-Kong the Hang-Seng index jumped by 52%. The bond market in 2009 was characterized by price increases in all bond types. In corporate bonds linked to the index, an average increase of close to 40% was recorded this year. The increase in prices of corporate bonds this year follows their erosion by approx. 20% in September-December The Tel- Bond 20 index increased by close to 22% and the Tel-Bond 40 index, of which many of the bonds included in it are connected to the real estate sector, increased by twice that rate, close to 44%, since the beginning of the year, following a decrease of about 33% during the last four months of Government bond prices, which were not affected by the crisis, recorded an increase this year of up to approx. 10%, whereas non-linked bonds, Shahar, increased by only approx. after an increase of close to 12.5% in the previous year. Updates in Legislation and Rulings affecting the Banking System in 2009 Over the last year, there were changes and initiatives for changes in legislation, together with changes in regulations, which have implications on the banking system and on the Bank, as set out below: Joint Investment Trust Law (Amendment No. 14), 2009 The draft law was published on The main amendment is a change to section 69 in the Joint Investment Trust Law. The main changes are as follows: an obligation was imposed on the fund manager to hold a tender for brokerage commissions with a trading company (a member of the Stock Exchange); the Board of Directors of the fund manager must fix a procedure for holding a tender which will be approved by the trustee; entering an undertaking with a stock exchange member overseas can be made without a tender (within the terms of the law); an undertaking by a fund manager under a brokerage agreement with a stock exchange member controlling the fund manager or the trustee of the fund can be made without a tender subject to the following conditions: 1. The stock exchange member must meet the minimum conditions that were set out in the tender. 2. The commission for any kind of a deal will not exceed the commission that the winner of the tender will be paid for a similar deal. 3. The undertaking was approved by the Audit Committee and the Board of Directors of the fund manager. The fund manager will not make payments from the fund s assets to stock exchange members related to the fund manager or trustee, for a period of 12 months commencing on the date decided by the fund manager in the prospectus, for the execution of transactions in the trust s assets, in an amount exceeding 20% of all commissions (of all types) that were paid from the fund s assets in that year.

22 22 / Annual Report 2009 The amendment will come into effect 12 months after publication of the amendment to the law. It should be mentioned that the amendment to the law replaces the same sections in the proposed Joint Investment Trust Law (Amendment No. 13), 2008, which deal with the requirement for a tender and restrictions on payments of brokerage commissions to a company related to a fund manager or a trustee. The amendment should have a significant effect on the business of the Bank and the results of its activities, because the Bank has significant activity both as a banker and as a trustee for mutual funds through its subsidiary company UBank Trust Company Ltd., which may bring about the need for significant reduction in one of these activities. As of the date of approval of these Financial Statements, no decision has yet been made by the Bank, regarding the manner of preparation for the implications of the above-mentioned legislation. Regulation of Engagement in Investment Advice, Investment Marketing and Investment Portfolio Management Law (Amendment No. 13), 2008 The amendment was published in the Official Gazette (Reshumot) on , and will come into effect sixty days after its publication. The proposed amendment deals with the following subjects, among others: Setting up an arrangement whereby foreigners that have been authorized in their own countries to engage in investment advice, investment marketing and portfolio management, will be allowed to offer their services in Israel without the need of an appropriate Israeli license, on condition that the services will be given within the framework of an authorized Israeli corporation. The authorized corporation will be made responsible and be given the duty of supervision with regard to the activity of the foreign trader in its framework. Among the threshold conditions for an undertaking between the authorized corporation and the foreign trader: an undertaking agreement, the foreign trader must hold a license from his country of origin to engage in the same service and the authorized corporation must be authorized on its own merit to provide the same services to which the undertaking agreement applies - regulations are proposed (detailed as follows for the regulation of the request for registration); the granting of an exemption from the license to manage portfolios for sophisticated customers (henceforth: qualified customers ) and the adding of customers with large asset portfolios and customers with significant experience in the capital market activity or relevant expertise for activity in this market to the list of customers for which there is an exemption from owning a license for advising, investment marketing and, as proposed, also investment portfolio management, due to their being qualified to purchase professional assistance with their own money in order to make investment decisions by themselves or because of their skill in the capital market, and as a result, do not require the protection of the law inherent in the requirement for a license; the granting of authority to the Israel Securities Authority to make use of outsourcing for purposes of supervision of license-holders; increasing activities permitted for a portfolio management company, including pension counseling/marketing and other subjects. Israel Securities Authority Circular - Principles of measurement of the Bank s earnings from investment advisory activities and the remuneration of investment advisors On , the ISA published a circular to banking corporations concerning the method of measuring the Bank s earnings from investment advisory activities and the remuneration of investment advisors. The aim of the circular was to provide a balance between a conflict of interest that might be created between the benefit of the Bank and the personal benefit of the investment advisor, and the benefit of the customers, and the concern of a breach of fiduciary duty and the exercise of caution set out in the law: 1. When use is made of measuring or compensatory mechanisms based on the contribution to profitability of the unit or the branch, action should be taken to reduce the potential for conflict of interests by diluting the effect of the parameter of profitability on measurement and compensation, and diluting the effect of the individual advisor on the profits of the unit. 2. An investment advisor should not be compensated directly or indirectly for the Bank s income from his investment advisory activity. 3. Personal measurement of investment advisors is permitted only on the basis of qualitative parameters, as much as possible, which are segregated from the Bank s profits from investment advisory activity which they performed.

23 The Board of Directors Report 2009 / 23 Circular of the Supervisor of Banks concerning environmental risks to banking corporations On June 11, 2009, the Supervisor of Banks issued a directive concerning environmental risks to banking corporation (henceforth: the directive ). Banking corporations will be required to incorporate in the range of credit considerations the identification and assessment of environmental risk, and to take steps to assimilate the management of exposure to environmental risk in the range of risks of the banking corporation. Implementation of the circular will be in accordance with criteria and timetables to be approved by the board of directors of the banking corporation, by , while for purposes of implementation it will be possible to draw on accepted principles and international standards on the subject of environmental risk management, with those adjustments necessary to the environment in Israel. Reform in the area of banking commissions A number of private members bills are tabled in the Knesset concerning restrictions on the level of commissions, baskets of commissions, the prohibition on charging types of populations with certain commissions, the prohibition of charging certain types of commissions and so on. In addition, there are private member s bills tabled in the Knesset seeking to make banking corporations pay interest on current account balances of their customers. The Bank is monitoring developments in the legislative process of those proposals, which are still in the preliminary stages of legislation. Powers of the Securities Authority Law (Amendments to Legislation), 2008 The Law was passed in the plenum of the Authority on The main changes proposed are: unifying the rules by which the TASE operates, which are now in three bodies of laws - the Constitution, Instructions and Temporary Instructions, into a single inclusive volume to be called Instructions, and that deciding on Instructions and making amendments to it will be performed by way of approving an administrative directive, after the receipt of the approval of the TASE Board of Directors for the ruling or for the amendment, whichever is the case; empowering the Authority to regularize, by administrative directives, most of the matters governed at present by regulations, in those areas over which it has jurisdiction; and deciding that the plenum of the Authority will be the body to give approval to administrative directives proposed by the staff of the Authority. The plenum will be responsible for imposing sanctions on those under the supervision of the Authority, including decisions regarding the imposition of monetary sanctions and civil fines, and it is proposed to give authority to the powers of the Authority by pre-ruling. Amendment to Income Tax Ordinance (Amendment No. 169 and Temporary Order), 2008 The Amendment was passed on The Amendment grants tax incentives to foreign residents to invest in Israel: an exemption from tax on interest, discount fees and linkage differentials on bonds traded on the Stock Exchange in Israel, and a tax exemption on capital gains for a foreign resident of a country that has signed a double taxation avoidance agreement. Furthermore, a corporation receiving a dividend in the 2009 tax year from a foreign resident corporation will be liable to Companies Tax at a rate of 5% instead of 25%, if the proceeds of the dividend are used in Israel. In addition, tax benefits were extended for residents of Sderot and Western Negev settlements. Execution Law (Amendment No. 29) On , Amendment No. 29 to the Execution Law came into effect, under which the subject of alternative housing is regulated. According to the Amendment, it will not be possible to make conditions on the right of a debtor to alternative housing, although it is possible to determine that the alternative housing offered to the debtor will be under an arrangement detailed below, provided that the significance of the matter is explained to the debtor in clear language that he understands. Under the abovementioned proposal, the value of the alternative housing will be of an amount which will enable the debtor to rent an apartment in the area where he lives which is appropriate to his needs and the needs of his family members living with him for a period not exceeding 18 months (except in special circumstances where the Enforcement Office Registrar can extend that period). The value of the alternative housing will be deemed to be part of the receivership expenses. Regarding pledge or mortgage agreements that were entered into before the Amendment comes into force, the proposed Amendment determines that it is possible to make conditional the debtor s right to alternative housing, except if is proven to the Enforcement Office Registrar that the debtor s right to alternative housing, and the significance of waiving it, were not explained to the debtor.

24 24 / Annual Report 2009 Amendment to the Companies Law, Recording a company as a company in violation The Amendment was published on As of , if a company breached its duty of paying a fee and/or other payments that it is obliged to pay to the Registrar of Companies, or if a company breached its duty of submitting an annual report, the Registrar of Companies in authorized to refuse to register a lien on the assets of the company in violation. Memorandum Supplementary Enforcement by the Israel Securities Authority Law (Amendments to Legislation), 2009 The draft law was approved by the Ministerial Committee for Legislative Matters on The Amendment brings about the existence of three parallel channels of enforcement: a. Proceedings for the imposition of a monetary sanction by the Authority, intended to deal with minor violations. b. Administrative enforcement proceedings - allowing the Administrative Enforcement Committee to impose a series of measures of enforcement, intended to deal with violations the proof of which requires the existence of disciplinary investigation proceedings. c. Criminal proceedings - which are intended to deal with serious crimes and which only at its conclusion will it be possible to impose punishment by imprisonment; an Administrative Committee will be set up to review the above violation of the laws. The Committee will be authorized, among other things, to impose: monetary sanctions of a significant amount; a requirement to pay compensation to those hurt by the violation, prohibition from serving in certain bodies and suspension of the license. Drafts and Proposed Legislation Proposed Law amending the Income Tax Ordinance (Exemption from Tax on Interest and Profits from Long-Term Savings), 2009 A private member s bill, tabled in the Knesset on It is proposed to exempt long-term savings plans from tax. Proposed Execution Law (Amendment - Discharge of a Borrower of Limited Means), 2009 A private member s bill, tabled in the Knesset on It is proposed to allow the granting of a discharge to a borrower of limited means by the Execution Office and thus to equate his status with a borrower of limited means who has been declared bankrupt. Proposed Joint Investment Trust Law, 1994, (Amendment No. 13), 2008 The proposed Law was approved by the Ministerial Committee for Legislative Matters on The main amendments proposed are: offer to the public of foreign mutual funds; increasing the duties of supervision imposed on the trustee and tightening supervision over fund managers; granting authority to the Securities Authority to deny as well as not to grant a company approval to serve as trustee or fund manager for reasons connected with its reliability; prohibiting a company from serving as a trustee in a fund if one of the following alternatives exist: 1. In the event that the company is controlled by the fund manager, a person controlling it, or a company under the control of any of them with more than 10% of the issued share capital of the company. 2. There is a business connection between the company, or a person controlling it, and the fund manager, or a material business connection with a person controlling a fund manager or a corporation under his control. 3. The revenues of the company together with the revenues of a person controlling it and a corporation under the control of such an above-mentioned person, which derive from a business connection with the fund manager group, including revenues from trusteeship for funds managed by the fund manager group, from trusteeship for bonds issued by a corporation included in the fund manager group, and from the provision of usual banking services, exceed 15% of its revenues together with the revenues of a person controlling it and a corporation under the control of such an above-mentioned person. For this matter, a business connection is defined as - including supplier-customer relationships, service providers/recipients, loan providers/recipients

25 The Board of Directors Report 2009 / 25 and others, excluding a connection deriving from the provision of services to a trusteeship for funds or bonds, and usual banking services during the course of the usual business of the bank, and on market terms only, where the revenue from them does not exceed 5% of the revenues of the bank; a material business connection is defined as - a business connection including the provision of usual banking services, where total revenues including revenues from all the business connections with the fund manager group exceed 5% of the revenues of the company together with the revenues of a person controlling it and a corporation under the control of such an above-mentioned person. 4. There are circumstances in which conflict may be created between the benefit of the company or the person controlling it or a corporation under the control of such an above-mentioned person, and the benefit of the unit holders: prohibition of receipt of brokerage services from a party connected with the fund manager or the trustee; a duty to hold a tender for purposes of a commitment with a bank/member of the Stock Exchange for the receipt of brokerage services, as well as prohibiting the payment of brokerage commissions or any other payment from fund assets to a company connected with the fund manager or the trustee (when bodies connected with the fund manager or the trustee cannot participate in such a tender); a prohibition of preference of the benefit of unit holders in a specific fund over another fund when they are managed by the same fund manager; determining provisions concerning the participation of the fund manager in meetings of public companies whose securities are held by mutual funds; allowing the charging of differential management fees in a fund from different populations of unit holders; changing the format of liquidating a fund and granting authority to the Israel Securities Authority to order the dissolution of a fund. In addition, obliging a fund manager to dissolve a mutual fund with a low asset-value; similarly, various matters are regulated in the proposed law connected with the manner of management of mutual funds, charging of management fees, transferring vital information to unit-holders, liquidating a fund, civil enforcement authorities of the Israel Securities Authorities and so on. If the Amendment in its present version will become binding legislation, there is expected to be a material effect on the business of the bank and its operating results, because the Bank has significant activity both as a banker and as a trustee for mutual funds through its subsidiary company UBank Trust Company Ltd., which may, if the legislative process is completed, bring about the need for significant reduction in one of these activities. As of the date of approval of these Financial Statements, no decision has yet been made by the Bank, regarding the manner of preparation for the implications of the above-mentioned legislation, if it is approved in its current version, and regarding which activities will be reduced, as mentioned above. Proposed Joint Investment Trust Law, 1994, 2009 The draft Proposed law was approved in the plenum of the Israel Securities Authority on and published for comments by the public by The main amendments proposed are: Regulation of Exchange-Traded Notes (Teudot Sal): 1. Activity by exchange-traded notes and issuers of exchange-traded notes will be regulated by means of the Joint Investment Trust Law and will be subject to supervision by the Authority. 2. Exchange-traded notes will be defined in a manner similar and corresponding to that of mutual funds and issuers of exchange-traded notes will be defined as exchange traded notes managers (corresponding to fund managers). These notes will change from the legal structure of a bond issued as a security under prospectus, to a legal structure similar in substance to a mutual fund in which the right of acquisition of the assets will belong to the investors. In addition, and unlike a mutual fund, an exchange-traded note will include an obligation of the exchange-traded notes manager to make up the difference, if such is created, between the amount to which the holder of the exchange-traded note is entitled on redemption, and the actual asset value of the exchange-traded note, As distinct from mutual funds, the exchange-traded notes manager can withdraw monies from the arrangement if the value of the assets is higher than the value of the liabilities, in accordance with a mechanism to be determined. 3. The application of norms applying today to fund managers and fund trustees, including the duty of licensing, to exchange-traded notes managers and their trustees. Among the norms there are

26 26 / Annual Report 2009 requirements on the subject of conditions for qualification to serve as a fund manager and as a trustee, limits on market share, the manner of management of the funds, limits of the assets which it is permitted to hold in a fund and their maximum amounts etc. Regulation of Exchange-Traded Funds (Kranot Sal): 1. A fund whose investment policy is intended to track through replication a market index or other underlying asset, can register its units for trading on the Tel-Aviv Stock Exchange, and transactions in its units will be allowed during trading only, in a similar manner to exchange-traded notes. 2. A fund manager will be a market maker for units in the fund and will quote prices according to rules stipulated in the legislation. 3. Trading of units in the secondary market - Concurrent with the activity of the fund manager, there will be a normal secondary market for units of the fund. 4. Existing tracker funds will be entitled to register for trading and convert themselves into exchange-traded funds. Additional changes: 1. Arrangement manager - It is proposed that an arrangement manager (i.e. a fund manager or exchange-traded notes manager) can, subject to the requirements of stability to be determined for each type of arrangement, manage all types of arrangements. 2. It is proposed to determine that the term of service of a trustee will not be less than five years (at present the limit is three years), and any extension will be for a further five years. In any instance of non-extension of the agreement, the fund manager and the trustee have to report the reasons for the non-extension of the period of service to the Authority. 3. Change in investment policy - This is possible once every twelve months. It will not be possible to make any material change (a change in investment policy of a fund which affects the volatility of the prices of the fund or requires a change in its classification), in the fund s investment policy. Exceptional cases will be determined in the regulations when it will nevertheless be permitted to make a material change in an arrangement. It is also proposed to determine that a merger will be allowed only regarding funds in the same classification. Proposed Joint Investment Trust Law (Tender for Undertaking with Stock Exchange Member), 2009 The proposed law passed its second reading in the Knesset on According to the proposed law, the selection of a stock exchange member by a fund manager and entering into an undertaking with him for purposes of executing transactions in securities, options and futures contracts for the fund, will be carried out by means of a tender under rules to be determined by the Minister of Finance. In addition, it is proposed to allow a fund manager to receive a full or partial refund of commission paid by the fund to a stock exchange member for purposes of executing transactions in securities, options and futures contracts on behalf of the fund. In the framework of the debate held in the Knesset on , it was decided that the proposed law would be joined and combined with Amendment No. 13 to the Joint Investment Trust Law and integrated into it. Proposed Law amending the Companies Law (Recovery of Companies), 2010 The proposed law was published on The aim of the proposal is to regulate the area of recovery of companies regulated at present under section 350 of the Companies Law, The main parts of the proposal: to provide a legal basis for meetings of holders of different types of bonds; to consider the cancellation of a requirement for obtaining a numerical majority in meetings of creditors and shareholders; creating a speedy process for obtaining approval of a compromise or arrangement formulated outside of the Court; granting authority to the Court to extend the period of freezing of proceedings for special reasons; an owner of a property cannot obtain possession in the event that the property is needed for the ongoing operation of the company; the debt of the company to the owner of a property is the amount that would be paid to a seller as a condition for transferring ownership not exceeding the value of its sale. The provisions concerning a compromise or an arrangement will apply to a company against whom an order to freeze proceedings has been granted. Providing a legal basis for the authority to appoint an office holder and determining his authorities in every event, the possibility of using pledged properties during the normal course of business of the company unless the Court ordered

27 The Board of Directors Report 2009 / 27 otherwise. The Court can oblige a provider of a vital service to continue supplying it, subject to the receipt of consideration. The authority of an office holder to adopt or reject an existing contract, to receive a loan. The Court will be authorized to enforce an arrangement or a compromise on meetings of types of bondholders who objected to them on condition that the proposal is fair and just in relation to all types of bonds not agreeing to it. The granting of authority to the Court to cancel proceedings if it is convinced that there is no possibility of saving the company. Proposed Securities Law, 2009 The proposed law was updated on It is proposed to change the definitions ownership, purchase, and interested party so that additional situations will be dealt with for purposes of examining reporting requirements, in relation to transactions executed with an interested party in relation to his holdings in the securities of the corporation. In this manner a mutual fund manager will be considered a holder of securities included in the assets of the fund and under his management, and a trustee will be considered a holder of securities for which he serves as trustee, in every matter and not only concerning their classification as interested parties. A person will be considered a holder of securities also in the event that the holding is performed by means of his investment portfolio manager. It is proposed that a creditor be deemed a holder of securities pledged in his favor as of the first time he took steps to realize the pledge or the first time he made use of voting rights relating to the pledged securities, whichever the earlier. It is proposed to amend the definition of a family member to include also family members whose relationship to the holder derives from their being parents or siblings of the spouse of the holder (addition of sibling or parent of the spouse). It is proposed to narrow the definition of joint ownership or purchase so that this apparent ownership will apply only as long as there in no controlling shareholder in the corporation. It is proposed to add additional apparent ownership to the definition ownership or purchase of securities together with others in accordance with which an individual and members of his family will be deemed as holding together (even if the family members do not live together or the livelihood of one is not dependent on the other). It is proposed to include in the definition interested party also cases of ownership of securities that are convertible into shares, and of rights to receive shares or debt. It is proposed that the responsibility of a person making a proposal in a purchase offer or sale offer will be made equal to that of an issuer. Furthermore, a person making a proposal in a purchase offer will be responsible to the holder of securities (including options, bonds and convertibles) of the target company as defined in the Purchase Offer Regulations, for damage caused to him as a result of his violating the provisions of the law. Memorandum Securities Law, 2009, Securities Regulations (Certificates of indebtedness), 2009 The draft proposed Law was approved by the plenum of the Securities Authority on , and published on the website of the Authority on for comments by the public. The major changes proposed are: the establishment of a register of trustees and the checking of compliance by trustee company with the conditions of qualification set out in the law in this connection; determining an amount of the deposit instead of a requirement for own equity, minimum amounts of insurance for a trustee company deriving from the volume of bonds for which it serves as a trustee, determining conditions of qualification for directors and those employed by the trustee; fixing the duty of reporting to the trustee and determining the contents of the annual report on trust matters; the duty to summon an annual meeting to approve the continuation in office of the trustee and to summon a meeting at the demand of a bondholder or at the demand of the trustee; determining the duty of the trustee to act in the interest of the public holding bonds of the same series, including examining compliance by the issuer with his obligations towards the bondholders, and the duties derived from this general obligation; safeguarding trustee assets for the benefit of the public holding the bonds, examining possible actions available to the bondholders if there are grounds to make the bonds repayable immediately (including a real concern of a material breach of obligations by the issuer). Proposed Law amending the Bills of Exchange Ordinance (Checks Crossed Non-negotiable), 2009 This is a private member s bill tabled in the Knesset on It is proposed to protect the consumer (mainly households and private individuals) and oblige the banks to issue them with books of non-negotiable checks only as the default alternative. A customer requesting checkbooks with no limitation of negotiability can do so by special request at the branch of his bank and on his responsibility.

28 28 / Annual Report 2009 Proposed Securities Law (Amendment No. 38) (Secure Electronic Mail System), 2008 The proposal was published on and will come into effect after regulations will be made and rules determined by the Authority. The main changes proposed are to allow the Israel Securities Authority to provide advices, demands, instructions or any other document that the Authority is authorized to provide to bodies under its supervision, by means of a secure electronic mail system. It is proposed to impose on addressees the obligation to use the said electronic mail system and to receive documents from the Authority through it at a frequency to be determined in regulations, and it is proposed to determine a presumption that a document provided through the system reached its destination after two business days. Proposed Securities Law (Off Exchange Dealer System), 2009 The proposal was approved in the Ministerial Committee for Legislative Matters on The main changes proposed are: a definition will be added of dealer ; the definition of securities will be expanded to include all financial instruments; a dealer will be obliged to obtain a license from the Authority for purposes of its activity; duties will be imposed upon a dealer whose aim is minimizing the effect of conflicts of interests between the dealer and customers, including increased disclosure duties towards its customers. A dealer will be required to show financial stability by means of having minimum own equity, a deposit and liquid assets. It will also have to hold appropriate insurance and will be required to comply with the rules determined in the regulations concerning the manner of handling customer funds. In addition, it will be required to prove compliance with technical conditions of computerization for purposes of compliance with his obligations. Furthermore, the duties of caution and skill towards customers will apply to it and its controlling shareholder, directors and CEO; reporting requirements to the public and to the ISA will be imposed on dealers. Proposed Bank of Israel Law, 2009 The proposed law was approved in first reading in the plenum of the Knesset on It is proposed that the Governor be authorized to issue directives concerning liquid assets to be held by a banking corporation, and that in cases when it did not act accordingly, the Governor is authorized to determine the rate of interest that the corporation is to pay. There is a possibility for granting credit to banking corporations and receiving deposits from banking corporations against the pledge of securities, while it is proposed that the pledge will be in effect against third parties, even if it has not been recorded in favor the Bank of Israel (henceforth: the Bank ) or not deposited, provided that the pledged securities are recorded in favor of the Bank of Israel with the financial intermediary, such as: a Stock Exchange member of the Stock Exchange Clearing System. The Bank will be authorized to require reporting and to supervise financial bodies that are subject to it, it is proposed to determine as a general rule that the Bank of Israel is authorized to manage accounts, and not just deposits, for banking corporations. Noncompliance with one of the directives will enable the Governor to impose a monetary sanction, including imposing direct responsibility on the organization that acted on behalf of the corporation. It is proposed to authorize the Governor to issue an order requiring the giving of information in relation to transactions in the foreign currency market in Israel. Proposed Courts Law (Combined Version) (Amendment), 2009 The proposed law was promulgated by the Advisory and Legislation Committee of the Ministry of Justice for comments by the public by It is proposed to set up an Economic Department in the Tel-Aviv District Court, which will hear all economic matters to allow for the efficient management of proceedings. Economic matters as per: the Companies Law, the Securities Law, the Joint Investment Trust Law, and the Regulation of Engagement in Investment Advice, Investment Marketing and Investment Portfolio Management Law. Proposed Supplementary Enforcement by the Israel Securities Authority Law (Amendments to Legislation), 2008 The proposed law for supplementary enforcement by the Israel Securities Authority was approved by the plenum of the Authority on and promulgated for comments by the public until The aim of the law is to streamline enforcement, so that legal proceedings will be used only for serious cases, and thus an administrative enforcement mechanism will be determined and an arrangement for the conditional application of proceedings. To this end, an Administrative Committee will be set up to review

29 The Board of Directors Report 2009 / 29 violations of the Securities Law, the Joint Investment Trust Law, and the Advisory Law. The Chairman of the Authority can decide in every case of violation or breaking the law whether to act through criminal proceedings, administrative proceedings of monetary sanctions. Enforcement measures will be fines for a significant amount, a requirement to pay compensation to anyone hurt by the violation, a payment to the State Treasury deriving from profits obtained as a result of the violation, a requirement to take steps to correct the violation and prevent its reoccurrence, a prohibition against serving in certain bodies, suspension or cancellation of a license, and conditional punishment; it is proposed to determine authority for civil investigation under which, in cases where suspicion arises of carrying out of a violation, it will be possible to request a search warrant from the Court, in any place not used solely as a place of residence. Proposed Uniform Contracts Law (Amendment - Duty of Noting Approval and Material Conditions), 2009 The proposed law was passed in preliminary reading on It is proposed to note in a prominent manner if the contract passed inspection by the Uniform Contracts Court in order to generate public awareness and to encourage businesses to be inspected by the Court. Proposed Uniform Contracts Law (Amendment - Determining the Minimum Rate of Index-linkage as a Discriminatory Condition), 2009 The proposed law was tabled in the Knesset on In contracts where there is a condition of a minimum rate of an index to which it is linked, i.e. if the real value of the monetary obligation rose, then the consumer pays more, but if its real value fell, the consumer is liable to pay more than the value of the product. It is proposed to prohibit such provisions. Memorandum Securities Law, Increasing Severity of Punishment The memorandum was approved by the plenum of the Authority on The proposal is expected to be combined with the proposal to amend the law concerning supplementary enforcement. The main changes proposed in the memorandum are: reducing the scale of punishment determined in section 53 of the law, increasing punishments determined in the sections on fraud and prohibiting the use of insider information, increasing the amounts of maximum monetary sanctions which can be imposed on violators of the provisions of the law. Proposed Amendment to the Banking Ordinance The proposed Law was approved by the Ministerial Committee for Legislative Matters on It is proposed that: 1. The Supervisor may order the transfer of information on a customer of a banking corporation and of a controlled corporation, for purposes of managing the credit risks of the corporation or a banking group, to a database set up for this purpose. The intention is for the bottom-up transfer of information subsidiaries for purposes of managing credit risks only. 2. Permitting the transfer of information above mentioned also to controlled companies (and not just bottom-up ). 3. Permitting the transfer of information for purposes of managing risks of another type, if this will not be an invasion of the customer s privacy. Proposed Banking Law (Registration) (Amendment No. 15), 2009 The proposed Law was published in the Official Gazette on It is proposed to amend section 24a. of the Law relating to the restriction in accordance with which a banking corporation will not hold more than one real holding corporation in the following manner: to allow the holding, directly or indirectly, of real holding corporations by a percentage lower than one per cent, which does not reflect any influence by the banking corporation on the said corporations; a corporation will be deemed a real holding corporation only if it has the ability to have a real effect on more than three branches of the economy; a banking corporation will be authorized to hold more than 1% of the means of control in one insurer only whose equity exceeds NIS 2 million (since an insurer will be seen as operating in only one branch of the economy).

30 30 / Annual Report 2009 Proposed Prohibition of the Unfair Use of Information on Securities Law (Amendments to Legislation), 2009 The memorandum law was promulgated on It is proposed to make an amendment to three laws: the Securities Law, 1968 (henceforth - the Securities Law ); the Regulation of Engagement in Investment Advice, Investment Marketing and Investment Portfolio Management Law, 1995 (henceforth: the Advisory Law ; and the Joint Investment Trust Law, 1994 (henceforth: the Joint Investments Law ). The main amendments are: a prohibition will be determined in the Securities Law on the unfair use of information, carried out in violation of the fiduciary duty of the person making use of the information to the source of the information. It is also proposed to impose duties of supervision on corporations that are financial intermediaries, employing other financial intermediaries, including a duty to fix internal procedures and appointing a responsible officer on behalf of the financial intermediary ( Compliance Officer ), to ensure enforcement of the prohibitions proposed in this proposed law. It is proposed to amend the Securities Law and to determine that information will not be considered as information unknown to the public once 30 minutes have passed from the time it was reported to the Magna System, and also proposed to retain the defense of information becoming public after one day has passed from the time it was published in another acceptable manner, but it is proposed to reduce this defense so that it will apply only to a person who is not an insider in the corporation. With regard to the Joint Investments Law, the restrictions will apply to a director, an employee of the fund manager, a member of the investments committee, and anyone employed by the fund manager even if not its employee, including a corporation under their control. The restrictions will apply also to the spouse of any of those listed above and family members residing with him or the livelihood of one is dependent on the other. Proposed Joint Investment Trust Law (Amendment of Trustees), 2008 A proposed private law, published on , whose main points are: imposing an obligation on the Securities Authority to approve or reject, within 30 days, the request of a company to act as trustee for mutual funds; imposing a duty on a trustee company to enter into a commitment with a fund manager meeting the requirements of the law, unless the Chairman of the Securities Authority is convinced that there are special reasons for not entering into a mutual agreement; determination by the Securities Authority of the manner of allocating mutual funds between trustees; in the event of the resignation of a trustee from his duties contrary to the opinion of the fund manager, the trustee will contain to serve in his position for 12 months, unless the fund manager makes a request to shorten the period; limiting market share so that a trustee cannot serve as a trustee for more than 5% of all the funds in the market or as a trustee for funds whose assets represent more than 10% of all the assets of all the mutual funds operating in the market, whichever is lower. The subsidiary, UBank Trustee Co. Ltd., serves as a trustee for funds with assets totaling approx. NIS 44 billion (33% of the market). Proposed Banking Law (Service to the Customer) (Amendment - Cancellation of Commissions on Basic Services in a Current Account), 2009 The proposed Law was submitted to the Knesset on It is proposed to cancel commissions on current account services, in order to make it easy for the customer to focus on the level of interest (on credit and on savings) and thus to allow for comparison between banks. Proposed Banking Law (Service to the Customer) (Amendment - Interest on Credit Balance), 2009 The proposed Law was submitted to the Knesset on There are identical proposed Laws. It is proposed to oblige banks to pay interest on sums accumulating in the current account of their customers.

31 The Board of Directors Report 2009 / 31 Proposed Regulation of Engagement in Investment Advice, Investment Marketing and Investment Portfolio Management Law (Amendment No. 12), 2009 The proposed amendment to the law was published on The amendment deals with two main issues: 1. A change in the definition of securities, so that it will not include exchange traded notes. Exchange traded notes will be deemed a financial asset, so that if an advising portfolio manager and/or an investments advisor have a connection to exchange traded notes, they will be defined as a marketing portfolio manager and/or an investments marketer respectively, in view of the connection with the financial asset, in a similar manner to the existing arrangement regarding mutual funds. 2. Cancellation of the insurance requirement as a condition of granting a license to an individual, while determining that compliance with the insurance condition will be a duty applying to a license holder, among other duties applying to him. The amendment will allow a person applying for a license meeting the other requirements for a license determined in the law, to receive it even before engaging in the profession. Proposed Credit Data Services Law (Amendment No. 3), 2007 The proposed Law was published on Its applicability was postponed until It is proposed to cancel a number of restrictions provided in the Law concerning the collection of data from official sources regarding customers: to shorten the period of non-payment of a collectible debt, it is possible make a report on the customer, to cancel the restriction of a minimum of two check warnings, to cancel the restriction according to which there is an obligation supply details in the warning notice, to cancel the requirement for a minimum of three debts from different sources for reporting purposes. Proposed Duty of Reporting by Financial Institutions on Unclaimed Funds Law, 2008 The proposal passed its preliminary reading on The aim of the law is to oblige financial entities in Israel to report on an ongoing basis to a body to be set up in the Commissioner of Capital Markets Division, which will be responsible for recording unclaimed finds by means of setting up a national database available to all. The intention is for funds for whom nobody has been found who is authorized to exert ownership on them or whose owner is unknown, including dormant accounts. Proposed Banking Law (Service to the Customer) (Amendment - Early Repayment Commission on Realization of an Asset), 2008 On , the proposed law was approved in its preliminary reading and sent for its first reading in the Knesset Economics Committee. It is proposed to cancel early repayment commission on the sale of a property of a borrower, so as not to cause further harm to those who are unable to meet the payments of a mortgage they had taken. It is claimed that in the actual realization of the property, the bank receives back the amount of the loan, and there is no point in harming the debtors. Member of Knesset Eithan Cabel published an identical proposed law on

32 32 / Annual Report 2009 Regulations Regulations for Supervision of Financial Services (Provident Funds) (Provident Fund under Personal Management), 2009 The regulation was published on It is proposed that providing advice regarding investment of monies of a provident fund under personal management, where instructions concerning investment of funds in it are given by the fund member, will be done only by a portfolio manager or by a person who is exempt from the requirement of receiving a license under the Regulation of Engagement in Investment Advice, Investment Marketing and Investment Portfolio Management Law, This directive is intended to prevent the giving of advice regarding the investment of provident fund monies by a person who is not authorized to make investments for provident funds. Furthermore, and in order to prevent the giving of said advice by a person who is, under the Banking Law (Licensing), 1981, prevented from managing provident fund monies, it is proposed that for the purposes of the Banking Law (Licensing) the said providing of advice will be deemed as managing provident fund monies. Regulations of the Execution Office (Provisionary Order), 2009 The regulation was published in the Official Gazette (Reshumot) on The regulation allows for activity in collecting debts up to the amount of NIS 10,000 without using a lawyer. Regulations for Landed Property (Management and Recording), 2009 The regulation, passed by the Knesset on , is applicable from Cancellation of the need to attach an extract to applications for carrying out a transaction in the Register, and cancellation of the need to submit an application form for most recording activities; clarification and specification concerning the documents required for submitting an application for a first-time registration, a renewal of registration and an amendment to an area and borders; the addition of provisions concerning recording and deleting a caveat (warning note); determining arrangements concerning the expiry of a mortgage by way of lodging and deleting old attachments and specific reference to authority to demand the submission of an application on special paper. Regulations of the Execution Office (Amendment No. 2), 2009 The regulation was published on An order will not be given for the sale of landed property used as a dwelling for a debtor, unless the Execution Office Registrar has summoned the parties to a hearing and a hearing has taken place at which the Registrar is authorized to decide on the sale of the property and the eviction of the debtor and his family members, if they have a reasonable place of residence or the economic capability allowing them a reasonable place of residence, or an alternative housing arrangement has been put at their disposal by means of another apartment, or the payment of compensation, or by any other way detailed in section 38 of the law. Draft Regulations of the Execution Office (Amendment No. 3), 2009 The regulations were approved in a meeting of the Constitution, Law and Judgment Committee of the Knesset on The draft regulation deals with the matter of giving information and an abbreviated track. There is the possibility of giving information to an entitled person in relation to information regarding a property or source of income of the debtor. In addition, applications for the execution of a monetary judgment or any other monetary charge which may be executed by law, such as the judgment of a Court, where the principal of the debt does not exceed NIS 10,000 (except for a judgment for and applications for realizing a pledge or a mortgage) can be carried out in an abbreviated track.

33 The Board of Directors Report 2009 / 33 Proper Conduct of Banking Business Directives Amendment to Proper Conduct of Banking Business Directive No. 411 The amendment was published on and comes into effect from The main changes are: the directive will also apply to a foreign corporation which the bank controls or is an interested party in it, as long as this does not contradict local directives; the addition of service recipient to the definition of a customer, so that it will also apply to casual customers ; change of the definition of a high risk country. There is an additional requirement to carry out Know Your Customer procedures when giving services to a person carrying out a transaction who is not registered as the account holder and/or an authorized signatory in the account. Reference is required in policy to various Know Your Customer rules for customers of various types, and to amend accordingly the Know Your Customer questionnaires. In addition, various directives were expanded in connection with the officer responsible, among others: his being independent from a business perspective, deciding on a working relationship between internal audit and the officer responsible in such a manner that his work will be subject to periodic audit, and appropriate resources allocated to its examination. The addition of a requirement to carry out ongoing monitoring of customer activity not through the account by the use of means such as: the use of external databases. The addition of a requirement that in accounts of high-risk customers the bank will perform increased reviews to ensure the existence of appropriate and up-to date information. Details of the duty of monitoring by the banking corporation of activity in the customer account. The definition of exceptional activity was expanded so that complex transactions are included in exceptional activity and reporting on it. Having correspondent bank relationships will not be possible with a financial institution allowing use of its accounts by a bank registered in a place where the bank has no physical presence. Specification of the requirement for training and assimilation of the subject for all the employees of the bank. Publishing Information on the Internet - Public Reporting Directives The directive, published on January 17, 2010, will come into effect for Financial Statements as of December 31, According to the directive, beginning with the date of publication of the Report to the Public for the year 2009, there will be a duty to publish the annual and quarterly financial statements for the years in a PDF format on the internet websites of the bank. In addition, the data is to be published in the format of a worksheet sent by the Information and Reporting Unit of the Banking Supervision Department. Banking corporations have to make technological preparations to allow the possibility of direct access ( links ) from the Bank of Israel website to information published on their websites. The Bank has made preparations for providing the said information. Draft Amendment to Proper Conduct of Banking Business Directive No Management of Credit Facilities in Current Accounts The draft, on , comes into effect from It is proposed that it will be possible to charge a customer with additional over-limit interest and special handling commission for an over-limit account immediately on the creating of the over-limit and not only after the account has been classified as a problematic debt in arrears, as stated in the present version of the directive. Proper Conduct of Banking Business Directive No Communication of External Auditor with Those Charged with Governance in the Banking Corporation In the framework of the adoption of American auditing standards by the auditors when carrying out an audit of the financial statements of banking corporations, a detailed annual report is to be submitted and when necessary a supplementary report. It was decided that a banking corporation has to give the Supervisor of Banks every year a copy of the detailed annual report and the supplementary report, no later than 15 days after the dates the auditor is required to give the banking corporation the said reports. Proper Conduct of Banking Business Directive No Supplementary provision for doubtful debts Amendment from The directive determines that when the total indebtedness of a specific sector to a banking corporation (on an unconsolidated basis) exceeds 20% of the total indebtedness of the public to a banking

34 34 / Annual Report 2009 corporation, the excess will be considered as exceptional indebtedness, for which the bank will be required to make an additional provision. In view of the fact that risk in infrastructure-type projects in the set-up stage is considered a combined risk of the construction sector and the sector for which the infrastructure is set up, the directive was amended so that it allows a banking corporation to select a track where it exceeds the 20% - 22% restriction, provided that it finances projects which are included in the framework of the Civil Engineering Works sector (except for building construction), and provided that indebtedness exceeding 18% of all the indebtedness of the banking corporation to the public for normal projects in this sector will be considered as exceptional indebtedness. Draft Amendment of Proper Conduct of Banking Business Directive No Minimum Capital Ratio In the framework of the proposed amendment, it will be possible to include the general provision made in accordance with section 6 of Proper Conduct of Banking Business Directive No. 315 in the framework of Tier 2 capital, despite the fact that with the application of implementation of the directive on the subject of Measurement and Disclosure of Impaired Debts, Credit Risk and Provisions for Credit Losses, banking corporations are not required to keep this provision. Circulars Circular to Investment Advisory License Holders concerning Referring Customers to Receipt of Portfolio Management Services It is proposed that referring a customer for portfolio management will be allowed based on professional and objective criteria, with the investment advisor bearing in mind the benefit of the customer only. Therefore, referring customers for portfolio management companies for the sake of getting direct or indirect benefits in kind, or because of the relationship between the corporations, amounts to improper behavior of the license holder. Bank of Israel Circular - Fair Disclosure by Electronic Means - Banking Regulations (Service to Customers) (Fair Disclosure and Giving Documents), 1992 The circular was published on According to the circular, when a customer requests to receive advices or account statements by electronic means, the banking corporation will be exempted from sending him additional advices under the regulations, provided the following conditions apply: the customer signed an agreement for the provision of internet banking services; the customer requested (in writing or by means of the internet website or in a recorded conversation) the receipt of advices by means of electronic mail or the internet website; the banking corporation made use of computerized tools enabling it to determine absolutely if the customer received the mail and opened it, or downloaded the message, or entered the internet website, and in each of the cases the banking corporation retains the information required for examination and monitoring compliance with the regulations; advices are to be sent in a secure environment. Circular on the subject of Chief Risk Manager and the Risk Management Function The Supervisor of Banks published the above circular on With the aim of strengthening ability to understand risks and to ensure their cautious management, there is need for an independent risk management function headed by a Chief Risk Manager. The Board of Directors and Management of the banking corporation are to regulate the setting up of a risk management function, headed by a Chief Risk Manager. The Chief Risk Manager will be a member of Management, reporting directly to the CEO and independent, in a manner in which he will not make business decisions involved in risk taking. According to the circular, the Supervisor of Banks is authorized to exempt certain banking corporations, which are subsidiary companies of banking corporations, from the requirement that their Chief Risk Manager will be a member of Management. The risk management function will ensure that risks inherent in the activities of the banking corporation are fully understood and will provided independent supervision over their management. Among others, his duties include identifying risks for determining risk-tolerance limitations, responsibility for control

35 The Board of Directors Report 2009 / 35 mechanisms, monitoring, and reporting to Management and to the Board of Directors - as detailed in the directive. In addition, the risk management function will be independent, organized in a manner that maintains segregation from parties taking risks that he supervises, and that it will be allocated resources accordingly. The Bank has made preparations for compliance with the directive as stated above in coordination with the Group Risk Management Function. Bank of Israel Circular - Points for Emphasis in Managing Credit Risk The circular was published on Against the backdrop of the global financial crisis and its effects on the capital market and banking corporations, banks are required to make special reference to the financial status of sensitive populations of borrowers. The Bank is required to determine a list of characteristics of sensitive populations of borrowers with the aim of identifying borrowers meeting the characteristics defined, in addition to the list of characteristics determined by the Bank of Israel. The Bank carried out a comprehensive survey of loan portfolios and reviewed the ratings of customers, the need to make debt arrangements, the need to strengthen collateral, and the classification of customers. In accordance with the Bank of Israel requirement, the business units accompanied closely by the Loan Review Unit, which validated the process carried out, carried out the survey and reviews. The review and its findings were presented to Bank Management, the Credit Committee of the Board of Directors, and the plenum of the Board of Directors. During the first quarter of 2010, monitoring will be carried out of implementation of recommendations and decisions made. Bank of Israel Circular - Lessons from the Financial Crisis on the subject of Managing Credit Risk The circular was published on In the light of incidents that became known because of the global financial crisis, the Bank of Israel circular is aimed at strengthening credit risk management in banking corporations. Banks are required to refer to the subjects detailed below in their credit policy and procedures accordingly: 1. Leveraged financing. 2. Reliance on personal guarantees. 3. Amortization schedule shorter than the range of repayment ability assessed by the Bank. 4. Classification of debts as debt restructuring of a problematic debt. The Bank is reviewing these subjects from the perspectives of operations and governance. Discussions are taking place in this framework in the Credit Committee and in Management with the aim of making guidelines more specific and where necessary integrating them into credit policy documents and credit procedures. Rulings Judgment in the Uniform Contracts Court On , a judgment was handed down in the Uniform Contracts Court in the matter of discriminatory conditions in a housing loan contract of the First International Bank. The judgment cancelled sections in the loan agreement and ordered the amendment of other sections, determining that they are discriminatory sections in a uniform contract. Although the judgment was given in respect of a housing loan contract, it contains determinations that may have an effect also on other contracts used in the banking system. As far as is known, on the First International Bank submitted an amended version of its loan contract to the Uniform Contracts Court. The Court sent the contract for comments to the Supervisor of Banks. On , the First International Bank filed an appeal against the judgment. The Bank is studying the judgment and its implications and monitoring developments in the proceedings.

36 36 / Annual Report 2009 Taxes on Income Reduction in the Rate of Tax: On July 25, 2005, the Knesset passed Income Tax Ordinance Amendment Law (No. 147), 2005, which determined, inter alia, a gradual reduction in the rate of Companies Tax, to 25% from tax year 2010 and afterwards. On July 14, 2009, the Knesset passed the Economic Efficiency Law (Legislative Amendments for the Implementation of the Economic Plan for 2009 and 2010), 2009, which determined, inter alia, a further gradual reduction in the rate of Companies Tax, to 18% from tax year 2016 and afterwards. In addition, on July 1, 2009, the Value Added Tax Order (Tax Rate for Non-Profit Organizations and Financial Institutions) (Provisional Order), 2009 was published in the Official Gazette (Reshumot), and an amendment to the order was published on December 31, Under the amended order, the rates of salary tax and profit tax applying to financial institutions for the period July 1, 2009 to January 1, 2010, will be 16.5%. From January 1, 2010 to December 31, 2010, the rates of salary tax and profit tax applying to financial institutions will be 16%, instead of 15.5%, which was in effect until June 30, Accordingly, the new rate of salary tax will be at the rates of 16.5% and 16% and will apply to the tax years 2009 and 2010 respectively, for salaries paid for work commencing in July 2009 and onwards. The new rate of profit tax will apply in relation to half of the profit for In view of this, in 2009 and 2010 the rate of profit tax will be 16%. Subsequent to the Amendments mentioned above, the statutory tax rates applicable to banking corporations were changed, and they will now be as follows: in %, in %, in %, in %, in %, in %, in %, and in 2016 and afterwards the applicable tax rate will be 29.00%. The effect of the changes in salary tax as of July 1, 2009 led to an increase in salary expenses for 2009 in the sum of NIS 0.4 million. In addition, the effect of changes in tax rates led to increased tax expenses on income in 2009 in the sum of NIS 0.5 million.

37 The Board of Directors Report 2009 / 37 Basel II Background The Basel Committee operates within the framework of the Bank for International Settlements (BIS), and, since 1988, has published publishing directives concerning the need for the allocation of minimum capital by banks. The purpose of the Committee is to create uniform banking standards, in order to improve the level of stability of the world banking system. The instructions of the Committee are adopted by regulators in many countries, including the Banking Supervision Department at the Bank of Israel. The Basel Committee for International Convergence of Capital Measurement and Capital Standards (henceforth: Basel II), in June 2006, published its recommendations to be implemented in accordance with the instructions of the central banks in every country. The instructions refer to credit, market, and operational risks, and include 3 pillars with reference to each of the types of risks: The First Pillar - minimum capital requirements, in accordance with the various approaches. The Second Pillar - the Internal Capital Adequacy Assessment Process (ICAAP) in relation to the risk profile of the bank, the supervisory, control and audit systems it implements, and its business environment. The Banking Supervision Department expects banking corporations to implement an appropriate internal process combining principal components of capital planning and capital management, and presents the appropriateness of the capital to the risks identified. The above includes, among others, having internal processes for implementing corporate governance, improving and enhancing control and audit systems, and creating a basis for an organized framework of methodology for assessing exposure to a range of risks, as part of the process of examining the appropriateness of capital. The process also includes risks not covered by the First Pillar, including concentrations of credit, interest-rate risk in the banking portfolio, and others. The Third Pillar - market discipline, requirements for disclosure and reporting to the public. The main change required of banks under the principles of Basel II, compared with guidelines previously used ( Basel I ), is in the manner of calculating minimum capital required. Until now, minimum capital in the matter of credit risks was calculated by means of rigid formulas dictated by the regulator, and based on general characteristics only of the loan portfolio (distribution by countries, banks, credit to the public, and housing loans). The Basel II guidelines require banks to make a detailed assessment of the credit risk to which they are exposed, according to external ratings or by means of risk rating models, and to allocate capital accordingly. An additional major change in Basel II guidelines is reflected in the implementation of the requirement for banks to allocate capital also in respect of operational risks with which they are confronted. Bank of Israel Directives On January 5, 2009, the Bank of Israel published a provisional directive on the subject: Working Framework for the Measurement of Capital Adequacy (henceforth: the Provisional Directive or Basel II Provisional Directive ), based on the recommendations of the Basel Committee on the matter of International Convergence of Capital Measurement and Capital Standards, that were published in June The Basel Committee recommendations grant discretion to Supervisors in the various countries regarding the manner of implementation of certain recommendations by the Committee ( national discretion ). The Provisional Directive reflects the position of the Supervisor in each of the subjects for which the Supervisor was granted discretion. The Supervisor s position was formulated after reviewing references made on the subject by other supervisory authorities worldwide, and examining its suitability to the directives, laws, and data of the Israeli economy as necessary. The Provisional Directive is the conclusion of a process that began in 2007, in the context of which drafts regarding various subjects were distributed to the banking system. These drafts were discussed at ongoing meetings with representatives of the banking system, and in joint working teams dealing with specific topics. The Directive came into effect as of December 31, As explained previously, the Banking Supervision Department encourages banking corporations to make preparations in a manner that will allow them, at the appropriate time in the future, to adopt methods based on internal credit-risk ratings. These approaches represent best practice methods worldwide in

38 38 / Annual Report 2009 this area, and the progressive striving for their implementation is important in reinforcing the quality of credit-risk management in Israel. The Supervisor of Banks emphasizes the connection that must be maintained between the total capital that a banking corporation is required to hold against its risks, and the strength and efficiency of risk management and internal control processes in the corporation, and he expects banking corporations to develop and upgrade their risk management system, controls and corporate governance. In addition, banking corporations are to carry out an appropriate internal assessment process, combining key elements of capital planning and management, resulting in the holding of adequate capital against those risks. The process of international convergence of capital measurement and capital standards is a continuous and ongoing process. The Basel Committee reviews and publishes, from time to time, and especially against the backdrop of the present economic crisis, amendments and clarifications with reference to risk management and the method of measuring capital. The Banking Supervision will monitor the developments and trends worldwide, and update its directives as necessary. According to the Provisional Directive, implementation of the directive began on December 31, 2009, whereas as from December 31, 2008 and up to September 30,2009 a parallel run was conducted of the calculation of the capital adequacy ratio according to the rules of Basel II (in parallel with current directives), which was reported to the Bank of Israel each quarter. In 2009 and the beginning of 2010, the Bank of Israel continued to publish consultation drafts and various publications, of which the main ones we note as follows: 1. An amendment to the Provisional Directive for sections 145 (G), 146(D), and 151 (A) of the Directive regarding recognition of eligible securities, that are in a securities account pledged in favor of the Bank, as reductions of credit risk. 2. Setting internal capital targets for an interim period - the Supervisory Review and Evaluation Process (SREP) will be carried out after Provisional Directive comes into force and will be based on the ICAAP reports whose date of submission will be published by the Bank of Israel. 3. A second consultation draft on the subject of recognition processes in external credit rating companies, and the mapping-out of their ratings for risk weighting in order to calculate capital adequacy. 4. An amendment to the Provisional Directive for section B.2 (B) of Appendix 1A of the Directive regarding the definition of capital that is included in the capital basis, credit that is given to finance capital components of banking corporations. 5. Chief Risks Manager and the Risk Management Function - a document defining principles for having a Chief Risks Manager and a Risk Management Function in banking corporations, and elaborates the status, duties, and responsibility involved. 6. Draft relating to the risk weighting of debts of banking corporations. The adoption of the alternative of a risk weighting one level lower than the risk weighting derived from the country rating, rather than the risk weighting in accordance with the rating of the banking corporation. Preparations of the Bank The Bank relies in many areas on the operational systems and specialized units of the Central Services Division of the parent company, the First International Bank of Israel Ltd., and therefore, implementation of the directives by the Bank is carried out side by side with their implementation in the parent company, making adaptations where needed. Accordingly, the preparations of the Bank for the implementation of the directives and requirements by the Bank of Israel on the subject of Basel II, in 2009 and at the beginning of 2010, are detailed below, as part of the preparations of the First International Bank: The Basel II project is managed in the framework of a designated administrative body established for the subject and through steering committees meeting usually on a monthly basis - the Upper Steering Committee headed by the General Manager of the First International Bank, and the Steering Committee headed by the Head of the Corporate/Business Department of the First International Bank. The members these committees include, among others, representatives from the various departments of the First International Bank, the Control and Audit Departments, representatives of the Bank, and external consultants advising the project. Working teams have also been set up to discuss and promote specific professional subjects. Once a quarter a report is made to the Board of Directors, on the status of progress in the project, as required by the Bank of Israel.

39 The Board of Directors Report 2009 / 39 For purposes of possible future implementation of advanced approaches for credit risks, the Bank has accumulated data of historic financial statements of companies that got into difficulties and of good companies. In addition, different solutions are tested, included in the framework of maintaining connections with consultants and suppliers in the area, in order to develop analytical models to rate customer risk for the internal rating approaches. The Bank of Israel announced that until the completion of the SREP process that is conducted by the Supervisor of Banks in relation to the ICAAP process (see below), the Bank has to calculate the minimum capital ratio according to both of the methods (Directive No. 331 and the Provisional Directive) as of December 31, The Bank has made preparations to comply with these requirements. Progress in the execution of the project The First Pillar - in accordance with the directives of the Bank of Israel, five reports have been issued on capital adequacy under the rules of the Basel II Provisional Directive (COREP) - as at December 31, 2008 and the four quarters of A detailed qualitative questionnaire was added to these reports. In the COREP report as at December 31, 2008, the ratio of capital to risk components was 13.8%, at March 31, 2009, the ratio of capital to risk components was 13.6%, at June 30, 2009, the ratio of capital to risk components was 14.9%, at September 30, 2009, the ratio of capital to risk components was 16.11% and at December 31, 2009, the ratio of capital to risk components was 16.7%. It should be noted that the calculation of capital requirements according to the Basel II directives, based on the data of previous quarters, did not take into account all the credit risk reductions possible according to Basel II directives. Consequently, there is an overstatement of the severity of the result leading to a reduction of the ratio of capital to risk components. The main components for which the treatment of credit risks has not yet been completed are offsetting securities in accounts that are intended specifically for holding eligible securities, guarantees received from foreign banks, segmentation of the exposure between corporations and retailers, the exposure in respect of unutilized credit facilities, and others. The Bank continues to make improvements to the computer systems, in a Group framework, with the aim of incorporating the above-mentioned components of risks reduction in reports to be submitted in the future. Credit risk - the Bank continues expanding the contents of the report and reviewing the data in order to improve the quality of reports to be submitted in the future. The Bank is implementing at this stage the standardized approach in accordance with Bank of Israel directives. The Bank of Israel has for the time being postponed the carrying out of a Quantitative Impact Study (QIS) for the advanced approaches. Operational risks- The Bank has decided to implement the Basic Indicator Approach (BIA).The parent company has made preparations for the accumulation of data according to 8 lines of business for the purposes of the future implementation of the standardized approach. Market risk - the performance of a Group gap survey has been completed in order to examine compliance by the Bank and the Group with Bank of Israel instructions in the matter. The Bank continues its training program for credit officers, branch managers, and managers of relevant units in headquarters units. The Second Pillar - in accordance with Bank of Israel directives, the company submitted the first draft of the ICAAP document on a Group basis by June 30, 2009, based on data as at December 31, The ICAAP Report of the parent company for December 31, 2009 will be submitted to the Bank of Israel before June 30, During the month of December 2009, the Bank submitted an ICAAP document based on the data as at December 31, 2008, in the format of a Group ICAAP document that was submitted by the parent company for the approval of the Board of Directors. This document serves as an infrastructure for the testing process of capital adequacy, including methodology linking the risk profile and capital. During the second half of 2010, the Bank will prepare its ICAAP for December 31, As part of the Banks preparations for the implementation of the directive, the Bank conducted the following actions and processes: Conducting gap surveys and building up the Bank s mapping out of gaps.

40 40 / Annual Report 2009 The Bank completed the conducting of gap surveys in relation to the 14 principles of the BIS, as required by the Banking Supervision Department at the Bank of Israel. The methodology formulated for closing gaps is a Group methodology, as far as possible, so that with regard to all gaps common to the Bank and the parent company, the solution for closure of the gap will be formulated and outlined at the level of the parent company and will be transferred for implementation by the Bank with the necessary adaptations and changes. The mapping out by the Bank of gaps based on the findings of the gap surveys, serves as the basis for deriving the internal capital and for the process of examining capital adequacy. The Third Pillar - The disclosure requirements regarding the statements for December 31, 2008 and up to September 30, 2009, were set out in the Provisional Directive published in December 2007, and the Bank has implemented them as required. On October 13, 2009, the Provisional Directive - Implementation in Statements of Banking Corporations and Credit Card Companies, for the year 2009 and thereafter, of the Disclosure Requirements the Third Pillar of Basel II was published. According to this publication, the frequency of the quantitative disclosure is quarterly and the frequency of the qualitative disclosure is half-yearly. The Bank has made preparations for the implementation the required disclosure in accordance with this Provisional Directive and the data is reported as required as of the statements of the end of The Bank s approach to the assessment of capital adequacy in support its activities General - The working framework of Basel II is based on three Pillars that complement each other and provide an infrastructure for capital assessment of banking corporations. This working framework replaces the provisions of Basel I in all matters related to the determination of the minimum capital ratio for banking corporations. - The First Pillar of Basel II, which is entitled Minimum Capital Requirements, provides clear and binding instructions for the calculation of capital adequacy of banking corporations, with reference to the main risks to which corporations are exposed (credit, market and operational risks). - The process for calculating capital adequacy under the First Pillar is based on a framework of instructions implemented based on the Directive, without allowing a banking corporation any subjective discretion in relation to the level of risk embodied in the various activities and/or the contribution of the quality of management and the control in reducing an embodied exposure. - In the Second Pillar of Basel II, which is entitled Supervisory Review the banking corporation is required to assess routinely its capital adequacy in comparison with the risk profile and the business environment, as distinguished from the calculation of capital adequacy carried out in the First Pillar. - The purpose of the Second Pillar is to enhance and strengthen the affinity between the Bank s risks profile, and risk-management systems and methodologies existing in the Bank, and the level of capital and capital means. The term capital adequacy expresses a subjective assessment of the corporation regarding the degree to which the overall level of its capital means is appropriate to its overall risk profile. In this framework, the banking corporation is required to assess the adequacy of its capital against all the risks it is exposed to, including risks that have already been measured and for which capital has been allocated in the First Pillar. Beyond the reassessment of capital adequacy with regard to the risks in the First Pillar (as mentioned above credit, market and operational risks), the banking corporation is required to assess further risks on a quantitative basis (concentration risk, interest in the banking portfolio) and on a qualitative basis (for example reputational, regulatory, compliance, legal, business, and strategic risks). The capital adequacy assessment in the framework of the Second Pillar is a self-made subjective assessment carried out by the corporation. This process of self-assessment, performed by the banking corporation regarding its capital adequacy, is the ICAAP process. In accordance with Bank of Israel instructions, this process is intended to ensure that banks will retain an appropriate level of capital level to support all the risks embodied in their business, and that banks will

41 The Board of Directors Report 2009 / 41 develop and carry out appropriate processes of risk management and capital management. The second and complementary part of the capital adequacy assessment process by the banking corporation is the capital adequacy assessment by the regulator, whose aim is to examine to what degree the capital adequacy assessment conducted by the banking corporation can be accepted. This process is called Supervisory Review (SREP), and includes a detailed framework of instructions for the review of the ICAAP document, enabling the regulator to draw a conclusion with reference to the capital adequacy of the bank under supervision. In accordance with the methodology outlined by the Group in the working framework of Basel II, the Bank submitted, during the month of December 2009, the ICAAP Document based on data as at December 31, 2008, for approval by the Board of Directors, in the format of the Group ICAAP Document submitted by the parent company. This document serves as an infrastructure for the examination process of the Bank s capital adequacy. The Bank is of the opinion, in accordance with the ICAAP that was conducted as at December 31, 2008, that the Bank has appropriate capital adequacy.

42 42 / Annual Report 2009 In accordance with the Directives of the Supervisor of Banks concerning disclosure requirements of the Third Pillar of Basel II, below are details of the disclosure requirements stipulated in the Directive: Table No. Quantitative Disclosure Page Qualitative Disclosure Page 1. Table Commencement of implementation - Note 12 B (d) Table 2 Report of Changes in Shareholders Equity Capital Structure - Note 12 A, B Table 3 a. Capital Adequacy - Risk Assets and Capital Requirements in respect of Credit Risks, Market Risks, and Operational Risk. b. Note 12 B - Capital Adequacy in accordance with Directives of the Supervisor of Banks Basel II - The Bank s approach to the Assessment of Capital Adequacy to support its activities Table 4 A,B Table 4C Table 4D Table 4E Table 4F Table 4G Table 4H 5. Table 5 Total Gross Credit Risk Exposures and Average Gross Exposure during the Period Classified by Main Classes of Credit Exposure. Addendum F to Management Review - Exposure to Foreign Countries Distribution of Exposure by Type of Sector or Counterparty, Classified by Main Types of Credit Exposure Division of the Portfolio by Remainder of Contractual Period to Repayment, Classified by Main Types of Credit Exposure Balances of Specific and General Provisions. Addendum E - Overall Credit Risk by Economic Sector Addendum F to Management Review - Exposure to Foreign Countries, Problematic Debts column Change in Balance of Provision for Doubtful Debts: Note 4 C - Provision for Doubtful Debts Credit Risk, Disclosure Regarding Portfolios Treated in Accordance with Standardized Approach 76 a. Chapter on Risk Management Policy: Section 5 - Credit Risk Management b. Accounting Policy on Critical Matters: Section 1 - Provision for Doubtful Debts Chapter on Risk Management Policy Section 5 C: Chapter on Capital Allocation in Respect of Credit Risks, Market Risks, and Operational Risk Table 7 7. Table 8 8. Table 9 9. Table 10 Reduction of Credit Risk: Disclosures under the Standardized Approach. General Disclosure Regarding Exposures Connected with Counterparty Credit Risk Securitization - Disclosure under the Standardized Approach. Market Risk - Disclosure of Banking Corporations using the Standardized Approach 10. Table Table 13 Disclosure Regarding Positions in Shares in the Banking Portfolio: Note 3 - Securities 12. Table 14 Interest Rate Risk in the Banking Portfolio a. Chapter on Risk Management Policy - Collateral Management Policy b. Note 1, P - Offset of Financial Instruments 165 a. Counterparty Credit Risk Management 79 b. Collateral Management Policy Note 3 - Securities Chapter on Risk Management Policy: Section 2 - Market Risks Chapter on Risk Management Policy: Section 7 - Operational Risks a. Chapter on Risk Management Policy: Discussion of Risk Factors b. Accounting Policy on Critical Matters: Impairment of Assets a. Chapter on Risk Management Policy: Section 2 D - Exposure to Changes in Interest Rates

43 The Board of Directors Report 2009 / 43 Directive concerning the measurement and disclosure of impaired debts, credit risk and provisions for credit losses On a circular was published by the Banking Supervision Department on the subject: Measurement and Disclosure of Impaired Debts, Credit Risk and Provision for Credit Losses (henceforth: the circular or the Directive ). This circular is based, inter alia, on US accounting standards and relevant regulatory provisions of banking supervisory institutions and of the SEC in the US. The guiding principles on which the circular is based constitute a significant change as compared with the existing provisions regarding classification of problem loans and the measurement of provisions for loan losses in respect of such debts. According to the circular, banking corporations are required to maintain a provision for credit losses at an appropriate level to cover the estimated credit losses relating to its credit portfolio. In addition to that stated above, it is required, according to the circular, to maintain, as a separate liability account, a provision at an appropriate level to cover estimated credit losses connected with off-balance sheet instruments, such as commitments to give credit and guarantees. The provision required to cover estimated credit losses in relation to the credit portfolio will be assessed in one of two paths: individual provision and group provision. For this matter, a specific provision for credit losses is to be implemented for every debt whose contractual balance (without deduction of accounting write-offs not involving an accounting waiver, nondeductible interest, provisions for credit losses and collateral) is NIS 1 million or more; and also in respect of other debts identified by the Bank for separate assessment, for which the provision for impairment is not included in a specific provision for credit losses assessed on a group basis. The specific provision for credit losses is to be assessed based on expected future cash flows, discounted at the affective rate of interest of the debt, or, when the debt is conditional on collateral or when the Bank determines that a confiscation of property is anticipated, on the fair value of the security that was pledged to guarantee that credit. A specific provision for credit losses assessed on a group basis - is to be implemented for provisions for impairment large groupings of small homogeneous debts (such as credit card debts, housing loans and consumer debts payable in installments), and for debts that examined individually and found to be not impaired. The specific provision for credit losses on debts estimated on a group basis, except for housing loans for which a minimum specific provision was calculated according to the period of arrears, is to be calculated according to the rules prescribed American Accounting Standard No. 5 - Accounting for Contingencies (FAS 5), based on a current assessment of the rate of past losses in respect of each of the homogeneous groupings of debts with similar risk characteristics. The provision required with reference to off-balance sheet credit instruments is to be assessed according to the rules established in FAS 5. In addition to the above, the Directive includes various definitions and classifications of balance and offbalance sheet credit risk, rules for the recognition of interest income from impaired debts and also rules for the accounting write-off of problematic debts. Amongst other things, the circular stipulates that an accounting write-off is to be made for every debt assessed on an individual basis that is considered to be noncollectible and of such a low value that keeping it as an asset is not justified, or a debt for which the banking corporation is carrying out long term collection efforts. Regarding debts assessed on a group basis, rules for writing off were determined based on the period of their arrears and their dependency on being debts secured by a residential apartment, except for housing loans for which a minimal provision has been made in accordance with the length of arrears, debts secured by collateral which is not a residential apartment, unsecured debts, debts of borrowers in bankruptcy and debts created fraudulently. The Directive will not be implemented retroactively in financial statements for previous periods. Instead at the first implementation date, banking corporations and credit card companies will be required, inter alia: - To make an accounting write-off for any debt which at that date meets the conditions for being written off in the accounts;

44 44 / Annual Report To classify as requiring special supervision, inferior or impaired, any debt that meets the conditions for such classification; - To cancel all interest income which has accumulated but not been paid for any debt which at that date meets the relevant conditions, and - To examine the need for adjusting the balance for current taxes and deferred taxes to be received or paid. Adjustments to the balance of the provision for losses on credit to the public and for off-balance credit instruments at the first implementation date arising from the requirements of this Directive, including the requirements for determining a provision, will be included directly in the retained earnings item in shareholders equity. It is to be made clear that for this purpose, in spite of the definition according to which a problematic debt which has undergone reorganization is an impaired debt, banking corporations and credit card companies are not required to classify it as an impaired debt if reorganized before the first implementation date, as long as the debt is not impaired based on the conditions set out in the reorganization agreement. Following the original Directive from December 31, 2007, the Banking Supervision Department published on August 27, 2009 a Draft Directive including mainly updates and clarifications of instructions prescribed in the original Directive, and also updates to certain instructions included in the Proper Conduct of Banking Business Directives, with the aim of adapting existing rules and terms to the new terms and instructions included in the original Directive and the current Draft Directive (henceforth: the new Draft Directives ). The following changes, among others, have been proposed in the new Draft Directives: - Delaying implementation of the rules set out in the original Directive and in the new Draft Directives as of July 1, Cancelling section 5 of Proper Conduct of Banking Business Directive No. 325, on the subject of Management of Credit Facilities, relating to accounting aspects of classifying certain accounts as problematic and recognizing interest income. These matters will be dealt with in the framework of the general Directive on the Measurement of Provisions for Credit Losses and Disclosure with regard to Problematic Debts. - With the aim of simplifying the rules for the measurement of provisions for credit losses on a group basis, which requires the use of complex statistical models and a history of data of accounting write-offs, which do not exist in the banking system, a Provisional Order has been included in the Draft Directive to be implemented in the years (hereinafter: the transitional period ), which includes a simpler model for calculating credit loss provisions on a group basis. - With the aim of adapting the definitions and terms included in Proper Conduct of Banking Business Directive No. 315, on the subject of the Supplementary Provision for Doubtful Debts, to the terms included in the new Draft Directives, as of 1 July 2010 the term problematic debts will be changed to Credit risk under negative classification and credit risk under special supervision, and it will include three types of the said debts: impaired debts, inferior debts and debts under special supervision. - The rates of supplementary provision applying to the various types of problematic debts will be as follows: Credit risk under special supervision - 1% Inferior credit risk - 2% Impaired credit risk - 4% - Reporting to the Supervisor of Banks on changes expected in shareholders equity, in credit to the public, and in credit risk as at 31 December 2009, as if the new Directives were implemented at that date.

45 The Board of Directors Report 2009 / 45 - To include in the Financial Statements as at June 30, 2010, a pro-forma Note detailing the expected affect from the implementation of the Directive on the main balance sheet items, as if the new Directive were implemented at that date. - To submit to the Banking Supervision Department a certification signed by the Chairman of the Board of Directors, the General Manager, and the Chief Accountant, regarding internal control over financial reporting implemented by the Bank, for purposes of determining the recorded balance of debt of credit to the public, and the provisions for loan losses included in the proforma Note as at June 30, 2010; to assess the effectiveness of this control; and to state that the said effectiveness was audited by the external auditors. Pursuant to the above-mentioned Directives, a Directive was published on February 18, 2010, including updates and further instructions, whose main provisions were: - Postponing implementation of the rules prescribed in the original Directive and in those published thereafter, to January 1, Disclosure requirements for the quarterly statements of 2010 were regulated, as detailed in the Directive. - Banking corporations are to send reports to the Banking Supervision Department in the format decided on the data included in the consolidated financial statements of the banking corporation, as if the new Directives were to be implemented as at the following dates: the report is to be sent no later than the report is to be sent no later than the report is to be sent no later than the report is to be sent no later than The format of the report is based on specific items of information for which disclosure is required according to the new Directives in the Notes, the Management Review, and the Report of the Board of Directors. It should be made clear that for the purposes of preparing the report according to the report detailed in the letter: - No calculation is to be made of operating results. All data required (including provisions for credit losses and accounting write-offs) are balances at the reporting dates. - The method of calculation of the amounts reported in the appendix (unless specifically mentioned otherwise) will be in accordance with the definitions provided in the new Directives. - The reports will include data based on reasonable estimates, providing this fact will be noted in the report. Implementation of the provisions of the Directive require the upgrading and/or establishing a computer infrastructure system to ensure the process of assessment and execution of the provision for loan losses, including internal control systems to check the proper implementation of the Directive and validation of the effectiveness of the method of calculating the provision. In view of the fact that Bank relies in many areas on the operating systems and units of the Central Services Division of the First International Bank, the Bank has made preparations for implementation of the Directive in the framework of Group preparations of the First International Bank (the parent company). In 2008, the Bank made preparations for the study of the Directive, and the manner of its implementation. In addition, within the framework of preparations by the Group, an administrative body was set up to carry out the Directive and the content of the project and the bodies relevant to its implementation were defined. In 2009, there began the development stages of the system and the relevant interfaces, their characterization, and their computerization, and tests began on transmitting and receiving. In 2010, concurrently with the completion of development of the interfaces, tests on receiving will be carried out as well as integration in the system, working procedures will be written, existing procedures will be adopted, and training will be carried out for the various units in the Bank in the assimilation of the new system. It should be noted that this is a complex project affecting many areas in the Bank, including computing, reporting and operating systems.

46 46 / Annual Report 2009 Implementing the directive is expected to have repercussions on future relationships between the Bank and its customers, resulting from the requirement to implement principles matching the business environment in the U.S. to the business environment that exists in Israel. The directive includes more stringent documentation requirements, and requirements for the assessment and carrying out of the provision for expected loan losses, in respect of debts in various classifications (out of those currently prescribed in the Public Reporting Directives and in Proper Conduct of Banking Business Directive No. 314, on the subject of Treatment of Problematic Debts ), and in respect of exposures to off-balance sheet credit. In addition, implementation of the directive requires preparation and significant changes to existing information systems, which are not adapted, at this stage, to reporting according to the principles proposed. In accordance with the requirement of the Bank of Israel, the Bank carried out a preliminary assessment of the implications of implementing the Directive in its statements. The Bank s assessment referred to material debts only (above the stipulated threshold), and was based, inter alia, in certain cases on subjective assessments and interpretations. According to this assessment, the expected effect of implementing the Directive on the Bank, as at , amounts to an increase in the provision for doubtful debts of about NIS 30.0 million, before the effect of taxation. The amount derives from the writing off of principal and cancellation of accumulated interest on debts to be defined as impaired because of extended legal proceedings, this in spite of the debts being well secured and the Bank anticipating the repayment in full of the debts, including accumulated interest.

47 The Board of Directors Report 2009 / 47 Description of the Bank s Business according to Operational Segments The Bank s operations are focused in 3 operational segments: private banking, corporate banking and the financial segment. General Information 1. The Bank applies the EVA (Economic Value Added) model used worldwide for purposes of measuring the contribution of every unit to the overall profitability of the Bank. Income, expenses and equity are allocated to every activity segment in implementing the model, as follows: a. Income of segments from outside entities: Income of the banking segment derives from financing income and operating income from private customers attributed to this segment. Also, the segment s income includes income from investment portfolio management, income from managing the Bank s mutual funds and income from private and public trusts. Income of the business segment derives from financing income and operating income from customers whose main activity is in the capital markets. Also, the segment s income includes income from trusteeships of mutual funds. Income of the financial segment derives from financing income resulting from managing the sources and uses of the Bank in the various index-linkage segments, and from the Bank s activity in securities for itself. Also, the segment s income includes income from activity of the dealing rooms regarding the management of the Bank s base- and interest-exposure. b. Intersegmental income: Intersegmental profit from financing activity before provision for doubtful debts: Financing income/expenses are first attributed to the segment to which the customer is attributed. After that the finance segment, which is responsible for managing the sources and uses of the Bank, debits/credits the other segments for the cost of raising the sources, which is calculated in accordance with the relevant index-linkage segments and duration. Intersegmental operating and other income: Operating and other income are first attributed to the segment to which the customer is attributed. After that, the relative part of that income (as determined for each type of income separately) is transferred to the other activity segments which provide services for the activity of that customer. c. Provision for doubtful debts: Provisions for doubtful debts (specific and supplementary) relating to the customers attributed to a segment are ascribed to each segment. d. Expenses of segments: Salary and related expenses are allocated among the segments in accordance with the actual expense. Other main expenses are allocated in accordance with the number of employees or by weighting the number of employees and equity or are of the premises used by the segment, as the case requires. Depreciation expenses are allocated specifically to segments in accordance with the assets used by them. e. The cost of central services and Management are loaded on the reporting activity segments, as part of the implementation of the model. (Central services include all the departments in the Central Services Division and the Chief Accountant s Division, the Bank s Corporate Secretary and Internal Audit and Information Systems).

48 48 / Annual Report 2009 f. The net return on equity is calculated on the average equity allocated to the reporting segments in accordance with the rate of 12% of the risk assets of each segment. When a reporting segment has no risk assets allocated to it for purposes of its activity, the equity allocated to the segment is calculated by the multiplier of the segment s expenses. In the financial sector, the yield used for purposes of calculating the net return on equity is after neutralizing the risk-free return on the Bank s inactive capital 2. The results of the segments are shown in detail in Note 26 to the Financial Statements. In Note 26 (B) (3) there are details of the composition of Unallocated amounts and adjustments. 3. In accordance with the guidelines of the Supervisor of Banks, the following activities are to be shown separately for each segment in the Directors Report: banking and finance, credit cards, capital markets, mortgages, construction and real estate. The Bank has no significant activity in the credit cards, mortgages and construction and real estate spheres. 4. The division between activity segments is based on types of customers or defined areas of activity. It is derived from the strategy of customer-focused activity by which the Bank has been operating over recent years. The results of the activity of the segments, classified according to the main activity segments, are shown in detail as mentioned in Note 26 to the Financial Statements. Since there are no uniform criteria in the banking sector for attributing customers to activity segments as above, each bank attributes its customers to activity segments reflecting its management concept and business strategy. In view of this, it is impractical to refer to the Bank s share of the banking sector in the various activity segments. Data on the results of the segments has been prepared in accordance with the Directives of the Supervisor of Banks on the matter of Main Activity Segments. In the framework of preparing the Note, inter alia, adjustments are made between management reports relating to the above activity segments which are based partly on the Management s review of the activity segments, and reporting in accordance with accepted accounting principles. Bellow is a summary of the net profit, according to the segment in reported amounts: 2009 The year ended December Private banking 2 (4.3) 2,1 (0.3) Corporate banking 30.1 Financial segment 40.8 Unallocated amounts adjustments (1.0) (0.2) Change percentage % % Total % 1 Reclassified 2 Excluding an expense related to the opening of the new branches, the profit of the segment for 2009 is in the amount of NIS 6.3 million ( NIS 10.5 million).

49 The Board of Directors Report 2009 / 49 Private Banking Segment Description of Area of Activity The area of Private Banking has developed a great deal in Israel in recent years. In an environment of a growing economy and growth in the assets of the highest income brackets, there is a need in Israel for high-standard private banking. The Bank, which has a long-standing reputation in this field, offers a platform of discreet, specialised and flexible private banking for high net worth customers and their businesses. Personal banking services are provided by the principal branches in Tel-Aviv and Jerusalem and through a system of branches at the center of exclusive neighborhoods in Israel built so far in Ra anana, Rishon- Letzion, Rehovot and Malha, and branches that are to be opened in the near future in further strategic locations (such as: the Ramat HaSharon Branch due to be opened as early as March 2010). Services are given by teams of professional and experienced bankers, and a system of investment advisors, which are the spearhead in this field. Operating within this segment is the Bank s Trust Company, which offers private and public trust services (also trust services to mutual funds that are included in the Corporate Banking segment). Furthermore, the segment includes the activity of two subsidiaries in the asset management sphere: UBank Asset Management Ltd. and UBank Mutual Funds Ltd. The Segment s Customers The segment includes all the Bank s private customers and their businesses. These are both private customers belonging to the personal banking division and also private customers in the capital market division, whose principal operations are in securities. The segment s customers include long-standing customers who have been with the Bank for many years (more than 15 years), alongside younger customers (with a history of up to five years) who are engaged in the free professions, foreign residents, founders and employees of hi-tech companies, corporate executives and those active in the capital market. With the opening of the new branches the sector has broadened its customer base. New customers now joining the Bank want professional and focused service, and to be offered value which suits their type of banking needs. The wide range of customers prevents dependency on one narrow segment of customers. The customers characteristics: limited time resources, available capital, business flexibility, complex business ideas, international investments and extensive know-how of the capital market. In the wake of developments in the capital market in recent years, special emphasis was placed on expanding the network of investment consultants specializing in markets in Israel and overseas, and providing the segment s customers with access to these services. The investment counsellors engage only in investment counselling for select customers. The relationship of counselors to this group of customers enables the Bank to extend professional service at a high level. Legislative Restrictions, Standards and Special Demands applying to the Segment The Bank operates under laws, regulations, and supervisory guidelines applying to the banking system from parties such as the Banking Supervision Department; the Commissioner for the Capital Market, Insurance, and Savings; the Anti-Trust Commissioner; the Israel Securities Authority and more. For information regarding regulation in the area of banking commissions, see the chapter on this under Updates in Legislation. Competition Competition in this segment is increasing, as a result of the growth in the financial assets of private banking customers, growing awareness towards service and an expanding range of financial services available in the market. Most of the segment s competition is with commercial banks engaged in the private banking field, foreign banks operating in Israel, investment firms, and entities that enable securities trading through

50 50 / Annual Report 2009 the Internet. In order to distinguish the Personal Banking from the Bank s competitors, the division was labeled as the Personal Banking Division, which takes the customer into a personal relation based world. The segment s customers are offered high standard personal service and financial solutions adapted to the customer s needs and the changing needs of the market. Technological Changes In the framework of the systems conversion to the systems of FIBI, on the process of absorbing FIBI s branch computer systems into both established and new branches ended. This process contributed to the improvement of the computer infrastructure of activity in this sector. In addition, the Bank uses the consulting system of the First International Bank, which is an advanced consulting system combining a computerized characterization model from which is derived the recommended structure of the investment portfolio based on the needs and preferences of the customer. Critical success factors in the sector Success in the private banking sector is based on a number of main factors: - Customer focused service, while putting an emphasis on personal relationship and flexibility in matching services and products to the individual needs of each customer. - Investment consultants at a high professional level. - Wide range array of financial solutions and products adapted to the private banking population and constantly updated in accordance with market conditions in Israel and abroad. - A dealing room system that allows customers with active investment portfolios constant access to capital and money markets in Israel and abroad. Principal barriers to entrance and exit of the sector Activity in the private banking sector demands investment and capabilities in the following subjects: - Training of skilled investment consulting staff, authorized by law, with a high level of service awareness. - A basket of services and products adapted to the needs of private banking customers and constantly updated in accordance with developments in markets in Israel and abroad. Products and Services The segment offers a range of products and services for day-to-day banking activity, investment consultancy services specializing in Israeli and global markets, and trading in Israeli and foreign securities, through both the dealing room and through the Internet site. The segment also offers the execution of transactions in foreign currency and direct access to the foreign currency dealing room, for large amounts. The Trust Company acts as a trustee for series of bonds of purpose companies (SPC) and advanced financial instruments (exchange traded certificates and cover options etc.), issued by companies through private or public offerings. In addition, the company acts a trustee in credit transactions for purposes of supervision and control of collaterals for these transactions, as a trustee of individual and corporate assets (including the lending of a name) and as a trustee in Escrow transactions. The company also grants administration services to hedge funds and private investment funds, including also trusteeship for purposes of deducting taxes by the funds. Marketing The segment s marketing strategy is focused on two key elements: activation of existing customers, with the objective of encouraging the volume of activity and expanding the areas of activity of existing customers of the Bank, as well as attracting new customers who meet the profile characteristics of the type of customer of the personal banking. The Bank markets its competitive advantages, including: the Bank s prestigious brand name, the Bank s reputation as a long-standing bank with historical roots that has always specialised in private banking

51 The Board of Directors Report 2009 / 51 and the capital market, devising specific products in accordance with the individual customer s requests, personal relationship with the customer, immediate accessibility to a professional investment counsellor conversant with his field, agility and flexibility of a small bank with the financial strength of the FIBI Group, service over and beyond usual banking hours and a personal banking representative of a high professional level. UBank Asset Management Ltd., UBank Mutual Funds Ltd. UBank Asset Management specializes in the management of investment portfolios in Israel and overseas for a variety of customers: public entities, government and private companies, non-profit organizations and private customers. A subsidiary - UBank Mutual Funds Ltd., manages a variety of mutual funds that invest in markets in Israel and overseas. The total monies managed by the Company and subsidiary as of the end of 2009 amounted to approx. NIS 1.4 billion, of which approx. NIS 0.7 billion is in the management of investment portfolios, and approx. NIS 0.7 billion in fund management. The Company works diligently on developing new products and creating investment opportunities for its customers, while monitoring the changes in the capital markets and studying the changing needs of its present and potential customers. Marketing operations are carried out through the marketing department. In addition, the company uses various advertising and sales promotion channels, such as advertising on the Internet, in the written press, participation in conventions and giving lectures. Furthermore, the company s sales personnel and the investment managers themselves take care to preserve close relations with counsellors in the entire banking system. The Bachar Commission s recommendations stipulated that a bank corporation shall not own a fund management company and allocated a period of 4-8 years for the sale of the fund management companies, eight years in the case of the Bank, August The Bank chose not to sell its mutual funds, but will continue to hold them for the period permitted by law. Future Objectives The private banking sector is expected to grow and focus in 2010 on growth in the number of customers in personal banking; this by means of retaining and activating existing customers and in recruiting new ones, adding to the Bank s branch network and increasing consultancy services, while giving personal highlevel service. In the field of managing financial assets, the company hopes to increase the number of managed portfolios and asset share. In the field of managing mutual funds, the company, that is considered as an expert in foreign markets, will continue to focus upon overseas niche funds, in improving yields and increasing marketing efforts with the aim of increasing asset share. Human Capital The number of workers that serve this sector amounted in 2009 to about 150 employees on average (in employees on average). Operating Results The Private Banking Segment ended the year with a loss of NIS 4.3 million, compared with a loss of NIS 0.3 million in Excluding the loss due to the new branches, the segment would end the year 2009 with a net profit of NIS 6.3 million, compared with a net profit of NIS 10.5 million last year. The increase of the loss derives mainly from an increase in operating and other expenses in light of the opening of Affluent Customer Banking branches during In addition there was a reduction in revenues from managing of the Bank s mutual funds and a decrease in repayment of debts. As at the bank opened four new branches for the affluent population (of which two were opened during 2008 and two at the end of 2007).

52 52 / Annual Report 2009 Set forth below is a summary of the Private Banking segment s results (in ): Banking and Finance Capital Market Total For the year ended 31, December 2009 Banking and Finance Capital Market Total For the year ended 31, December Profit from financing operations before provision for doubtful debts: From external entities (30.9) 1.7 (29.2) Inter-segment Total profit from financing operations Operating and other income: From external entities Inter-segment (4.2) 1.9 (2.3) (4.4) 2.2 (2.2) Total income Provision for doubtful debts (0.3) - (0.3) (2.5) - (2.5) Operating and other expenses, (including depreciation) Profit (loss) from ordinary operations before taxes 0.4 (7.1) (6.7) 2.4 (2.9) (0.5) Provision for taxes on profit from ordinary operations 0.2 (2.6) (2.4) 0.9 (1.1) (0.2) Net profit (loss) 0.2 (4.5) (4.3) 1.5 (1.8) (0.3) Net return on equity (in percentages) 0.4% (24.5%) (6.0%) 3.8% (9.7%) (0.5%) Average balance of assets Average balance of liabilities 2, , , ,728.6 Average balance of risk assets Average balance of mutual funds assets Average balance of other assets under management Composition of profit from financing operation before provision for doubtful debts: Margin from credit activity Margin from deposits activity Other Total profit from financing operations before provision for doubtful debts Reclassified.

53 The Board of Directors Report 2009 / 53 Corporate Banking Segment Description of Areas of Activity The Corporate Banking segment includes the following areas of activity: trading Services in securities in Israel and abroad (front and back-office system), operations for mutual funds, operating services for hedge funds and trust services for mutual funds provided through the subsidiary "UBank Trust Company Ltd." Moreover, the segment provides banking services for the capital market division's customers. The Segment's Customers The customers of the Corporate Banking Segment include leading institutions in the capital market, including: mutual funds, groups engaged in insurance, pension and provident spheres, hedge funds and portfolio managers. The segment consolidates the activities of several companies in the insurance, pension and provident fields, which account for approx. 33% of the segment's income. It is therefore, natural that they are significant customers for its operations. Likewise, the segment's customers include companies and self-employed people who are active in the capital market, including option traders, arbitrageurs and day traders. Private customers activity is classified within the framework of the Private Banking Segment. Legislative Restrictions, Standards and Special Demands applying to the Segment The Bank operates under laws, regulations, and supervisory guidelines applying to the banking system from parties such as the Banking Supervision Department; the Commissioner for the Capital Market, Insurance, and Savings; the Anti-Trust Commissioner; the Israel Securities Authority and more. In accordance with Proper Conduct of Banking Business Directives Nos. 312, 313 and 315, limits apply to the total debt permitted for single borrowers, groups of borrowers, the total credit of the six largest groups of borrowers in the Bank, customers defined as interested parties and a limit to sector concentration. These restrictions may have an effect on the manner and extent of activity of the business sector in the Bank with those of its customers. Joint Investment Trust Law (Amendment No. 14), 2009 The draft law was published on The main amendment is a change to section 69 in the Joint Investment Trust Law. The main changes are as follows: an obligation was imposed on the fund manager to hold a tender for brokerage commissions with a trading company (a member of the Stock Exchange); the Board of Directors of the fund manager must fix a procedure for holding a tender which will be approved by the trustee; entering an undertaking with a stock exchange member overseas can be made without a tender (within the terms of the law); an undertaking by a fund manager under a brokerage agreement with a stock exchange member controlling the fund manager or the trustee of the fund can be made without a tender subject to the following conditions: 1. The stock exchange member must meet the minimum conditions that were set out in the tender. 2. The commission for any kind of a deal will not exceed the commission that the winner of the tender will be paid for a similar deal. 3. The undertaking was approved by the Audit Committee and the Board of Directors of the fund manager. The fund manager will not make payments from the fund s assets to stock exchange members related to the fund manager or trustee, for a period of 12 months commencing on the date decided by the fund manager in the prospectus, for the execution of transactions in the trust s assets, in an amount exceeding 20% of all commissions (of all types) that were paid from the fund s assets in that year. The amendment will come into effect 12 months after publication of the amendment to the law. It should be mentioned that the amendment to the law replaces the same sections in the proposed Joint Investment Trust Law (Amendment No. 13), 2008, which deal with the requirement for a tender and restrictions on payments of brokerage commissions to a company related to a fund manager or a trustee. The amendment should have a significant effect on the business of the Bank and the results of its activities, because the Bank has significant activity both as a banker and as a trustee for mutual funds through its

54 54 / Annual Report 2009 subsidiary company - UBank Trust Company Ltd., which may bring about the need for significant reduction in one of these activities. As of the date of approval of these Financial Statements, no decision has yet been made by the Bank, regarding the manner of preparation for the implications of the above-mentioned legislation. On the Proposed Joint Investment Trust Law, 1994, (Amendment No. 13), 2008 Was approved by the Ministerial Committee for Legislative Matters. The main amendments proposed are: offer to the public of foreign mutual funds; increasing the duties of supervision imposed on the trustee and tightening supervision over fund managers; granting authority to the Securities Authority to deny as well as not to grant a company approval to serve as trustee or fund manager for reasons connected with its reliability; prohibiting a company from serving as a trustee in a fund if one of the alternatives defined in the proposal exist. If the Amendment in its present version will become binding legislation, there is expected to be a material effect on the business of the bank and its operating results, because the Bank has significant activity both as a banker and as a trustee for mutual funds through its subsidiary company UBank Trust Company Ltd., which may, if the legislative process is completed, bring about the need for significant reduction in one of these activities. As of the date of approval of these Financial Statements, no decision has yet been made by the Bank, regarding the manner of preparation for the implications of the above-mentioned legislation, if it is approved in its current version, and regarding which activities will be reduced, as mentioned above. Competition Most of the competition in the Corporate Banking segment is with the large and mid-sized banks in Israel and with brokers and investment houses. The major institutional customers of the Corporate Banking segment work with other banks, and some own investment houses that serve as stock exchange members. The main ways for the bank to deal with the competition is by providing a comprehensive solution for customers capital market needs, and nurturing the customers while providing an immediate, fast and effective response to their needs, while also adapting personal banking values to the institutional customers. Technological changes As of , following the conversion of systems to the computer systems of the First International Bank, the sector relies for its operations on the computer system of the parent company while preserving the Bank s unique commercial system, the U-TRADE system. Critical success factors in the sector - Providing services at the highest professional level, while meeting appropriate response times and adapting financial services and products to the business needs of each customer. - Financial creativity and expertise in sophisticated fields of activity such as derivative financial instruments, securities, and foreign currency. - Strict observance of management and control of credit risks, by in-depth knowledge of each customer and ongoing monitoring of changes in his condition and in the condition of the market, with the purpose of maximizing the potential for profit and limiting risks as much as possible. - Advanced technological systems. - Long-term relationships and in-depth acquaintance with long-service customers that have been with the Bank for many years. Principal barriers to entering and leaving the sector - Constant investment in advanced technological systems. - Flexibility and creativity on the part of the Bank and providing an immediate and precise response to the needs of the customers, while preserving the one stop shop principle.

55 The Board of Directors Report 2009 / 55 Services and Products The segment provides operational and banking services to mutual funds managed by outside parties. Apart from securities clearing house services, the sector offers allied services such as: options and finance transactions, share and bond trading in overseas Stock Exchanges, and trading and clearing of mutual funds and hedge funds overseas. The segment s customers operate, inter alia, through a unique trading system, of the Bank-U-TRADE which was developed independently by the Bank s computer unit. The system enables direct transfer between trading in Tel Aviv and trading on the New York exchanges. The Bank invests substantial resources in developing and improving the system and adapting them to the changing needs of its customers. During the year the trading system was expanded in order to enable pre-market trading in the USA and also direct trading on the London Stock Exchange. The Bank also provides brokerage services and is ready to increase these services mainly in light of the change expected in 2008 among pension funds, provident funds and corporate-concern funds of these other institutional entities, after which they will receive brokerage services from a number of external entities. Trustees for mutual funds This activity is carried out within UBank Trust Company Ltd., which is the oldest and largest banking company in Israel for providing trust services to funds. At the end of 2009, the Company serves as trustee for 438 funds managed by 23 different entities (approx 36% of the mutual funds in Israel), of which approx. 49% of the income derives from 146 funds that are managed by four entities. The assets of all the funds for which the Company served as trustee at the end of 2009 total approx. NIS 44 billion (approx 33% of the market). The Company is trustee for a wide range of funds specializing in various investment channels in the capital market. Goals for the Future The corporate banking segment is expected to focus its efforts on the retention and expansion of its market share by expanding its customer base and the volume of activity, developing advance services and nurturing the segment s customers while providing an immediate and precise response to their needs. The segment also aspires to provide personal banking services at a high standard to institutions, while maintaining the principal of a one-stop shop. Emphasis will be placed on utilizing the opportunities existing in the market, owing to structural changes, and the Bank s ability to provide appropriate solutions to customers. In the field of trusteeships for mutual funds, the company hopes to maintain and increase its market share while utilizing the strong reputation it has earned. Human Capital The number of workers that serve this sector amounted in 2009 to about 92 employees on average (in employees on average). Operating Results The Corporate Banking Segment ended the year with a net profit of NIS 30.1 million, compared with a net profit of NIS 26.3 million in 2008, a decrease of 14.4%. The increase in net profit is due mostly to an increase in operating and other income from the capital market activity in all its areas net.

56 56 / Annual Report 2009 Below is a summary of the Corporate Banking segment s results (in ): Banking and Finance Capital Market Total Banking and Finance Capital Market Total For the year ended 31, December For the year ended 31, December Profit from financing operations before provision for doubtful debts: From external entities (49.9) 5.4 (44.5) Inter-segment Total profit from financing operations Operating and other income: From external entities Inter-segment (1.1) - (1.1) (0.3) - (0.3) Total income Provision for doubtful debts (0.2) - (0.2) Operating and other expenses, (including depreciation) Profit from ordinary operations before taxes Provision for taxes on profit from ordinary operations Net profit Net return on equity (in percentages) 74.9% 29.3% 41.6% 56.3% 19.7% 28.3% Average balance of assets 1, , , ,287.7 Average balance of liabilities 3, , , ,529.0 Average balance of risk assets Composion of profit from financing operation before provision for doubtful debts: Margin from credit activity Margin from deposits activity Other Total profit from financing operations before provision for doubtful debts Reclassified.

57 The Board of Directors Report 2009 / 57 The Financial Segment Description of Areas of Activity The Segment is divided into three sub-segments: the asset and liability management department (hereinafter referred to as: ALM ), dealing rooms and liquidity unit. The income in this sector derives mainly from the Nostro activity of the Bank and the management of exposures to market risks and liquidity. In the framework of the management of exposures and market risks, this includes the effect of activity in derivatives financial instruments is, which for the most part serves as part of the policy of managing the index-linked balance sheet of the Bank, and partially the activity by specialized desk-officers that serve as financial profit centers integrated in the Nostro activity of the Bank, and in the share of the Bank in the profits of companies included on equity basis. The segment s Customers The segment provides services to the customers of the other segments - private and institutional - mainly in the dealing room area. Likewise, the division provides derivative financial products and structured products to the customers of the other segments. Legislative Restrictions, Standards and Special Demands applying to the segment The Bank operates in the framework of laws, regulations, and supervisory guidelines applying to the Israeli banking system from parties such as the Banking Supervision Department; the Commissioner for the Capital Market, Insurance, and Savings; the Anti-Trust Commissioner; the Israel Securities Authority and more. In addition, the board of directors set guidelines regarding the permitted exposures concerning the managing of market and liquidity risk exposures. Services and Products ALM Department: The department manages the Bank s nostro position within the trading securities portfolio and the available-for-sale securities portfolio. In addition, the department manages the exposure to basis and interest risks in all the linkage sectors, in accordance with the decisions made by the ALM Committee and subject to the limitations approved by the Bank s board of directors. Liquidity unit: The unit deals with the management of the Bank s liquidity by participating in loan and deposit tenders of the Bank of Israel, operations with banks and executing shekel / foreign currency swap transactions. Dealing Rooms: Comprehensive services to the Bank s customers are provided by the dealing rooms, in executing financial transactions in markets in Israel and overseas for purposes of investment and hedging exposures in foreign currency and interest. The types of transactions include conversion and purchases of a wide range of currencies for immediate and future delivery, options on foreign currency and interest derivatives in foreign currency, etc. Within the context of the shekel dealing room, the Bank operates as a chief market maker on behalf of the Ministry of Finance and also a market maker for Shachar type bonds on the Stock Exchange. In 2009 the Bank was rated in the third place of 15 of the bond market makers. Competition in the Segment Most of the competition in this segment is in the dealing room area with the dealing rooms of other banks. The Bank s dealing room provides its customers with fast and efficient services and quotes prices at competitive margins.

58 58 / Annual Report 2009 Marketing and Distribution Channels Marketing and distribution activities are carried out by employees of the finance division and through the network of bankers and consultants in the branches. Goals for the Future In the area of management of the Nostro portfolio, management of the exposure to market risks and management of liquidity, the targets of the sector in this area are the pro-active management of exposures and the Nostro, with the aim maximizing profits while maintaining control of the exposure to market risks and appropriate liquidity, according to the limits prescribed in the guidelines of the Board of Directors. The Bank intends to continue the development of the dealing room, through expansion of the customer base and increasing deepening activity and business connections with them. Moreover, the sector intends expanding the supply of structured and derivative products marketed to private customers and institutional clients of the Bank. Human Resources The number of workers that serve this sector amounted in 2009 to 27 employees on average (in employees on average). Operating Results The Financial Segment ended the year with a net profit of NIS 40.8 million, compared with a net profit of NIS 39.5 million in 2008, an increase of 3.3%. The increase derives mainly from an increase in the operating return on the available for sale securities portfolio, locally and abroad, and an increase in profit realization in the available for sale securities portfolio in the amount of NIS 20.8 million. Profits in the available for sale securities portfolio in 2009 are offset by other that temporary impairment of NIS 13.7 million. (An other that temporary impairment was recorded in 2008 in the amount of NIS 15.4 million of which NIS 5.4 million were in mortgage backed bonds). In addition, the increase derives from a range of activities in the area of the Finance Division, including being market maker for government bonds and other trading activities, which are an part of the routine activity of the Bank. The increase was offset by a decrease in income that derives from the investment in investee companies and a decrease in income from dividend. Below is a summary of the Financial segment s results (in ): Profit from financing operations after provision for doubtful debts Operating and other income Total income 96.0 Provision for doubtful debts - (0.9) Operating and other expenses Profit from ordinary operations before taxes Net profit Net return on capital 36.6% % Average balance of assets 5, ,843.4 Average balance of liabilities Average balance of risk assets Reclassified.

59 The Board of Directors Report 2009 / 59 Fixed Assets and Facilities The Bank operates in Six branches. The Jerusalem branch - the Bank is the owner of the branch building. In the other branches of the Bank, including the building which serves as the Bank s headquarters and Tel- Aviv Branch. The Bank rents premises in various buildings. Rental agreements for the rented premises are for different periods, and for the most part the Bank has options to extend the rental period. Taxation The Bank and some of the subsidiary companies are defined as financial institutions for the purpose of the V.A.T. Law. In accordance with that Law, a salaries and profits tax is imposed at the rate of 16.5% (until 1 July, %) on the salaries paid and on the profits earned, respectively, for the activities in Israel of a financial institution. For information in respect of the tax assessments of the Bank and of the consolidated companies, see Note 23 (C). The Bank has the status of approved broker (QI), as defined in the regulations of the Income Tax Authorities in the USA. The significance of this status is that the Bank has entered into an agreement with the Tax Authorities in the USA according to which the Bank will deduct tax at source from its customers income in respect of the activities of its customers, who are not Americans, in American securities. Additional information Risk Management Policy 1. General A. The Bank s activity is accompanied by exposure to risks, of which the more material are: credit risk, market risk, liquidity risk, operational risks and legal risks. B. The risk management policy of the Bank is aimed towards achieving the strategic and business targets that were set, and increasing profit expectancy, while cultivating specialization at the Bank, and utilizing advantages of variation and size, while maintaining the levels of risk that were approved and the existence of appropriate mechanisms for management, control and supervision. C. The Bank s overall concept of risk is based on the principle that for every banking activity that involves risk the following will be defined and characterized: risk policy and appetite, exposure limits for delineating and defining the scale and depth of the exposure, a system of control and audit, a reporting system, and a mechanism for quantifying, measuring and reporting the profit, in accordance with acceptable standards. D. Risk management and control are conducted through an appropriate infrastructure of control, supervision, monitoring, and audit mechanisms, in the framework determined by the Banking Supervision Department at the Bank of Israel. E Mr. Yaacov Garten, Deputy General Manager and Head of the Central Services Division, is the Chief Risk Manager of the Bank. Mr. Shimon Vaknin, Manager of the Finance Division, is the Market and Liquidity Risk Manager of the Bank. Mr. David Katz, Manager of Risks and Credit Management Department, is the Credit Risk Manager of the Bank. Mrs. Michal Tilo, Manager of the Regulation and Processes Department, is the Operational Risks Manager of the Bank. Mrs. Michal Tilo replaced Mr. Moshe Haver who served in the position until Adv. Racheli Shaul Hasharoni, Manageress of the Legal Department, is the Legal Risks Manageress of the Bank.

60 60 / Annual Report 2009 F. The additional risks to which the Bank is exposed (see the Chart of the Discussion of Risk Factors on page 92 are also managed and supervised as part of the overall management of the business, and by each of the members of Management in the area under his responsibility, and, at the same time, as part of the integrative risk management of the Bank. Relationship of the Board of Directors and Management to risk management issues Control, supervision, and monitoring of the appropriateness of risk management in the Bank is performed, among other things, by the Board of Directors, committees on its behalf, and committees of the Management in the various area of risk, of which the principal ones are: A. Once a year, the Board of Directors outlines overall policy on exposure to the different risks, by means of discussion and approval of the Risk Management Document of the Bank. This document establishes, among other things, the overall risk appetite, demarcation of risk, and the maximum ceiling for exposure in the various operating areas and segments. It also sets standards for management, measurement, control, and reporting on the exposure to different risks. B. At every meeting of the Board of Directors, there is a follow-up and monitoring of developments in the principal financial exposures, and an examination of compliance with the limitations. The Board of Directors also performs monitoring and control of the Bank s compliance with the limitations set and of the appropriateness of the system of risk management and control in the Bank. C. The Board of Directors established a committee on its behalf, the Credit and Risk Management Committee that will meet as of 2010 at least six times a year and will coordinate everything mentioned in paragraph B above. D. The Credit and Risk Management Committee of the Board of Directors meets, as mentioned in paragraph C, six times a year to discuss credits. E. Every week there is a meeting of the Assets and Liabilities Management (ALM) Committee meets under the General Manager and with the participation of the relevant Members of Management, which discusses developments in the Nostro portfolios in shekels and in foreign currency, and developments in the financial markets. The relevant management and control bodies in the Bank participate in the discussion. F. Eight times a year there is a meeting of the Audit Committee of the Board of Directors. G. Once a quarter a discussion takes place with Management and the Board of Directors regarding the overall Exposure Document of the Bank, in which are reported exposures of the Bank to financial risks, credit risks, operational risks and legal risks, and the Bank s compliance with the limitations set by the Board of Directors. As of 2010, prior to the discussion by the Board of Directors, a detailed discussion will place will be held in a committee of the Board of Director, the Credit and Risk Management Committee. H. The Risk Management Unit in the parent company is responsible, among other things, for the implementation and assimilation of the overall Group policy for risk management that it compatible with Group targets and goals, and for the execution of ongoing supervision and monitoring of the banking subsidiary companies. In addition, the unit is responsible for the implementation and assimilation of the provisions of the Second Pillar of Basel II as part of the advancement and improvement of the overall risk management system of the Group, including the Bank. I. Bank Management, in coordination with the Group, continues to enhance and improve tools for the measurement, supervision, control and reporting required, in order to obtain an updated picture, in real time, of the Bank s exposures to the various risks.

61 The Board of Directors Report 2009 / Market Risks A. Market risk is an existing or future risk to the income and capital of the Bank resulting from changes in rates and margins in the financial markets in which it operates and that have an effect on the value of the Bank s assets or liabilities: interest rates, exchange rates, inflation, prices of securities, prices of products, fluctuations in these parameters, and changes in other economic indices. B. The Bank has a detailed policy for the management of exposure to the market risks, which is approved every year by Management and the Board of Directors. The policy document outlines and specifies, among other things: an overall market risk appetite and a risk appetite for a cross-section of individual risk, principles for activity and limitations on the level of the various instruments, periodical reporting to the Board of Directors on the exposure to risks, an examination of changes required in accordance with changes in the Bank s activities, a definition of the bodies involved in the management process, measurement, control and supervision of risks. Below are the capital requirements in respect of market risks in accordance with directives of the Banking Supervision Department: According to directive Capital requirement in respect of: Interest risk Shares risk Exchange rate of Foreign Currency and inflation Total Capital requirement in respect of market risks According to Basel Spesific risk General risk Total Capital requirement in respect of: Interest risk Shares risk Foreign Curreny risk Total Capital requirement in respect of market risks

62 62 / Annual Report 2009 C. Basis Exposure General Basis risk is an existing or future risk to the income and capital of the Bank that may occur because of unexpected changes in the Consumer Price Index, or in exchange rates, because of the difference between the value of assets and the value of liabilities (including the effect of futures transactions and embodied options). Basis exposure is measured and managed in each of the various linkage-sectors: CPI-linked sector, and the foreign currency and foreign currency linked sector. In accordance with accounting principles, capital is defined as an unlinked shekel source, such that an investment of capital in a sector other than the unlinked shekel sector is defined as a basis exposure. Management of the exposure - Management of basis risks and the investment of available capital in the various linkage sectors are carried out based on assessments and updated forecasts regarding expected developments in the money and capital markets. - The mix of the investment in available in the various linkage sectors is managed on an ongoing basis subject to the restrictions reported above, and based on forecasts regarding the relevant market variables, while utilizing differences in prices between the cost of sources and the return on the use of the various linkage sectors, and the profitability of long positions or short positions in each sector. - Within the framework of managing of linkage balances, the Bank makes use, among other things, of derivative financial instruments, as a means of neutralizing exposure to basis and interest risks. Risk appetite - The Board of Directors of the Bank has set restrictions regarding the positions allowed (long or short) in assets and liabilities and in capital exposure for each sector. Available capital is defined as shareholders equity with the addition to the specific and general provision for doubtful debts, after deduction of net non-monetary assets, including mainly investments in companies included on equity bases, shares, buildings, and equipment. - Stress scenarios - The Board of Directors of the Bank has set a limitation on the level of maximum erosion of fair value with regard to activation of several stress scenarios in the area of the exposure to market risks - including basis risks. This limitation was determined as up to 15% of shareholders equity. The results of the scenarios and their significance are reported four times a year to Management and the Board of Directors. Surplus of the assets over the liabilities (including the influence of derivatives transactions) as at the balance sheet date was as follows: Type of Linkage December 2008 Maximum permitted limit Unlinked The Bank s Capital Consumer price index (85.2) 95.3 * Foreign currency or linked thereto Non-monetary items Total shareholders equity * The limit exists while neutralizing the trading portfolio. Surplus of liabilities over the assets as at , neutralizing the trading portfolio is NIS (268.9) million, (as at NIS (4.2) million).

63 The Board of Directors Report 2009 / 63 Below is a table of sensitivity to theoretical changes in the rate of exchange (s) of the bank capital percentage change in rate of exchange Dollar Euro All Currencies Dollar Euro All Currencies Decrease of 5% (1.7) (0.1) (1.9) (2.2) 0.3 (1.8) Decrease of 10% (3.3) (0.2) (3.8) (4.4) 0.7 (3.6) Increase of 5% (0.3) 1.8 Increase of 10% (0.7) 3.7 Notes: 1 An increase /decrease scenario represents a strengthening/weakening of the respective currency against the Shekel. 2 Changes in the rate of exchange of other currencies not listed separately have an immaterial effect on the profits of the Bank. 3 The statistics show the effect of changes in the rates of exchange after tax. During 2009, the Bank complied with all the limitations of basis exposure approved by the Board of Directors. D. Exposure to interest rate changes General Interest rate risk is an existing or future risk to the income and capital of the Bank that may be created because of the gap in repayment dates or interest adjustment dates between the different assets and liabilities in any of the operating segments. Interest rate risks, for each portfolio, are the dominant risks to which the Bank is exposed with regard to its effect on the fair value of assets and liabilities and the profit. Management of the exposure Management of the exposure to interest rate risks is done by the proper distribution of investment of available capital between the different time-periods, and the reduction of the exposure to erosion of the fair value resulting from unexpected changes in interest rates. The main exposure to interest rate risks in the Bank is attributed to the finance activity in the unlinked shekel sector and results from investment characteristics derived from the durations of uses and sources of funds, and from the Nostro activity of the Bank in this sector, including market making. Risk appetite - The Board of Directors of the Bank has set restrictions on the overall exposure to interest rate risks, by demarcation of the maximum exposure to erosion of fair value of available capital, with a parallel change of 1% in the interest rate curve of the CPI-linked sector (on a consolidated basis), the unlinked shekel sector, and the foreign currency sector. - In addition, restrictions on exposure to interest rate were decided in terms of the maximum loss according to the estimated Value at Risk (VAR). The VAR limit is NIS 20 million. - Stress scenarios - The Board of Directors of the Bank has set a limitation on the level of maximum erosion of fair value with regard to activation of several stress scenarios in the area of the exposure to market risks - including interest risks. This limitation was determined as up to 15% of shareholders equity. The results of the scenarios and their significance are reported four times a year to Management and the Board of Directors. Actual Exposure on the Reporting Date - Interest exposure in the unlinked shekel segment derives from the fact that activity is typified by a longer duration of assets than the duration of liabilities, and in respect of the total investment in this channel, which is the most dominant of the three linkage segments.

64 64 / Annual Report Interest exposure in the CPI-linked shekel segment derives from the fact that activity is typified recently by a longer duration of assets than the duration of liabilities. - In the foreign-currency and foreign-currency linked segment, the exposure is relatively lower than the CPI-linked and unlinked shekel segments, because of, among other things, significant activity in various financial instruments, and mainly in interest rate swaps, which contribute to reducing the exposure to changes in interest in this segment. Below is a description of the effect on the erosion of the Bank s available capital of a corresponding rise of 1% in the interest curve: Actual Exposure % Limit % Actual Exposure % Limit % Unlinked shekel Linked shekel Foreign curing and linked to foreign curing Below are the duration gaps*: Type of Linkage Limit Unlinked Consumer price index Foreign currency or linked to foreign currency * Because of the change in the new format of Addendum D, pursuant to the directive of the Supervisor of Banks, as of , there is no reconciliation between duration figures in the above Table and the Addendum. Duration figures as of were calculated in accordance with Addendum D in the old format. Interest risk in the banking portfolio: Below is the effect of an increase/decrease in the rate of exchange to the fair value of the Bank, (as a percentage of fair value): Increase of 1% Decrease of 1% Increase of 1% Decrease of 1% Shekel curve (1.97) 2.25 (3.12) 3.31 Linked curve 0.46 (0.32) (0.96) 1.18 Dollar interest (0.75) 0.80 (0.49) 0.50 Euro interest 0.04 (0.06) (0.04) 0.04 Foreign currency interest (all currencies) - - (0.57) 0.58 Basic assumptions: 1 The banking portfolio includes all the assets and liabilities of the Bank in the balance sheet, including derivative financial instruments, except for the trading portfolio. 2 The calculation is made without reference to early repayments of loans/deposits (based on past experience early repayments are not material). 3 Interest risk is examined on a current basis.

65 The Board of Directors Report 2009 / 65 Below is the fair value of financial instruments, except for non-monetary items (before the effect of hypothetical changes in interest rate), in s: NIS Foreign currency 2 Unlinked Linked Dollar Euro Other Total Financial assets 1 6, , ,872.2 Amounts to receive due to derivative financial instruments 3 1, , , ,750.5 Financial liabilities 1 5, , ,345.1 Amounts to pay due to derivative financial instruments 3 1, , , ,748.5 Net fair value of financial instruments (87.0) NIS Foreign currency 2 Unlinked Linked Dollar Euro Other Total Financial assets 1 5, , ,374.8 Amounts to receive due to derivative financial instruments Financial liabilities 1 5, , ,900.1 Amounts to pay due to derivative financial instruments Net fair value of financial instruments (15.0) (1.5) Including hybrid financial instruments. Not including balance sheet balances of derivative financial instruments and fair value of off-balance sheet financial instruments. 2 Including Israel currency linked to foreign currency. 3 Amounts receivable (payable) for derivative financial instruments and for off-balance sheet financial instruments, discounted at interest rates used for calculating the fair value shown in Note 15 b. to the Financial Statements. 4 Net fair value of financial instruments shown in each index-linkage segment is the net fair value in this segment on the assumption that the stated change occurred in all the rates of interest in the index-linkage segment. The total net fair value of financial instruments is the net fair value of all the financial instruments (except for non-monetary items) on the assumption that the stated change occurred in all the rates of interest in all index-linkage segments. For further details concerning the assumptions made in calculating the fair value of financial instruments, see Note 15 b. to the Financial Statements.

66 66 / Annual Report 2009 The effect of hypothetical changes in interest rates on the net fair value of the Bank s financial instruments except for non-monetary items, in s: 2009 Net fair value of financial instruments, after effect of changes in interest rates 4 Change in fair value NIS Foreign currency 2 million In NIS Unlinked Linked Dollar Euro Other In percentage Offsetting influences Total Total Total The change in fair value Parallel immediate increase of one per cent Parallel (15.5) (1.6) (24.7) (5.60) immediate increase of 0.1 per cent Parallel (15.0) (1.5) (2.5) (0.57) immediate decrease of one per cent Parallel (14.4) (1.5) Net fair value of financial instruments, after effect of changes in interest rates 4 Change in fair value NIS Foreign currency 2 million In NIS Unlinked Linked Dollar Euro Other In percentage Offsetting influences Total Total Total The change in fair value Parallel immediate increase of one per cent Parallel (15.5) (1.6) (24.7) (5.60) immediate increase of 0.1 per cent Parallel (15.0) (1.5) (2.5) (0.57) immediate decrease of one per cent Parallel (14.4) (1.5) The fair value of financial instruments is determined according to the model, the assumptions and parameters that were used for calculating the fair value of the financial instruments are in Note 15 b. Figures for the end of the year represent the exposure existing for the Bank throughout the year. The effect of hypothetical change in interest rates on the net profit is not materially different from the effect on the fair value, net. 1 Less than NIS 0.1 million. During 2009, the Bank complied with all interest exposure limits prescribed by the Board of Directors.

67 The Board of Directors Report 2009 / 67 E. Options risks General Options risks are the risk of loss deriving from changes in the parameters affecting the value of the options. Risk appetite - The Bank s foreign exchange dealing room trades in a range of financial products, including options. In addition to limits stipulated on total basis and interest exposure, and against the backdrop of the sensitivity of the economic value of options to changes in basis, interest and especially in the volatility of the basis asset, the Board of Directors has defined additional limits on dealing room activity in options. - The Board of Directors of the Bank set out limits in relation to activity permitted in options both in terms of volume and in terms of maximum loss under the scenarios. The scenarios refer to simultaneous changes in the rate of exchange and in the volatility of the basis assets. In addition, limits were fixed by the Board of Directors on maximum changes in the value of the options portfolio in terms of sensitivity indices (GREEKS). The principal limits fixed by the Board of Directors for activity on options are: a. Maximum marginal (delta) amount of $5 million during the day and $2.5 million overnight. b. Maximum loss of $150 thousand. Managing the exposure Tools for managing exposure to options risks include the Vol-Spot sensitivity matrix which shows the exposure resulting from the creation of a combination of various scenarios of fluctuations in the exchange rate and in volatility. In addition, use is made of an interest-curve risk exposure scenario (RHO scenario) which examines the change in value of the position in the event of a movement of 1% in the interest curve. In addition, the Bank makes use of the Weighted Vega model for managing exposure to volatility risk. During 2009, the Bank complied with all limits approved by the Board of Directors. F. Evaluation of the Exposure to Market Risks, Management and Control Tools The Bank manages and controls market risk exposure by means of various tools as mentioned above, and described in detail as follows: - The Value at Risk (VaR) measured the expectancy of maximum loss in fair value of the Bank (assets and liabilities, including derivative financial instruments), during a given investment horizon (10 business days), with a specific level of certainty (99%) and under normal market conditions. The current VaR calculated in the Bank is based on the Variance Co-Variance method. In addition, the Bank runs models when necessary, including an historic simulation, and a Monte Carlo once a month. VaR figures are calculated by the Bank on a daily basis, on the financial assets and liabilities of the Bank (the banking portfolio, the trading portfolio). The VaR system in incorporated as an integral part of the work of the Market Risk and Liquidity Control Unit, which updates the Finance Division on the exposures. - Back Testing - The quality of forecasting of the VaR model is examined by the Market Risk and Liquidity Control Unit by means of retroactive measurement. Actual Exposure on the Reporting Date As of December 31, 2009, the Bank s VaR was approx. NIS 2.7 million, compared with approx. NIS 10.9 million as of December 31, The decrease in comparison with the previous year is attributed to the decline in the total and duration of the Bank s investment portfolios and a decline in the level of volatility of the standard deviation.

68 68 / Annual Report Stress scenarios - Stress scenarios for examining the maximum level of erosion of fair value: The Board of Directors of the Bank has set limits on the maximum level of erosion in the fair value of the Bank in respect of operating a number of stress scenarios in the area of the realization of market risks. This limit is fixed at up to 15% of the shareholders equity of the Bank. - Stress scenarios for examining capital adequacy, and the effect of realization of stress scenarios on the ratio of capital to risk assets: as part of its preparations for implementation of the directives of the Second Pillar of Basel II, and the advancement of risk management in the Group, the Bank has drawn up a range of stress scenarios for examining capital adequacy. The range includes scenarios in the area of market risks, liquidity, and credit (including the securities portfolio in shekels and in foreign currency), and scenarios combining the realization of several risks concurrently. The results of the stress scenarios and their significance are discussed at least four times a year by Management and the Credit and Risk Management Committee of the Board of Directors. Exposure management tools include various models implemented in the Bank whose results are reviewed on a daily basis, such as duration, fair value, and sensitivity to changes in the interest curve. G. Supervision and Control over the Management of Market Risk Exposure The Bank maintains an appropriate system of control, supervision, and audit mechanisms on the marketrisk management process. The Bank s control concept is for the ongoing identification, quantifying, and assessment of market risk exposure and monitoring compliance with the limits set. Market-risk exposure management is examined and monitored on a routine basis by designated committees and forums, including, among others: - The Credit and Risk Management Committee of the Board of Directors - the above committee will begin operating from The committee is a committee of the Board of Directors designated for the areas of risks in the Bank and their method of management. The committee will hold preliminary discussions on most of the subjects connected with the area of financial management in the Bank and credit in the Bank, before various matters are brought for discussion and decision in the plenum of the Board of Directors; and also performs the following: followup and monitoring of developments in exposure to the various financial risks and credit risks, discussing the manner and scope of advisable financial limits, follow-up and monitoring the Bank s compliance with exposure limits prescribed, and follow-up and monitoring of the appropriateness of risk management, including risk monitoring. - Once in a quarter, a discussion takes place by Management and the Board of Directors on the Bank s Total Exposures Document, when market risk exposure is discussed. - ALM (Asset and Liability Management) Committee - the committee headed by the General Manager of the Bank discusses and follows up the implementation of the financial risks policy as determined by the Board of Directors, and discusses the main developments in market risk exposure based on a range of reports received by it. The committee meets once a week and also discusses, based on management reports, the liquidity position, financial developments, and the operations and results of the Nostro Unit. - The Market Risk and Liquidity Management Control Unit - the unit, which belongs to the Risk and Credit Management Department, is responsible for the control of market risks and liquidity in the Bank. The unit operates by virtue of Proper Conduct of Banking Business Directive No Risk Management. In the framework of its activities, the Market Risk and Liquidity Management Control Unit controls and examines the quality of the tools used for measuring risk, examines the limits set and their suitability to the exposures of the Bank, and reports immediately on any deviations from these limits, if any. - Internal Audit - the Internal Audit Department of the Bank is the Internal Audit Department of the parent company, which integrates auditing the subject of risk management in the Bank into its annual work plans. Internal Audit is responsible for giving an independent opinion of the degree of effectiveness of implementation of process and procedures for managing risks in the Bank, and also expresses its opinion to Management and the Board of Directors of the Bank on the degree of suitability and quality of operation of internal control process.

69 The Board of Directors Report 2009 / 69 H. Reporting Market Risk Exposures Management and the Board of Directors of the Bank receive a range of reports on exposure to market risks, with different cross-sections, from management and control bodies. In addition, exposures to market risks in comparison with frameworks and limits prescribed by the Board of Directors, and authorities for managing them, are reported in the quarterly Exposures Document, as required under Proper Conduct of Banking Business Directive No During 2009, the Exposures Document was discussed once a quarter by the Board of Directors of the Bank. From 2010, the document will be discussed by the Credit and Risk Management Committee of the Board of Directors, and by the Board of Directors. In addition, exposures and compliance with limits are reported in the framework of the quarterly report of the Market Risk and Liquidity Control Unit in the Central Risk Control Department of the parent company. 3. Liquidity Risk Management A. General - Liquidity risk is the current or future risk that the Bank will have difficulty in supplying its liquidity needs in exceptional situations of demand and supply, including unexpected liabilities, unexpected withdrawals of deposits by the public, unexpected demand for credit and uncertainty regarding the availability of sources of funds. - The Bank implements an overall policy of liquidity risk management in Israeli currency, foreign currency, and linked to foreign currency, in accordance with the requirements of Proper Conduct of Banking Business Directive No. 342 of the Banking Supervision Department of the Bank of Israel. - Accordingly, the Board of Directors of the Bank approved a liquidity-risk management policy, and set limits for the liquidity gap and liquidity ratio under a normal and stress scenario on the cash flows. The policy includes, among other things, reference to tools for measurement, control, and monitoring, and reporting mechanisms to be maintained as part of liquidity risk management. - The Bank operates tools for the management, control, and supervision of liquidity, based among other things on an internal model developed for purposes of compliance with part of Proper Conduct of Banking Business Directive No B. Infrastructure for Liquidity Risk Management - Systems and Models for Measurement and Management of the Exposure The infrastructure for managing liquidity risk in the Bank combines various models for routine management in shekels and in foreign currency, and the implementation of stress scenarios: - For purposes of overall liquidity management, and for purposes of compliance with Directive No. 342 of the Proper Conduct of Banking Business Directives, whose aim is the examination and monitoring of the liquid means of the Bank under different scenarios, the Bank bases itself on an internal model developed by the Group for managing liquidity risk in shekels and in foreign currency. The model facilitates management, control, supervision, and monitoring of the liquidity position in shekels at an ongoing daily level, and in foreign currency for longer periods. The internal model assesses the level of potential reliance on the various assets of the Bank as realizable for various periods, as well as the level of cash flow liabilities anticipated for different repayment periods. The model is supported by different tests made by the Bank, which rely on a historical examination of the behavior of the Bank s balance sheet and off-balance sheet balances. The model uses dynamic management tools, at a daily level, for examining the Bank s liquidity position and for managing liquidity risk. The results of the model are reported to the ALM committee once a week and audited on a routine basis by the relevant bodies including the Market Risks and Liquidity Control Unit belonging to the Risk and Credit Management Department. - In addition, for purposes of managing ongoing liquidity in shekels, the Bank uses an internal system

70 70 / Annual Report 2009 developed for purposes of compliance with the requirements of the reform in the payments and clearing system (the Zahav - RTGS system. The system facilitates the concurrent settlement, without delay between execution of the payment instruction and its confirmation, and allows the Bank to identify at any given moment the monetary cash flow passing though accounts. - The Short/Long model in the foreign currency segment Activity of the banking system in the area of asset and liability management in foreign currency is typified by the generation of long-term uses of funds financed by short-term sources. This activity derives mainly from the lack of availability of long-term sources of funds in foreign currency and/ or their high cost. Activity such as the above exposes the Bank to financial risks of two sorts - liquidity and margin. - Stress scenarios For purposes of examining liquidity in extreme and stress situations, a daily scenario is built based on data of the Bank s internal model. The scenario reflects the liquidity position in stress scenarios based on a combination of severe parameters observed over the last 12 months data. When the amount of current data is larger, the observations will be increased to 24 months, in each of the balance sheet and off-balance sheet items. In addition, the Bank conducts stress scenarios combining stress scenarios in capital and money markets in Israel and abroad, and examines their effect on the capital base and the capital ratio of the Bank. C. Supervision and Control of Management of Exposure to Liquidity Risk The Bank s control concept is for the identification, quantifying, and assessment of risks and the monitoring of compliance with the limits set out in the procedures. Liquidity-risk exposure management is examined and monitored on routine basis by designated committees and forums, including: - The ALM (Asset and Liability Management) Committee. - The Credit and Risk Management Committee of the Board of Directors. - The Board of Directors of the Bank. - The Internal Audit Department of the Bank, which integrates audits on the subject of liquidity risk management into its annual work plans. D. Reporting Exposure to Liquidity Risk - Exposure to liquidity risks in comparison with frameworks and limits prescribed by the Board of Directors, and authorities for managing them, is reported weekly in the framework of the ALM Committee, headed by the General Manager. - Exposures are reported in the quarterly Exposures Document, as required under Proper Conduct of Banking Business Directive No The Exposures Document is discussed once a quarter by Management and by the Board of Directors, and from 2010, the document will be discussed by the Credit and Risk Management Committee of the Board of Directors. - Exposure to liquidity risk is also reported in the quarterly report of the Market Risk and Liquidity Control Unit in the Central Risk Control Department of the parent company. - A quarterly report four times a year on the results of the stress scenarios four times a year to the Credit and Risk Management Committee and to the Board of Directors. In addition, Bank Management and the Board of Directors are updated on a routine basis and when necessary on developments in the Bank s exposures to liquidity risks. According to the internal liquidity model developed by the parent company and adopted by the Bank as of , the ratio for cover in the shekel segment and in the foreign currency segment between liquid assets and liabilities during 2009 complied with the limits prescribed by the Board of Directors and requirements of the Bank of Israel.

71 The Board of Directors Report 2009 / Risk Management in the Securities Portfolio in Foreign Currency - Market Risks and Indebtedness a. The securities portfolio of the Bank in foreign currency is managed in accordance with investment limits and guidelines approved by the Board of Directors of the Bank. The Bank invests only in debentures issued by companies of investment grade, after analyzing the credit quality of the issuer, the market risks inherent in the investment and the liquidity of the debentures. b. After the date of execution of the investment, the Bank maintains control over its various investments, as part of the management of the risks in the securities portfolio in foreign currency. Analysis is performed at the level of the individual security, the individual company, and the overall portfolio level, with reliance on published information concerning the issuing company, its financial results, and other parameters from which the condition of the company or the investment may be studied. Managing the risks and monitoring investments takes place on a real-time basis. c. The Bank has four independent control and support systems backing up investment activity: - The Middle Office. - The Back Office. - The Market Risk and Liquidity Risks Control Unit. - The Loan Review Unit. These units audit investment activity, compliance with investment procedures and limits, developments in the fair value of the securities, and the suitability of the models and tools used for managing risk in operations, in the most reasonable time frame possible after the date of execution. d. The measurement of fair value in the securities portfolio is performed by the Middle Office. With reference to the most part of investments in the portfolio, the measurement of fair value is made based on price quotations of an international supplier of prices outside the Bank - a leading company that provides revaluation services to hundreds of leading financial institutions worldwide, with more than 25 years experience. The company is engaged in the provision of quotation and revaluation services and not in the area of securities trading. e. A part of the supervisory and control mechanisms over risk management, a reporting routine has been developed in the Bank regarding the manner and scope of exposures in the securities portfolio under management. Reports are made to both decision-making and control units. The main reporting format in the Bank is as follows: - Immediate reporting of disclosure of a deviation from limits and procedures. - Immediate reporting of widening of margins, change in rating, and any other exceptional event in the portfolio, as necessary. - Weekly meetings of the ALM Committee headed by the General Manager. - Quarterly reports in the framework of the Total Exposures Document to Bank Management and the Board of Directors.

72 72 / Annual Report Credit Risk Management A. General Credit risk is the risk of harm to the value of the Bank s assets and its profitability due to deterioration in the ability of borrowers to meet their obligations to the Bank and/or deterioration in the quality of borrowers or the value of collateral provided as security for credit. In order to minimize the risk, a Credit Risk Management Policy has been defined in the Bank and limits regarding borrowers/sectors in the various operating segments and products. B. Allocation of Capital in respect of Credit Risks, Market Risks and Operational Risk Total risk assets and capital requirements in respect of credit risks, market risks and operational risk deriving from the following exposures: Type of exposure Risk assets in s Capital requirements (9%) in s Sovereign risk Banking corporations Corporations 1, Collateralized by commercial real estate Retail exposures to individuals Housing loans Securitization 0.2 Other assets Total in respect of credit risk 2, Market risks Operational risks Total risk assets 3, Amount less than NIS 0.1 million See details in section I below on the distribution of capital allocation in different cross-sections. For purposes of rating the credit exposure of sovereign risks and banking corporations under Basel II, the Bank made use of public ratings of the firms Moody s, S&P, and Fitch according to the lowest of their secondary ratings. C. Policy and Risk Appetite General The Bank s policy for the managing credit risk is based on the correct spreading of risks, and the careful and controlled management of exposures, both at the level of the individual customer, and at the level of economic sectors and the various business sectors. This policy is founded on the examination of the repayment ability of the customer at the individual level and on analysis and evaluation of a range of additional parameters, which have implications on the financial strength of the customer. Credit risk management policy is discussed and approved once a year by Management and the Board of Directors of the Bank. In the framework of the credit policy, the Board of Directors of the Bank has set out a strategy for

73 The Board of Directors Report 2009 / 73 reducing unexpected exposure to credit risks, which includes action guidelines including marketing targets and instructions taking into account the capital adequacy required in relation to credit given. - During recent years, the credit risk exposure of the Bank was increased and accordingly its credit policy was widened to include limits and standards some of which are stricter than the limits decided on by the Supervisor of Banks at the Bank of Israel. These limits are designed, among other things, to reduce exposure to the size of a single borrower or group of borrowers. - As part of ongoing credit risk management and the implementation of the policy of the Board of Directors, examinations are made, on a routine basis, of the business activity characteristics of the customer, the cash flows and his asset liability structure, the quality of the collateral, the sectorial segment in which he operates and parameters such as high dependence on customers, suppliers and the like. - The Bank has and continues to take steps to improve margins and overall profitability from customers, so as to reflect the level of risk inherent in their activity, while using focused processes and controls which result in the expression of total revenue from the customer (margins and fees), in relation to the overall loan portfolio. Risk Appetite The policy of the Bank includes a broad and detailed review of targets and the manner of developing credit business in the various sectors and operating areas, while defining detailed principles for each sector and area including individual limits at the level of sub-sectors and products typified by a high level of risk. The Bank s appetite for credit risk, as set out in the framework of the Policy Document, is conservative in comparison with regulatory limitations. In the framework of the policy, the Board of Directors of the Bank has set out a strategy for reducing unexpected exposure to credit risks, which includes a broad system of credit risk limits for various sectors and operating areas. D. Systems for the Measurement, Assessment and Management of Credit Risks - The Bank bases itself on models developed by the Group for rating the credit risk inherent in the activity of the customer. The models are based on objective and subjective parameters connected with the condition of the customer. In order to reinforce the connection between the risk rating of the customer and the return deriving from the activity, the Bank fixed a minimum return for each risk rating. - Computer systems provide credit risk managers with a broad-based mechanism for ongoing monitoring of customer activity, and for different cross sections: level and mix of activity, utilization of credit facilities, collateral level and current information on the financial condition of the customer. The systems facilitate the provision of the best service to business customers at the highest level of professionalism and proficiency. In addition, a computer system is implemented in the Bank for credit applications, which improves and streamlines the decision-making process and control over it. - The parent company continues, in coordination with the Bank, to enhance and improvement tools for measurement, reporting and control required by it, in order to obtain a current picture of the situation in connection with the various risk characteristics present in the business environment of those receiving credit. E. Policy for the Management of the Collateral System General - The Bank has a detailed policy on the subject of the receipt of assets as collateral for credit, the manner in which they are pledged, and the rates of reliance for each individual type. The main points of the policy are discussed once a year by Bank Management and approved once a year by the Board of Directors of the Bank, and appear in detail in procedures. The main types of collateral on which the Bank relies are: deposits, securities, pledges of real estate and bank guarantees.

74 74 / Annual Report 2009 In the framework of the credit policy of the Bank, procedures and control systems have been set up in the area of management and operation of the collateral system. Supervision and Control over the Collateral System All indebtedness of the customer to the Bank, including the value of collateral held against it, is centralized in the obligo system, by mean of which the Bank performs a daily follow-up of the collateral position vis à vis credit exposures. - A daily follow-up of shortfall in collateral at customer level is carried out in the branches by means of a daily report, in which the indebtedness of the customers and his collateral is detailed vis à vis the credit facilities approved for him, and which gives a complete picture in real time of the exposure of the customer. - For handling accounts of customers active in the capital market there is a system developed by the parent company and updated in coordination with the Bank. Special characteristics for sophisticated customers operating in the capital market are integrated in the system. - Concurrent with the actions of the branch at the level of the individual customer, supervision and control work is performed also in the Risk and Credit Management Department. - In addition, the Bank is constantly reviewing its compliance with regulatory directives in all aspects of the limitation on concentration of credit: borrower/group of borrowers or exposure to sectors of the economy. Distribution of exposure by type of exposure as of (in s): Type of exposure Balance of exposure (after specific provision for doubtful debts) Total exposure covered by guarantees (before multiplying by credit conversion coefficients) Total exposure covered by credit derivatives (before multiplying by credit conversion coefficients) Amounts added Total exposure covered by financial collateral eligible under standardized approach after multiplying by collateral coefficients Sovereign risk 4, Banking corporations 1, Corporations 4, ,924.0 Collateralized by commercial real estate Retail exposures to individuals Housing loans Securitization Other assets Total risk assets 10, ,951.1 Distribution of exposure by economic secter as at Credit is generally divided as follows: 72% of the credit at the Bank s risk, including off-balance sheet items, is given to customers in the financial services sector (after off-setting the permitted deductions according to the Bank of Israel s directives, the credit in this sector is less than 20%); 5.2% to other business services sector; 3.7% to customers in industrial sectors; 6.6% to construction and real estate sectors; and 2.2% to private persons. The accrued balance of the general provision for doubtful debts and the supplementary provision for doubtful debts, pursuant to the Bank of Israel s directives, as at December 31, 2009, constituted approx. 0.2% of the total credit and credit risk to which the provision relates.

75 The Board of Directors Report 2009 / 75 F. Policy for Problematic Debts and Provisions for Doubtful Debts - There are structured process in the Bank set out in working procedures for the early identification and location of problematic borrowers. In addition, there are work processes set out in procedures with reference to the process for making a provision for doubtful debts, which reflect a conservative assessment of credit loss expected for the Bank. - The Bank of Israel Directive on Measurement and Disclosure of Impaired Debts, Credit Risk and Provision for Credit Losses will lead to a change in the treatment of this matter. Below are the overall credit risk balances relating to problematic borrowers according to classifications set out in the Supervisor of Banks directives, in s, in reported amounts: Problematic debts 1 : December 2008 Non - income bearing Restructured Temporarily in arrears Under special supervision of which: debt for which there is a specific provision Total balance sheet credit to problematic debtors Off - balance sheet credit risk in respect of problematic borrowers Problematic borrowers bonds Overall credit risk in respect of problematic borrowers Bonds of which a provision for a decrease in value was recorded Not including problematic debts that are covered by collateral that can be deducted for the purposes of restrictions on the liability of a borrower and a group of borrowers. 2 As calculated for the purposes of restrictions on the liability of a borrower and a group of borrowers. 3 Restructured credit during the year and restructed credit in past years. G. Supervision and Control over the Management of Exposure to Credit Risks The Bank maintains an appropriate framework of control, management, supervision, monitoring, and audit mechanisms over the credit-risk management process. Credit risk management is reviewed and controlled on a routine basis by the following units, among others: - The Credit Risk Management Unit Reports to the Manager of the Risk and Credit Management Department and comprises desk officers among whom customers are allocated according to the business unit in which the customers are active, and according to types of credit activities. This provides for professional proficiency. - The Loan Review Unit of the First International Bank (parent company) The Loan Review Unit of the parent company belongs to the Central Department for Credit Risk Control and is responsible for the control of the credit risks of the significant specific borrowers in the Group as a whole, and in the Bank. The Unit acts independently in accordance with Proper Conduct of Banking Business Directive

76 76 / Annual Report 2009 No. 319 ( Loan Review ), according to which the population defined as large borrowers is to be examined on a three-yearly rotation, and in a manner that every year at least one third of this population will be examined. The Unit is guided by the Board of Directors in its work and reports to it. - The Middle Office - This is a unit belonging to the Risk and Credit Management Department reporting to Head of the Central Services Division. The unit specializes in performing controls and is a professional body in the area of control. The unit identifies the various risks as soon as possible after they are created, in the dealing rooms of the Bank, and develops controls and working procedures to reduce Bank exposure. In the framework of its activity, the unit examines compliance with limits prescribed in the areas of credit management in the various dealing rooms at the intra-day level and performs stress scenarios on specific portfolios. - The Internal Audit Department The Internal Audit Department evaluates the overall process of the Bank in credit risk management, and evaluates the implementation of policy and the execution of the decisions of the Board of Directors in matters of credit risk management, compliance with limits, and the reliability and timeliness of management information. The Department is responsible for providing an independent assessment in connection with the degree of compliance with procedures and the effectiveness of implementation of processes and procedures for managing credit risks. H. Reporting on Exposure to Credit Risks Management and the Board of Directors of the Bank receive reports on exposure to credit risks, in comparison with approved facilities, to limits prescribed by the Board of Directors and authorities for their management in the framework of the quarterly Exposures Document as required in Directive No. 319 of the Proper Conduct of Banking Business Directives. The Exposure Document is discussed once a quarter by Management and by the Board of Directors. The Bank has drawn up a range of stress scenarios for examining capital adequacy. In this framework, the Bank examines a range of stress scenarios also in the area of materialization of credit risks (and scenarios combining the materialization of credit risks concurrently with other risks). In this framework, the effect of the materialization of the risk on the capital basis is examined. The results of the scenarios and their significance are reported once a quarter to Management and to the Board of Directors. I. Distribution of Allocation of Capital for Credit Risks by Various Cross-sections: Total exposures to gross credit risks and gross average exposure during the period, classified by main types of credit exposure (s): Type of exposure Gross credit risks (after specific provision for doubtful doubts) Gross average credit exposure 1 Loans 5, ,807.3 Debentures 1, ,925.8 Derivatives (OTC) Off-balance sheet exposures 2, ,243.7 Other assets Total gross credit exposures 10, , Gross average credit exposure is calculated based on average exposures for the last five quarters.

77 The Board of Directors Report 2009 / 77 Distribution of exposure by type of sector or counterparty, classified by main types of credit exposure (s): Type of Exposure Sovereign Banking corporatios Corporations Debts collateralized by commercial real estate Housing loans Retail exposures to individuals Securitization Other Total Loans 3, , ,840.4 Debentures 1, ,658.2 Derivatives (OTC) Off-balance sheet exposures , ,204.7 Other assets Total gross credit exposures 4, , , ,838.9 Distribution of the whole portfolio by contractual repayment period, classified by main types of risk exposure (s): Type of Exposure Demand and up to one month Above one month up to three months Three to twelve months One to three years Three to five years Five to ten years Total Cash flows No Maturity date Total Loans 4, , ,840.4 Bonds , ,658.2 Derivatives (OTC) Offbalance sheet exposures - 2, , ,204.7 Other assets Total 5, , , ,838.9

78 78 / Annual Report 2009 Total balances (rated and unrated) before reduction of credit risk (s): Type of Exposure Exposure balance net 0% 20% 35% 50% 75% 100% 150% Risk assets calculated by the Bank Deduction from base capital Sovereign risk 4, , Banking corporations 1, Corporations 4, , Collateralized by commercial real estate Retail exposures to individuals Housing loans securitization Securitization Other assets Total 10, , , , Total balances (rated and unrated) after reduction of credit risk (s): Type of Exposure Exposure balance net 0% 20% 35% 50% 75% 100% 150% Risk assets calculated by the Bank Deduction from base capital Sovereign risk 4, , Banking corporations 1, Corporations 2, , Collateralized by commercial real estate Retail exposures to individuals Housing loans securitization Securitization Other assets Total 8, , , ,

79 The Board of Directors Report 2009 / 79 Disclosure regarding exposures connected with counterparty credit risk: s Gross fair value Nominal amount Amount of exposure = AGROSS 2 + fair value as per standardized approach Cash Government securities Collateral Shares in TA-100 index Exposure after collateral Type of exposure Interest derivatives Foreign currency derivatives , Share derivatives Total , s Nominal amount Amount of exposure 3 Cash Government securities Collateral Shares in TA-100 index Exposure after collateral Credit exposure , Other Total 1, , Amount less than NIS 0.1 million. 2 AGROSS is nominal amount x add-on (addition coefficient). 3 Nominal amount multiplied by collateral coefficient. The total exposure in respect of the Bank s investments in synthetic securitization: Securitization exposures as per risk weighting as of (in s): Exposure Risk weighting Capital requirement Total securitization exposures % 0.2 J. Management of Counterparty Credit Risk A. General A counterparty credit risk is the risk that the counterparty will enter into default before the final settlement date of the payments in respect of the transaction. An economic loss will be caused if, at the time of the entrance of the counterparty into a default condition, there will be transactions with him of a positive economic value. As opposed to credit exposures, where the exposure is one-sided and the Bank alone bears the risk of loss, a counterparty risk creates a two-sided risk of loss since according to whether the value of the transaction is positive or negative for each of the parties to the transaction. Exposure to counterparty risk is typified also by the market value of the transactions. The market value of the transactions is uncertain and can change throughout the life of the transaction due to changes in the relevant parameters in the market.

80 80 / Annual Report 2009 In the framework of the Bank s current activity with foreign banks and investment houses, the Bank allocates credit lines for a variety of activities, including deposits, settlement risk, forex, structured products, commercial line of credit, foreign currency nostro, and daily liquidity. The quantifying and assessment of the exposure for every activity, and the determination of authorities and criteria for compliance with frameworks for activity are laid down in Bank policy and procedures approved by the Board of Directors. B. Policy In the framework of the Bank s Credit Policy Document, the Board of Directors of the Bank has set out policy and risk appetite at Group level for activity with banks and investment houses, whether at the overall risk appetite level or at the level of exposure to the individual counterparty in a cross-section of the type of exposure and the individual transaction. The credit policy of the Bank with reference to the manner and scope of exposures with counterparties is based on a number of parameters derived from the financial strength of the counterparty, including the credit rating given to the institution by leading rating companies worldwide (Moody s, Fitch, and S&P), its total shareholders equity, ownership structure, the country in which it operates, and the like. The Bank takes steps to minimize counterparty risks by means of several acceptable agreements for minimizing exposure with third parties (Netting Agreements). - The ISDA Master Agreement is the basic agreement used between banks and its main advantage is the ability to perform netting of liabilities in the event of bankruptcy of one of the parties so that exposure is reduced to a net zero exposure. - The CSA Agreement is an agreement for the creation and operation of a mutual mechanism of transferring liquid assets to secure exposures in open transactions between two banks, after calculation of the exposure. This mechanism is used on a routine basis, and reduces exposure to the minimum amount prescribed. Until now, the Bank has signed ISDA Master Agreements with approx. 13 banks, and CSA agreements with approx. 7 banks, and transfers of funds have actually been executed under the agreements with some of them. The Bank maintains a conservative position in assessing the risk of banks with which the Bank works under the ISDA and CSA Agreements, and, at this stage, does not give a weighting to the exposure for the reduction permitted in credit risk in respect of minimizing the risk inherent in these Netting Agreements. The Bank is working towards the implementation of the arrangement that will facilitate settlement by means of the CLS. As part of the management of current counterparty risks, the Bank performs routine daily control of compliance with the limits of the credit lines allocated to activity with banks and investment houses, including examining routine reports of changes in the rating of counterparties allocated credit lines, and changes in the credit margin they are traded in. Institutions in which, among other things, significant changes are anticipated in the parameters mentioned are reexamined in the framework of the various credit committees.

81 The Board of Directors Report 2009 / 81 C. Existing credit exposure of the bank to foreign financial institutions 1 as at : External credit rating 4 No. of institutions Balance sheet credit risk 2 Off-balance sheet credit risk 3 Total credit risk Credit exposure to foreign financial institutions AAA to AA A+ to A BBB+ to BB * Not rated ** Total Problematic debts Existing credit exposure of the bank to foreign financial institutions 1 as at : External credit rating 4 No. of institutions Balance sheet credit risk 2 Off-balance sheet credit risk 3 Total credit risk Credit exposure to foreign financial institutions AAA to AA A+ to A BBB+ to BB * Not rated ** Total 42 1, ,357.8 Problematic debts Including banks and brokers (at banks only) 2 Deposits with banks, investments in bonds and other assets concerning derivative instruments. 3 Mainly guarantees and securing third party debt. 4 For purposes of rating financial institutions, the Bank made use of the ratings of the FITCH, Moody s, and S&P agencies (the lowest of them). The ratings are changed from time to time by the rating agencies and are correct as at for 2009 and as at for The balances of problematic debts after deduction of debts covered by collateral which may be deducted for purposes of the single borrower and group borrower restrictions. Including elements of off-balance sheet risk. * Credit exposure in the amount of NIS 10.2 millions in respect of European bank with a BBB+ rating, which received a government support package ( credit risk in the amount of NIS 5.6 millions), and a credit risk in the amount of NIS 0.1 million in respect of a bank in Hungary rated BB-. ** Exposure relating to unrated two private European banks. The institutions included in the exhibit are foreign banks. In the framework of the routine activities of the bank with these institutions, the Bank allocates credit facilities to a range of activities, including; deposits, bonds, forward contracts, clearing and guarantees.

82 82 / Annual Report 2009 Below is a list of countries in which there is exposure for the Bank and overall credit risk: Country Overall credit risk United States Germany England Switzerland Spain France Belgium Canada Ireland Portugal Sweden Norway Austria Australia New Zealand Denmark Hungary Holland Italy Total ,357.8 The conservative risk appetite defined by the Board of Directors of the Bank is expressed in the distribution of credit exposure among financial institutions, which for the most part is with institutions with high ratings. In addition, the Bank maintains exposures to counterparties by means of a network of netting agreements, which significantly reduce the risk to revenue and the equity of the Bank in situations of payment default by these institutions. 47% of the current credit exposure of the Bank is attributed to leading foreign financial institutions in OECD countries, rated in the rating groups AAA to AA-, and 51% of current exposure is attributed to financial institutions rated in the range of A+ to A-. The Bank deals with various banks and brokers in Israel and abroad, in accordance with credit facilities determined in advance under the Bank s credit policy. The guidelines for choosing a bank or broker are based mainly on the financial strength of the counterparty, as expressed in the ownership structure of the institution, the credit rating given to it by the leading rating agencies in the world, its equity, the country where it operates and the nature of its activity (mainly diversification of its retails customer base). Most of the facilities are short term facilities for transactions of up to three months. The Board of Directors of the Bank approves facilities to banks and brokers in accordance with Group policy. The Bank performs routine daily control on compliance with the facilities by means of computerized reports which are checked by the Risk and Credit Management Department. In view of the material changes and volatility in financial markets in Israel and abroad, the Bank is taking measures to adapt its activity with banks and brokers abroad, in order to reduce the effect of risks as much as possible. In this light, deposits in foreign banks are made for in the short term only. The duration of deposits in foreign banks is less than a month.

83 The Board of Directors Report 2009 / 83 Futures transactions (mainly forex transactions) are executed with foreign banks subject to facilities approved by the Board of Directors. Control over compliance with the facilities (whether in respect of forex transactions or facilities for settlement) is performed daily by the Risk and Credit Management Department (Middle Office). Balance sheet credit risk includes approx NIS million of deposits with banks, the majority of which have been repaid and the funds re-deposited. Furthermore, this credit risk includes NIS million of bonds of banks, which have a high rating and whose residual average duration is 1.22 years. In accordance with the guidelines of the Supervisor of Banks, the information shown above does not include off-balance sheet credit exposures for derivative instruments. This information is included in Addendum E concerning overall credit risk by economic sector. Off-balance sheet credit exposure included above consists of guarantees given by the foreign bank to secure third party debt. Off-balance sheet credit risk for derivative financial instruments of foreign financial institutions, as calculated for purposes of single borrower restrictions, amounts to approx NIS 74.4 million. D. Reporting of Exposure to Counterparty Credit Risk The Middle Office produces a variety of immediate and other reports on the level, scope, and manner of exposure and in different cross-sections. 6. Risk Management in Derivative Financial Instruments The Bank operates in a variety of derivative financial instruments. The policy for managing derivative instrument risk, including the scope of activity and the range of instruments allowed for use, is approved in the framework of the Board of Directors of the Bank. A. Dealing Rooms The Bank s dealing rooms are intended for different and varied activity in the capital and foreign exchange markets. The dealing room trades in a wide range of financial instruments, including market making in currencies and government bonds. Among other things, the Bank is also active in the Maof and foreign currency area in the Tel-Aviv Stock Exchange. The exposure created, whether in basis or in interest, resulting from these activities is included in the limits approved by the Board of Directors for basis and interest exposures. Below is a summary of the scope of activity in derivative financial instruments (nominal value): As of December Hedging transactions: Interest contracts ALM and other transactions: Interest contracts Foreign exchange contracts (including Spot) 10, ,220.5 Contracts for shares, share indices, commodities and others 11, ,253.1 Total derivative financial instruments 21, ,044.9

84 84 / Annual Report 2009 B. Structured Products The Bank acts as a marketer of structured products, mainly of the parent company. Activity is not material. C. Credit Risks in Financial Instruments in the Maof Market The Bank allows some of its customers credit activities in the Maof market. The Bank has a detailed credit policy on all matters connected with the reliance on collateral in the capital market. Together with this, the Bank carries out stringent ongoing control of the portfolio risk in relation to collateral and approved active facilities on the basis of the credit policy prescribed by the Board of Directors of the Bank. D. Supervision and Control over the Management of Derivative Instruments Risk The Bank s activity in derivative financial instruments for its own account is controlled and supervised by the Risk and Credit Management Department including by the Middle Office. 7. Operational Risks A. General An operational risk is defined as the risk of a loss resulting from failed or faulty internal processes, human actions, system malfunctions, or external events. The definition includes legal risk, but does not include strategic risk or reputation risk (exposure and management aspects of legal risk are discussed at length in the section 10 below). Operational risk is inherent in all the procedures taken across the Bank, in all activities and working procedures, in systems and the variety of products. As a result, the Bank sees the management of exposure to operational risk as an integral part from the risk management and the management of its business activity. The management of operational risk includes: identification, assessment, monitoring, and control/reduction of the risk. The management of risks is performed with the aim of maintaining the ability to assess operational risks, to limit exposure to them and the financial damage resulting from them, and to manage the allocation of capital in the best way possible. During 2009, the Board of Directors of the Bank, Management and officers selected for management of operational risk, continued extensive activities to assimilate the Second Pillar of Basel II and the supplementary instructions of the Bank of Israel. The preparation of the Bank as a whole in this issue was done with the cooperation of the FIBI Group. B. Policy The Board of Directors of the Bank set a policy for the management of operational risk that outlines the activity, frameworks, and managerial functions needed for the management of operational risks. The policy document is discussed and approved by Management and the Board of Directors of the Bank, at least once a year. C. Supportive Organizational Structure In the framework of the policy for management of operational risks, officers, interfaces, and areas of responsibility were defined with the aim of establishing a support system for the management of operational risks at the Bank: A Chief Risks Manager responsible for the range of procedures and systems connected with risk management. Reporting to him is an Operational Risks Manager responsible for carrying out the management of operational risks in full. Reporting to the Operational Risks Manager are an operational risks center, a business processes officer and operational risks officers. These functions were defined for the purpose of the routine management of operational risk.

85 The Board of Directors Report 2009 / 85 In the First International Bank Group, an Operational Risks Manager has been defined with responsibility for the range of processes and systems connected with the management of operational risks in the Group. The Bank maintains an Operational Risks Forum headed by the Chief Risks Manager, which is the forum designated to handle operational and legal risks. In addition, the Bank maintains a Risks Monitoring and Management Committee headed by the General Manager, whose aims are the monitoring of risks and their management. The Operational Risks Forum which operates in parallel with the Risks Monitoring and Management Committee, works towards implementing the policy for Operational Risk Management as approved by the Board of Directors, and focuses its activity on the exposure to operational and legal risks. Additionally, this forum deals with exposures to embezzlement and fraud as they occur, among other things, in events in the First International Group, in the various risk surveys and by Internal Audit, and with ways to minimize them, by establishing preventative and compensatory controls. D. Management of Operational Risk Operational Risk Surveys The main tool for identifying exposure to operational risks is surveys carried out by firms of accountants and specialized external bodies. A survey is a structured process of mapping and location of operational risks throughout the processes taking place in the different units in the Bank. As of the fourth quarter of 2009, risk surveys at the Bank are carried out in accordance with Group methodology. In the framework of the survey, ratings are given to each exposure, in financial values, and recommendations are given for the reduction of exposure to risk. Recommendations received are summarized in an implementation program, which is followed up and controlled until it is assimilated. The implementation program includes manual and mechanical reviews, changes in working processes, procedures, and technological improvements of the systems. Following the conversion of the Bank s computer systems to First International systems, the Bank bases itself on and uses operational risk surveys performed in the First International Bank referring to the same business processes. Separate surveys will be performed when there are unique processes at the Bank, in implementation and infrastructure. The subsidiary companies of the Bank are the main areas where unique processes are performed for the Bank. E. Key Risk Indicators The Bank has started the process of identifying key risk indicators and threshold values for identification. Key risk indicators provide the Bank with a tool for monitoring and pro-active management of operational risk, due to their ability to provide early warnings of increased risk of future losses. These indicators are forward-looking, and are meant to reflect the potential sources for operational risk such as: rapid growth, the launching of new products and more. - Collation and reporting events of failure and loss The Bank collates and documents internal events of failure and loss. This database is used for the verification of assessments by content specialists in evaluating operational risks in business processes and organizational units at the risk-exposure rating stage, for long-term analysis and identification of trends, and for reporting. The collation of external events of failure, for evaluation of the reliability of the internal loss data and for expansion of the database used for risk assessments conducted in the framework of the First International Group. - Forum for the management of operational and legal risks A forum for the management of operational and legal risks in the Bank, headed by the Chief Risks Manager, meets at least once in each quarter. The purpose of the forum is to conduct a daily follow up of the level of the Bank s exposure to operational and legal risks and of actions taken by the units and subsidiary companies of the Bank to minimize exposure to risks.

86 86 / Annual Report 2009 Representatives from the Bank participate in the Group forum for the management of operational risks. - Business continuity and disaster recovery The Bank, in accordance with Bank of Israel instructions, has made preparations to ensure business continuity and disaster recovery. The Bank has drawn up a policy for recovery from the time of a disaster and a policy for business continuity, procedures, working teams, and a recovery site. A forum for business continuity and disaster recovery in the Bank, headed by the Chief Risks Manager, meets at least once in each quarter. Representatives from the Bank participate in the Group forum for business continuity and disaster recovery. F. Reporting The Operational Risks Manager reports to Management and the Board of Directors once in a quarter on the activity in the field. The report includes reference to the following subjects: policy, risk surveys, risk indicators, events of failure and loss, the conduct of the forums, methodologies, and tools of management of operational risk. G. Data Security Mataf ( Computerization and Financial Operations Ltd. - a subsidiary company of the First International Bank), is responsible for providing data processing, computing and computer communication services to the Bank. In August 2005, the General Manger of Mataf was appointed Information Technology Manager of the Bank. The Bank has adopted the policy principles of the First International Bank for management of information technology. Mataf has undertaken to run an array of backups for computers, communication systems, software, and databases, in order to provide a continuous and reliable computing environment. H. Insurance The First International Bank Group, including the Bank, is covered by three main insurance policies as of the date of this Report: 1. B.B.B. insurance cover: There is a joint limit of liability in this policy for the following four policy headings: 1.1 Banker s Insurance: this chapter covers direct financial damage caused to the Bank from dishonesty or fraud by employees of the Bank, damage caused resulting from loss or damage to valuable property, risks in transferring valuable property, damage caused by forgery of checks, forged collateral, forged cash etc. 1.2 Computer crime insurance: this chapter covers damage caused by payment or transfer of monies or property, granting credit, charging an account or the giving of value of any kind by the Bank, as a direct result of the fraudulent or malicious entering of electronic information directly into the Bank s computer system or a computer system of a service bureau or an electronic transfer system or a communication system with clients; or as a result of the fraudulent or malicious change or corruption of electronic information stored in the systems, when the fraudulent action was done by someone acting with the intent of causing loss to the Bank, or to produce financial gain for himself or someone else. 1.3 Professional liability insurance: this chapter covers the Bank for its legal obligation towards third parties concerning a claim for financial loss caused by a negligent action, error, or omission, or breach of trust of an employee of the Bank. 1.4 Personal safe-deposit box insurance: this chapter covers the legal liability of the Bank for loss or damage to clients property including cash and jewelry, which are in personal safe-deposit boxes in the premises of the Bank. 2. Directors and Officers liability insurance: this chapter covers the liability of directors and officers in respect of a claim of breach of the duty of caution and and proficiency, breach of faith towards the

87 The Board of Directors Report 2009 / 87 company, where the officer acted in good faith and he had the basic assumption that the act would not cause harm to the company, and in respect of any financial obligation imposed on him in favor of someone else. 3. Elementary insurance policies: the main insurance cover is property insurance, liability insurance, personal accidents insurance, and insurance for cash. I. Capital allocation against operational risk For purposes of evaluating the scope of exposure to operational risk, the Bank has adopted the Basic Indicator Approach as elaborated in the First Pillar of Basel II. This approach relates to capital allocation as a specific amount (a fixed coefficient) of the Bank s total gross income. The implementation of the Basic Indicator Approach will be for a period of three years from the date of initial implementation, until the implementation of advanced systems for credit risk. J. Risk of embezzlement and fraud Pursuant to the instructions of the Supervisor of Banks, and as part of preparations for the implementation of the directives of Basel II, the subject of risk of embezzlement and fraud was incorporated within the framework of operational risks. Following this, the Operational Risks forum discussed exposures to risk of embezzlement and fraud as may arise, among other things, in events in the First International Group, in various risk surveys and by Internal Audit, and methods of minimizing them, by establishing preventative and compensatory control systems. 8. Compliance risk A. General Proper Conduct of Banking Business Directive No. 308 of the Banking Supervision Department requires banks to act in comply with Consumer Directives applying to the Bank s relationships with its customers. Compliance risk results from non-compliance with consumer provisions of the law, including consumer regulatory directives that obligate the banking corporation, i.e. provisions of the law and authorities that apply to the Bank s relationships with its customers. B. Policy The Board of Directors of the Bank approves and determines the working program of the Bank s compliance function once a year. C. Supportive organizational structure Officers, interfaces, and areas of responsibility have been defined in the Bank with the aim of complying with Directive No. 308, and management of compliance risks: The Compliance Officer is the Manager of the Regulation and Processes Department, and in accordance with the principle of non-dependency in the Directive, the Department reports to a Deputy General Manager, the Manager of the Central Services Division and Chief Risks Manager, who is not a business function. Reporting to the Compliance Officer are Money Laundering Prohibition and Compliance Officers, who are the professional function in each branch/unit and responsible for verifying compliance with the various regulations and for reporting immediately to the Compliance Officer in the event of a breach of a Consumer Directive. D. Management of compliance risk The Compliance Officer heads the Coordination Committee for Compliance Enforcement that includes representatives from the different Bank units (Legal Department, Regulation and Processes Department,

88 88 / Annual Report 2009 Human Resources and Administration Department, a representative of Internal Audit, Credit and Risk Management Department, a representative of the principal branches, a representative of the branches for wealthy individuals). The Committee, which meets at least once a quarter, is responsible for coordinating between the different units in the Bank and acts towards enhancing cooperation in order to implement the compliance program. In addition, the Committee discusses issues relating to the compliance program with regard to compliance with the Consumer Directives. - The Regulation and Processes Department is responsible for coordinating control at the Bank of compliance with Consumer Directives in accordance with the compliance program and the annual working program, and for reporting deficiencies or gaps at all levels of authority in the Bank, by examining new products and/or new activities, as well as performing control on a routine basis on products and existing activities to see that they meet the various regulatory directives in the consumer area and in the area of prohibition of money laundering. As part of its role, the Department also reviews new circulars and procedures from the perspective of bank-customer relationships, prior to their publication. - At least once in five years, the Bank conducts an infrastructures survey, in order to make sure that the Bank is indeed appropriately prepared to implement its obligations which derive from the Consumer Directives. The Department checks compliance with Consumer Directives and regularly monitors, with the assistance of the Legal Department, changes in legislation and in regulatory directives that relate to Consumer Directives. - The Regulation and Processes Department has a working interface based on working procedures with other support units in the Bank, such as the Legal Department and the Credit and Risks Management Department, and an interface with related professional forums, such as the forum for following up implementation of statutory directives, the Risks Monitoring Committee, and the Procedures Committee. - The Bank conducts ongoing assimilation processes in the subject of compliance with Consumer Directives by means of the use of programmed teaching, seminars and training for the Central Services Division and branches, given independently or based on the Group training system. E. Reporting exposure - Once a quarter, the Compliance Officer reports to Bank Management on his activity during the past quarter. The detailed report includes a summary of the Department s activity, detailed recommendations, details regarding violations of Consumer Directives that were identified during the reported period, and recommendations on steps that need to be taken as a result of the violations, and the prevention of their recurrence, and the Bank s preparations for implementation of new Consumer Directives. - At least once a year, the Compliance Officer reports to the Board of Directors of the Bank. - In addition, the compliance program determined by the Board of Directors of the Bank includes definitions for immediate reports. 9. Prohibition of money laundering and the finance of terrorism risks A. General Prohibition of money laundering and the finance of terrorism risks (hereafter: Money Laundering ) are risks of the imposition of significant monetary sanctions on the Bank for not complying with the provisions of the law on the subject prevention of money laundering and the finance of terrorism, and the risk of creating criminal responsibility for the corporation and its employees. In addition, materialization of a criminal offence against the provisions of the law in the area of prohibition of money laundering and the finance of terrorism may lead to the materialization of reputational risk. The banking sector is subject to various directives within the framework of prevention of money laundering and the finance of terrorism, that include, among others, the Prohibition of Money Laundering Law, the Prohibition of Financing Terrorism Law, the Money Laundering Prohibition Order, Money Laundering Prohibition Regulations, Proper Conduct of Banking Business Directive No. 411 (see the Chapter on Updates in Legislation) various circulars and more.

89 The Board of Directors Report 2009 / 89 B. Policy The Board of Directors of the Bank approves the policy document once a year. C. Supportive organizational structure Officers, interfaces, and areas of responsibility have been defined with the aim of complying with the provisions of the law and for the management of prohibition of money laundering and the finance of terrorism risks: The person in charge of the obligations of the Bank under the Prohibition of Money Laundering Law is the officer appointed in the First International Group for the prohibition of money laundering. The Manager of the Regulation and Processes Department is also a Representative for the prohibition of money laundering, and reporting to him are Prohibition of Money Laundering and Compliance Officers. D. Management of the prohibition of money laundering and the finance of terrorism risk - The duties of the person in charge of the prohibition of money laundering include, among others: development and performance of controls in order to ensure that the Bank implements the provisions of the law, including controls on reporting according to the type and the size of the transaction, ensuring that policy and procedures are put into writing in accordance with updates in legislation and the provisions of the law, the carrying out and/or reviewing of training sessions, delivering reports on unusual activities to the Authority for the Prohibition of Money Laundering, and checking up implementation of Bank policy in all of the Bank s subsidiary companies. During 2009, the Bank fully assimilated the controls, tools and procedures defined by the officer appointed by the Group. - The Money Laundering Prohibition Officers are the professional function in each branch and unit responsible for ongoing activity to prevent money laundering and the financing of terrorism, according to procedures and directives, including conducting reviews and reporting unusual activities. The officers are selected from the employee population of the Bank under the recommendation of the branch manager/area manager branches for wealthy individuals/division Manager. - From time to time, the Bank holds seminars for all Prohibition of Money Laundering Officers, conferences for managers, lectures in the branches themselves, and supplemental studies and training for all employees, both independently and in the framework of the Group Training Department. In addition, the Bank dissimilates programmed teaching material for checking the assimilation of the content of the teaching material the employees of the Bank. Most of the relevant employees of the Bank undertook and passed the test. Training processes that were conducted enhanced awareness of the subject. - The Bank conducts regular steps to locate and improve data by means of control reports dissimilated to the branches together with the appropriate instructions. - The Legal Department conducts follow-ups of updates in legislation and verifies that they are sent to the Prohibition of Money Laundering Representative, and the provision of legal support to anyone needing it, for compliance with the duties of the Representative and the activities of the Department and of the Bank. - The Prohibition of Money Laundering Representative is a member of the Group Advisory Committee whose main duties include: discussing unusual activities for which doubts are raised as to if they must be reported to Authority for the Prohibition of Money Laundering, discussing accounts in which there are complex activities in order to examine and decide if unusual activity is involved, etc. E. Reporting exposure Once a year, the officer appointed for the Prohibition of Money Laundering reports to Management of the Bank on activity during the past year. As of 2010, the report will be given quarterly. The detailed report includes, among other things, reference to focal points of risks located by the person responsible and methods for handling them, and a report on the implementation of Know Your Customer policy.

90 90 / Annual Report 2009 In addition, the policy set by the Board of Directors provides definitions for immediate reports to the Authority for the Prohibition of Money Laundering. 10. Legal risks A. Legal risk is defined as the risk of loss resulting from the inability to legally enforce the performance of an agreement, non-compliance with the provisions of the law including regulatory directives, risks resulting from activities without legal counseling/legal back-up with customers, suppliers and/or third parties, risks that involve legal procedures and any other risk that may expose the Bank to a claim or legal lawsuit. B. Policy and management of exposure The Bank operates according to Group policy for the management of legal risks, which is submitted for approval by Management and the Board of Directors every year, and includes a description of legal risk, and ways of identifying, mapping out, and minimizing it. In this framework, the Bank takes steps for identifying in advance legal risks involved in all stages of the different processes. In accordance with this format, there is ongoing monitoring of developments in legislation, standardization, rulings, courts of law, and bodies that have legal-type authority. In addition, the Bank examines proceedings that may have consequences on the ongoing activity of the Bank s units and acts to reduce risks on the basis of those developments. In the framework of legal treatment, emphasis is put on locating the focal points of legal risk and dealing with them. The Bank has made preparations as necessary for updates required in agreements and the range of legal documents used by it. Furthermore, every new product/service/activity is examined from a legal point of view in order to minimize legal risk as much as possible. The Bank also takes measures for ongoing identification and mapping out of risks, including the use of risk surveys and by the drawing of conclusions in order to prevent a recurrence of the risk, including by improving existing controls and/or implementing new controls. In addition, procedures are set out in the Bank for work carried out by the Central Services Division and the branches, and routine training is given for their implementation with emphasis legal matters involved in the Bank s activity. C. Reporting on exposure to legal risks Exposures to legal risks are summarized and reported in the quarterly Exposures Document as required in Directive No. 339 of the Proper Conduct of Banking Business Directives. The Exposures Document is discussed once a quarter by Management and the Board of Directors. When a material event occurs of a legal nature such as a lawsuit or the materialization of any risk, a report is made to the Legal Risks Manager with regard to the event. An examination is also made as to the degree and manner of the effect of the event on the Bank. The Legal Risks Manager gives instructions regarding the measures to be taken in order to minimize the degree of exposure to a legal risk created, and, if necessary, consults other departments such as the Compliance Officer and Internal Audit. D. Management of legal risks on a Group basis The legal risks policy of the Bank is adjusted for changes required by the legal risk management policy of the parent company. The Bank is instructed to implement and report to the parent company on legal risks identified by it.

91 The Board of Directors Report 2009 / Determining the fair value of securities and derivative financial instruments In accordance with accounting principles applying to banking corporations, securities and derivative financial instruments are shown on the fair value basis (for information on the valuation of investments in securities and the estimation of the fair value of derivative financial instruments, see the chapter dealing with Accounting Policy in Critical Matters and Accounting Estimates). The calculation of the fair value of unquoted derivative financial instruments is made by the Middle Office unit in the foreign exchange dealing room. The calculation of the fair value of unquoted securities is made by the Middle Office unit for Nostro activity. The Middle Office unit is an element which is independent of the business function carrying out the transactions. The calculations are reviewed and checked by the Finance Division. Furthermore, additional tests and reasonableness controls are carried out on the fair value calculation by the Accounting Department. Commencing on , verification and validation of the fair value is carried out by the Risks Location Committee and an entity acting on its behalf, once a quarter. Before the annual financial statements an arbitrator was appointed whose duty is to arbitrate if there is disagreement over the fair value calculation, between the entity determining fair value and the validating entity. New derivative financial instruments are brought for discussion and approval to the Risks Identification Committee headed by the General Manager.

92 92 / Annual Report 2009 Discussion of Risk Factors Below is a table summarizing the risk factors and the degree of their effect (high, medium, low): Risk Factor 1. Overall effect of credit risk Low 1.1 Risk because of quality of borrowers and their securities Low Degree of Effect 1.2 Risk because of sectoral concentration Medium 1.3 Risk because of borrower s concentration/borrowers groups Medium 2. Overall effect of market risk Medium 2.1 Interest risk Medium 2.2 Inflationary risk Low 2.3 Exchange rate risk Low 2.4 Share price risk Low 3. Liquidity risk Low 4. Operating risk Medium 5. Legal risk Low 6. Goodwill risk Low Other risk factors relevant to the Bank: 7. Legislation and Regulation risk Medium 8. Conversion of the Bank s computer system Low Below is the background to decisions taken regarding risk factors and their effect on the Bank that are detailed in the table presented above: 1. Overall effect of credit risk: Based on that stated in 1.1, 1.2, and 1.3 below, the overall effect of credit risk can be considered minor. 1.1 Risk because of the quality of borrowers and their securities - low risk effect Risk caused by impairment of the repayment ability of the customer and the type of collateral offered the Bank against credit. The Bank s past and present policy is very conservative and includes doing transactions with customers with a high level of financial stability and/or good collaterals. In addition, most of the Bank s credit is short-term, which enables rapid evaluation and response in the event of changes. In December 31, 2009 the provision for problematic debts is 0.6% from balance sheet credit and off-balance sheet credit amounted to NIS 32.2 million, a substantially lower rate than usual in the banking system. In 2009 and 2008 the Bank actually recorded income under the heading of the provision for doubtful debts. 1.2 Risk because of sectoral concentration - medium risk effect. Risk caused because of the exposure of a relatively high level of credit to a certain sector or area of activity, emanating from a lack of sectoral diversification and which may impair the repayment ability of customers comprising the sector, if there was deterioration in the condition of the sector, which might derive from a change in demand or supply, a change in the prices of raw materials, security and political changes, regulatory changes and so on. The Bank is relatively highly concentrated in the financial sector. However, it should be noted that the Bank is in compliance with the various limitations set by the Bank of Israel, regarding exposure to each sector. The Bank s exposure to the financial sector, after allowable deductions, is low than 20%. In addition, credit to most of its customers in the financial sector is fully secured by financial securities, and credit, which is not fully secured, was granted by the Bank mainly to large institutional bodies that are financially very stable (for additional information-see the chapter

93 The Board of Directors Report 2009 / 93 on restrictions and supervision of the Bank s activities). 1.3 Risk because of the concentration of borrowers/group of borrowers - medium risk effect. Risk caused because of a relatively high level of credit exposure to a borrower or group of borrowers, emanating from a lack of adequate diversification by size of borrower and which may impair the repayment ability of the above borrower or group, if there was deterioration in their situation. The Bank is in compliance with the terms of the limits detailed in the chapter on restrictions and supervision of the Bank s activities. On December 31, 2009, the limits on a single borrower were as follows: single borrower NIS 82.0 million, borrowers group - NIS million and six largest borrowers - NIS million. The effect of the risk of concentration of a single borrower or group of borrowers increased from small at the end of 2008 to medium at the end of 2009 in view of the fact that as a result of the extensive operations of the Bank in the capital market area, the Bank is close the above-mentioned limits. 2. Overall effect of market risk: Based on that stated in paragraphs 2.1, 2.2, 2.3, and 2.4 below, the overall effect of market risk can be classified as an effect with a medium risk level. The increase of the risk level from low in 2008 to medium in 2009 derives mainly from the interest risk weighting (see paragraph 2.1 below). 2.1 Interest risk- medium risk effect. Interest rate risk is the risk that unforeseen changes in interest rates may harm the financial situation of the Bank. This risk exists mainly when the duration of the assets differs from the duration of the liabilities in a certain segment and is affected also by the gap between total assets and total liabilities in that sector. The Bank keeps to a policy of matching, as much as possible, dates of repayment or interestadjustment of assets and liabilities in each of the indexing sectors and taking restricted positions. For further information - see the chapter dealing with interest-rate exposure in the framework of the Risk Management Policy. Notwithstanding that stated above, because of the drastic changes in interest rates in Israel and worldwide, and in the light of the low absolute level of interest in Israel and worldwide, the effect of this risk effect was raised from low to medium, in view of its multiple effect on the financing income of the Bank. 2.2 Inflationary risk- low risk effect. Inflation risk is the risk that unforeseen changes in the rate of increase of the CPI will cause harm to the Bank s situation. This risk exists when there is no matching between the balance of assets linked to the Index and index-linked liabilities, or when there are accompanying financial instruments. As part of the policy of exposure to basis risks, the Bank s Board of Directors has set limits on the Bank s exposure in the CPI linked sector. The bank maintains low exposure to change in the CPI linked sector. For additional information-see the chapter on basis exposure, included under risk management policy. 2.3 Exchange rate risk - low risk effect. Exchange rate risk exists when there is a difference between the balance of assets and the balance of liabilities in a certain foreign currency. As part of the policy of exposure to basis risks, the Bank s Board of Directors has set limits for the Bank s exposure in the foreign currency sector. The Bank maintains low exposure to changes in foreign currency exchange rates. For additional information-see the chapter on basis exposure, included under risk management policy. 2.4 Share price risk-low risk effect. Risk of a fall in share prices. The exposure is minimal as the Bank has a small investment in shares.

94 94 / Annual Report Liquidity risk - low risk effect. Risk emanating from uncertainty of unforeseen withdrawals of deposits by the public and credit demands. The Bank is managed with high liquidity, inter alia, as a result of significant balances which the Bank holds mainly in liquid monetary assets (mainly deposits and government bonds). For additional information-see the chapter on liquidity, included under risk management policy. 4. Operating risk - medium risk effect. For information on the Bank s operating risk, see the chapter on operating risk included under risk management policy. The operating risk in the field of computerization is separately discussed under section 8 below. 5. Legal risk- low risk effect. For information on the Bank s legal risk see the chapter on legal risk included under risk management policy. 6. Goodwill Risk - low risk effect. As a small bank operating mainly in the capital market and private banking, there is great importance in the good will of the Bank in the eyes of its customers, so that damage to its good will may have a material effect on the activities of the Bank. However, in our opinion, the effect of the risk can be considered low since the Bank is a subsidiary of FIBI. 7. Legislation and Regulation Risk - medium risk effect. In these areas, there are frequent changes and/or innovations in legislation, and in the policy of the various authorities. These changes affect the activity of the Bank and its investee companies, and will/or may affect them in the future. The Bank allocates resources in order to adapt activity to them, either by investing in systems or in personnel and their training, and receives assistance from other entities in the Group in these areas. The level of this risk was increased from a small to medium, mainly because of the expected influence of Amendments Nos. 13 and 14 to the Joint Trust Investments Law on the Bank. For further information - see the Chapter dealing with updates in legislation (on pages 21, 24-25). 8. Conversion of the Bank s computer system - low risk effect. The effect of the risk decreased from the medium effect at the end of 2008, to a low effect at the end of 2009, in view of the conclusion of the conversion of the computer systems. For further information on the subject of systems conversion, see the Chapter dealing with Information Systems (on page 16) In view of the major changes and volatility in the financial markets in Israel and worldwide, the Bank is taking measures to adapt its independent activity and activity with customers in order to reduce as much as possible the effect of risks. Macro-economic risk is of course likely to have a great influence of the Bank s profitability. Since this risk is not unique to UBank and affects the whole banking system, the severity of this risk has not been rated and has been removed from the table of risk factors, although it can be viewed as having an effect on the prior risks described in the table. The business results and performance of the Bank are directly affected from the state of the economies in Israel and worldwide. Deterioration in economic conditions, as well as deterioration in the political and security conditions in Israel, is likely to cause harm to the Bank s results. The main activity of the Bank is in the State of Israel. As a result, a material economic slowdown is likely have a material effect on the Bank s results. Moreover, a recession in the economy may reduce activity cycles in the capital markets and lead to a decline in the Bank s activity in this area. The processes are likely to have an effect on the Bank s revenue.

95 The Board of Directors Report 2009 / 95 Accounting Policy on Critical Matters and critical accounting Estimates Accounting policy on critical matters relates to issues that are of importance in describing the Bank s financial position, issues that are difficult, subjective and require complex evaluations as a result, because of the need to estimate the influence of matters that by their nature are uncertain. Set out below are the critical subjects as above, in respect of which the accounting policy should be understood in order to understand the Bank s reported results. In each of these critical subjects management used the best available information in order to make the estimates necessary in evaluating the Bank s assets and liabilities and the Bank believes that the estimates used are proper. Below is the accounting policy that has been adopted with regard to these subjects: 1. Provision for Doubtful debts The financial statements include provisions for doubtful debts (a specific provision and also a general and supplemetary provision) whose object is to update the value of the credit portfolio as at the balance sheet date in accordance with generally accepted accounting principles and the directives of the Supervisor of Banks. The supplementary provision is based upon exceptional credit amounts in accordance with quality characteristics of the obligo portfolio as determined in the Supervisor of Banks directives. The discussion on the classification of debts as problematic debts according to the various quality groups defined in the directives (special supervision, temporarily in arrears, restructured and nonincome bearing) is carried out in the context of the credit committee that meets once a month. The final decision as to the classification is made in the doubtful debts committee that is made once a quarter and is inter alia based on the discussions held by the credit committees. The criteria that are used for the purposes of the evaluation in respect of the classification are, inter alia: arrangements signed with customers for restructuring their debts, customers who are not repaying their debt in accordance with arrangements that were made with them, customers who are deviating from a credit line for more than three consecutive months, customers who during a defined period had not made deposits in the amount of the debt, negative external information about the customer and a change in the condition of the sector in which the customer operates. An additional important indicator is the customer s low rating. As at the Bank adopted the rating system existing in FIBI. This system weightes various criteria, such as: the Bank s experience with the customer, his creditability, economic ability, the amount of the credit granted to him and the credit line that was approved for him, his collateral and deviation from credit lines. In addition, additional criteria are examined in the case of a company/business, such as: the economic ability of the shareholders and the company s managers, their credibility, legal claims, business results according to financial statements, the risk of the sector in which the company operates, the state of the business (dependency upon a supplier, dependency on a product, competitiveness, length of relationship, statutory restrictions etc). The specific provisions reflect the loss inherent in the credit portfolio, including liabilities in off-balance sheet items. The decisions to make specific provisions for loan losses are made once a quarter in the context of the doubtful debts committees, inter alia on the basis of the legal advisers recommendations. In determining the adequacy of the provisions, the committees are required to evaluate the inherent risk in the credit portfolio and to evaluate overall repayment ability. For the purposes of these evaluations, substantial judgement must be exercised based on the information as to the debtors financial positions and an evaluation of the collateral that was received from them. Gathering information with regard to the debtors financial position is based upon various sources of information as necessary: information received from employees of the branch on the basis of their knowledge of the customer, information received from conversations with the debtor, if this is possible, financial ability investigations by external investigators, information from external data bases (such as the

96 96 / Annual Report 2009 Registrar of Companies, the Land Registry, the Official Receiver, the Execution Office, BDI and D&B) and in some cases opinions are also received from external experts. The collateral is valued in accordance with the Bank s credit policy. This policy, which is presented for the Board of Directors approval each year, relates to the principles of valuing the various assets that serve as collateral, marketable and non-marketable. In the consolidated profit and loss statement for 2009 reducing specific provisions in the sum of NIS 4.0 million and supplementary provisions and reducing in the sum of NIS 0.1 million were recorded ( specific provisions in the sum of NIS 4.1 million, and reducing supplementary provisions of NIS 0.3 million). In the consolidated balance sheet as at December 31, 2009 the provision for doubtful debts amounted to NIS 34.7 million - representing approx. 0.7% of the total credit risk amount (as at December 31, a provision in the sum of NIS 44.8 million - representing approx. 1.0%). 2. Valuation of Investment in Securities According to the accounting rules applicable to banking corporations, securities in the financial statements are presented as follows: Trading securities - are presented in the balance sheet according to fair value. Profits or losses are charged to the profit and loss statement respectively. Available for sale securities - bonds (marketable and non-marketable) and marketable shares are presented in the balance sheet according to fair value and profits or losses that have not yet been realized from adjustments to their fair value are charged to a capital reserve and not to profit and loss. Non-marketable shares are presented in accordance with their adjusted cost. The majority of the securities that the Bank holds are marketable in an active market (whether it is a stock exchange or an over-the-counter market), and therefore, they have an available market value. For bonds that are not marketable the present value of future cash flows is used. Following the crisis in the financial markets, the Bank reviewed and update its sources of information on which it based its fair value evaluation of the investment in securities. The value of bonds of foreign banks is based on quotations from an international supplier of prices external to the Bank - a leading international company supplying valuation services for hundreds of leading financial institutions worldwide, with more than 25 years experience. The company deals with giving quotation services but not in trading in securities. In addition, for control purposes, a cross-check is made of securities prices from the supplier s system for quoted prices from another financial information system, which the Bank used previously. For purposes of calculating the value of unquoted securities, Bank Management examined the discount rate received from interest rates and in addition, an examination was made of quoted securities of the same issuer or similar securities in the market, where possible. In certain cases, when differences were found during the course of the examination, prices were reduced by raising the discount rate, as required, in order to show the inherent risk in the security and its true value. On the subject of examining the impairment of the investment in securities, see paragraph 5 below. The sensitivity of the fair value of the unquoted bond portfolio (calculated according to the present value of future cash flows) to a change of 1% in the interest rate used for their valuation is as follows (in NIS millions): Decrease of 1% Increase of 1% Change in fair value 0.4 (0.4) 3. Estimating the fair value of derivative financial instruments The Bank operates in the area of derivative financial instruments, whose statement in the financial reports is based on fair value, as opposed to value based on the principle of accumulation. The fair value calculation of derivative financial instruments, for their foreign currency element, are based on data existing in international capital markets, and for their Israeli currency element, on the rates of unlinked and index-linked interest, of which an assessment is made by the Risk and Credit Department of the Bank, considering current market prices, liquidity and marketability in the domestic market. The margin between

97 The Board of Directors Report 2009 / 97 selling interest and buying interest also represents a subjective factor influencing calculations of the fair value of derivative financial instruments. Most transactions in derivative financial instruments are short-term transactions, in which there is no expressed credit risk. The credit risk component in long-term transactions is taken into account in their pricing. The fair value of different types of options is based in the most part on the Black and Scholes Model, and is affected by the volatility inherent in the rate of exchange, interest and the relevant indices for the option which the Bank purchase or wrote. With regards to complex derivative financial instruments that have no tradable market, fair value calculations are generally made in the leading information systems in the field, which are employed by dealing rooms and banks world wide (bloomberg system and super derivatives system). These interest rates are also used for calculating the fair value of assets and liabilities hedged against derivative financial instruments, if they meet the criteria of hedging, as required by accounting principles and the Directives of the Supervisor of Banks in the matter. The Bank s activities in derivative financial instruments are mostly in short term transactions. In view of this, the effect of the estimates noted above on fair value calculations of the stated instruments, is not material. 4. The fair value of financial instruments The following table summarizes the fair value of financial instruments by distribution between fair value of prices quoted in an active market or otherwise: () Prices quoted in an active market Other Total Financial assets 3, ,790.6 Financial liabilities 2, , () Prices quoted in an active market Other Total Financial assets 2, ,590.1 Financial liabilities 1, , Decrease in Value of Assets The Bank applies procedures to ensure that the value of its assets in the consolidated balance sheet does not exceed their proper value. If necessary, the Bank records decreases in value of its assets. In January 2009, the procedure for reviewing the impairment of securities available for sale in the Nostro portfolio was approved in the meeting of the Board of Directors. For purposes of reviewing impairment in the Nostro portfolio, a special management committee meets once a quarter, with the participation of the General Manager, the Manager of the Headquarters Division, the Manager of the Risks and Credit Management Department, the Manager of the Finance Division, and the Chief Account (as observer). The function of the committee is to examine if impairment is of an other than temporary nature which has to be recorded in profit and loss. An examination of the need for asset value decreases requires the use of various assessments and estimates in accordance with the type of the asset: a. Investment in bonds: Bonds in the available for sale portfolio, whether marketable bonds or non-marketable bonds, are presented in the balance sheet according to their fair value, but this revaluation is charged to a capital reserve and not to profit and loss.

98 98 / Annual Report 2009 For every reporting period, the Bank examines whether the impairment in value of the fair value of securities classified in the available for sale portfolio is of a nature other than temporary. The Bank recognizes in the reporting period impairment of a nature other than temporary, at least, in respect of an impairment of any security meeting one or more of the following conditions: - A security that was sold before the publication of the report to the public for this period; - A security that the Bank intended to sell within a short period of time before the publication of the report to the public for this period; - A debenture for which there was a significant decrease in the rating between the rating of the debenture at the date of acquisition by the Bank and the rating of the debenture at the date of publication of the report for this period; - A debenture that was classified as problematic by the Bank after its acquisition; - A debenture in respect of which there was a payment default after its purchase; - A security, whose fair value at the end of the reporting period and also at a date shortly before the publication date of the financial statements, was lower than cost by a significant amount (for debentures - adjusted cost). This is unless the Bank has concrete objective evidence and a conservative analysis of all the relevant factors proving at a high level of certainty that the impairment was of a temporary nature. In addition, determining if the impairment is of a nature other than temporary is based on the following considerations: - The amount of loss in relation to the cost of the security (regarding debentures - adjusted cost); - The period of time in which the fair value of the security was less than its cost; - A deterioration in the condition of the issuer or in the overall situation of the market; - The intention and ability of the Bank to hold the security for a long enough period of time that would allow for an increase in the fair value of the security or until redemption; - In the case of debentures - the rate of return until redemption; - In the case of shares - the reduction of dividends allocated or its cancellation; In addition, the Bank recognizes an impairment of a nature other than temporary in respect of beneficiary rights purchased and in respect of beneficiary rights that continued to be held by the Bank in the securitization of financial assets, when current information of other events indicate a probable deterioration in the forecast of cash flows deriving from the financial instrument. When impairment in value occurs of a nature other than temporary, the cost of the security is reduced to the fair value and serves as the new cost basis. The cumulative loss relating to a security classified as available for sale which was charged in the past to a separate item in shareholders equity in the framework of total other profit, is transferred to profit and loss when there exists for it an impairment in value of a nature which is not other than temporary. Increases in value in subsequent reporting periods, are included in a separate item in shareholders equity under total other accumulated profit and is not charged to profit and loss (the new cost basis). In 2009 an impairment of an other than temporary nature was recorded in the consolidated profit and loss under financing item (Note 17) in the amount of NIS 13.7 million. In 2008 an impairment of an other than temporary nature was recorded in the consolidated profit and loss under financing item (Note 17) in the amount of NIS 15.4 million, of which NIS 5.4 million for mortgage-backed bonds. In 2007 an impairment of an other than temporary nature in mortgage-backed bonds was recorded in the consolidated profit and loss under financing item (Note 17) in the amount of NIS 1.8 million. b. Investment in shares: Shares in the trading portfolio are recorded in the financial statements according to market value. Shares in the available for sale portfolio - if they are marketable shares, are presented at market value and the revaluation is charged to a capital reserve and not to profit and loss. Where there is a material

99 The Board of Directors Report 2009 / 99 and prolonged negative revaluation, the subject is examined by economists in the Bank who examine the company s condition and whether its value on the market represents a nontemporary value decrease. Non-marketable shares are presented in the balance sheet according to their adjusted cost. Each period, the Bank examines the value of these shares and whether there is need for making value decreases. The Bank s economists use the best information available for carrying out their assessments, generally information contained in financial statements received from the company, and if necessary conversations are held with key personnel in the company in order to have a better understanding of its operating performance and anticipations for the future and also in order to obtain additional information, if any, such as: information about an external investor if any, obtaining valuations, if carried out, etc. Furthermore, comparisons are made with similar companies in the field. In 2009 provisions for impairment of an other than temporary nature were recorded in the consolidated profit and loss under net losses from investments in shares (Note 19) for shares available for sale in the amount of NIS 3.8 million, compared to NIS 2.7 million in 2008, and NIS 0.3 million in Liabilities in respect of legal claims Among the other liabilities of the Bank are provisions for various legal claims against the Bank, including requests for class actions, if required. The provisions were made conservatively based on Management s evaluation and based on legal opinions. Once a quarter a discussion is held by the Board of Directors, regarding claims filed against the Bank. For purposes of evaluating the risks in legal proceedings filed against the Bank, Bank Management relies on the opinion of external legal consultants representing the Bank in these claims. These opinions are given by external legal consultants to the best of their discretion, on the basis of the facts presented to them by the Bank and on the basis of the legal position (judgment and precedence) as far as they are aware at the time of the evaluation, and which are often subject to differing interpretation and possible counterclaims. The evalution of the risks in class actions being approved involves even greater difficulty, since this a relatively new legal area, and the legal procedures involved as well as the most basic aspects are still in the formative stages. In view of that said above, the actual results of the claims may be different from the provisions made. Contribution to the Community and Donations In 2009, the Bank joined the Etgarim Voluntary Association, whose aim is to enable children, youth, and adults with physical, sensory, and psychological disabilities and those with special needs to fulfill their personal potential, to expand their abilities in all areas of life, and to integrate them into the community. Thanks to the Bank s contribution to the Association, three groups of children and young people were adopted in the framework of the Adopt a Class project, whose aim is to give children with disabilities an annual framework of extreme sports activity to reinforce their self-confidence and give them an elevated and positive self-image. The program integrates educational content and extreme sports activities with the aim of maximizing the children s (disabled and distressed youth) personal potential, by providing tools for developing skills for dealing with daily life on their own. In addition to financial support facilitating educational-rehabilitation activity, employees of the Bank volunteered to take part in meetings and activities. Total donations for the year 2009 amounted to NIS 335 thousand, approx. 0.5% of the net profit from ordinary activities of the Bank. Disclosure with regard to the Bank s Internal Auditor The chief Internal Auditor details Mr. Nir Abel, CPA, has served as the Chief Internal Auditor of the Bank since August The Internal Auditor is an employee of the parent company (FIBI) and serves as internal auditor of all Group companies, except for two subsidiary companies abroad. The Internal Auditor has a B.A. in public accounting and economics from the Hebrew University in Jerusalem, and is experienced in the area of audit in the banking system. The Internal Auditor carried out a number of managerial duties in the Internal Audit Department of

100 100 / Annual Report 2009 Bank Hapoalim over a period of about 13 years, and has been the Chief Internal Auditor of Bank Otzar Hachayal since The Chief Internal Auditor meets the provisions set out in section 3(a) of the Internal Auditing Law. The Internal Auditor and his staff serve only in audit functions, without conflict of interest, and work in accordance with the Internal Auditor Regulations as stated in section 146 (b) of the Companies Law, the provisions of Paragraph 8 of the Internal Audit Law, and the provisions of section 8 of the Banking Regulations. Method of Appointment and Organizational Reporting Responsibilities The appointment of the Internal Auditor was approved by the Audit Committee and the Board of Directors on July 4, The Internal Auditor s superior in the Bank is the Chairman of the Board of Directors. Internal Audit Work Plan The Internal Audit work plan is based on a multi-year (4 years) risk-focused work plan. In structuring the multi-year audit plan, the Internal Auditor bases himself on a variety of factors, including mapping out the various units, lines of business, and processes in the organization; mapping out and assessing risks inherent in these units and processes (credit, market and operational risks); operational risk surveys carried out in the Bank (including risk of embezzlement and fraud); all the provisions of laws and directives of the Supervisor of Banks; and incidents of failure occurring in the past in the organization and/or in parallel organizations in the system. The audit plan for 2009 is a result of a number of varying factors which are the base for building the work plan; the main ones being: the updated multi-year work plan, the Proper Conduct of Banking Business Directives, risk surveys carried out in the Bank, instructions of the Audit Committee, activation of new areas of activity and changes in the organizational structure of units in the organization, recommendations of the external auditors and findings of the detailed report of the certified accountants, audit findings in Bank of Israel reports, audit resources, recommendations of officers in the Bank and previous findings. The multi-year and annual work plans have been approved by the Audit Committee and Chairman of the Board of Directors. Changes (material) from the approved program are brought for discussion to the Audit Committee. Number of Positions As mentioned above, the Internal Auditor is a full-time employee of the First International Bank. The average number of employees in internal audit was about 5.5. This number of positions is derived from the multi-year work plan, staff turnover during the course of the year and additional manpower from outsourcing. Conduct of Audits Internal audit work is carried out in accordance with the various requirements of the law, including the Internal Auditing Law, the Banking Ordinance, Banking Rules (Internal Audit), and accepted professional standards - Standards for the Professional Engagement in Internal Auditing of the Institute of Internal Auditors in Israel, in all aspects of examining the propriety of the organization s operations from the aspect of compliance with laws, proper conduct, integrity, savings and efficiency, non-dependency on the audited entity, directives and instructions of the Supervisor of Banks, and directions of other regulatory entities. It should be noted that there is a formal deed of appointment for Internal Audit, providing a basis for its status and authority in the corporation. The deed of appointment is approved as required by the Audit Committee of the Board of Directors and distributed among all Bank employees. Access to data The Internal Auditor has free and independent access, as provided in section 9 of the Internal Audit Law 1992, to all the Bank s and the subsidiaries systems, including the information systems and financial data. The Internal Auditor report The Internal Auditor reports to the Audit Committee on everything concerning working procedures and internal procedures.

101 The Board of Directors Report 2009 / 101 The Internal Auditor gives current reports to the Chairman of the Audit Committee, which include a copy of each audit report and also periodical activity summary reports (quarterly, semi-annual, and annual). All the reports are discussed in the meetings of the Audit Committee. The Chairman of the Audit Committee, after consulting with the Internal Auditor, and notifying the Chairman of the Board of Directors for his response, decides which material internal audit reports are to be brought for discussion by the Audit Committee. In addition, selected reports are discussed in meetings with the General Manager, and with the audited units concerned, before presenting them to the Audit Committee. Copies of minutes of the Audit Committees are submitted to members of the Board of Directors to bring the contents of the discussions to the knowledge of those members of the Board of Directors who are not members of the Audit Committee. In cases of reports with particularly serious findings, a more urgent report is given to those performing the above positions. On the audit activity summary report for 2008 was discussed in the Audit Committee, on the audit activity summary report for the first half of 2009 was discussed in the Audit Committee, and on the audit activity summary report for 2010 was discussed in the Audit committee. Estimating the lnernal Auditor by the Board of Directors In the opinion of the Board of Directors and the Audit Committee, the scope, nature and continuity of the operations and work plan of the Internal Auditor are reasonable under the circumstances and enable the carrying out of the objects of internal audit in the corporation. Remuneration The Internal Auditor s compensation is paid by FIBI, and the Bank is charged for audit services. The auditor s remuneration is appropriate for his position. In the opinion of the Board of Directors, the auditor s remuneration does not cause for any bias in the auditor s professional judgment. The Approval Process of Financial Reports The office-holders engaged with preparing the Bank s financial statements are the General Manager of the Bank, Mr. Ilan Raviv, and the Manageress of the Chief Accountant Division and Chief Accountant, Mrs. Orit Itzcovitch. The body responsible in the Bank for overall control is the Board of Directors. The Board of Directors has appointed a Balance Sheet Committee, which holds detailed discussions on the financial reports and formulates its recommendation prior to bringing them to the Board of Directors for approval. The Balance Sheet Committee comprises four members, three of whom with financial and accounting expertise (including two external directors). At the Balance Sheet Committee, as well as the Board of Directors when they are discussing and approving the financial reports, the auditors of the Bank are invited to be present, and they are requested to present their main findings, if there were any, that arose during the audit or review process; and they are available to the members of the Balance Sheet Committee and the members of the Board of Directors for any question or clarification before their approval. On a quarterly basis, the Audit Committee of the Board of Directors holds a discussion on provisions for doubtful debts, for purposes of approving the provisions for doubtful debts and provisions for impairment in the nostro portfolio before bringing the financial statements for approval by the Board of Directors. In addition, in the framework of the controls and procedures concerning disclosure in the financial reports in accordance with the provisions of section 302 and 404 of the Sarbanes-Oxley Act, information relating to the disclosure requirements in the financial reports is collected and brought before the Management of the Bank. The reporting of significant deficiencies is brought for discussion in the Audit Committee and the Board of Directors as required before the approval of the financial reports. The reporting of material weaknesses is made in the financial reports, if such exist. In the framework of the approval process of the bank s financial reports, background documentation and/or draft financial reports of the Bank, including the Directors Report, are handed for review to the

102 102 / Annual Report 2009 members the Balance Sheet Committee and to the Board of Directors as required, before the regular meeting for discussing the reports. The meeting of the Board of Directors dealing with the approval of the financial statements of the Bank is also attended members of Bank Management, including the General Manager, the Chief Accountant, and the external auditors. During the meeting of the Board of Directors at which the financial reports are discussed and approved, the General Manager of the Bank gives a detailed review of the major points of the financial reports as well as material issues in the financial report. In addition, the ongoing activity of the Bank and the effect of this activity on the Bank s results are reviewed, with emphasis on material issues. At the same time, a discussion is held during which office-holders in the Bank answer question by the Directors on matters connected with the results of operations and the financial statements. At the conclusion of the discussion, a decision is made by the Board of Directors on the approval of the Bank s financial statements. Report on Directors with Accounting and Financial Expertise The Supervisor of Banks guideline provides that banking corporations must make disclosure in the Board of Directors report with regard to the appropriate minimum number of directors (not holding an additional position in the Bank) with accounting and financial expertise that the banking corporation s Board of Directors decided and that, in the Board of Directors opinion, enables it to comply with its responsibility of examining the banking corporation s financial position and for the preparation and approval of the financial statements, and also to give particulars about the directors that have such expertise. This decision is made with regard, inter alia, to the size of the corporation, the type of its activity, the number of members of its Board of Directors and its complexity. The Bank s Board of Directors has determined that the appropriate minimum number of directors with accounting and financial expertise, as defined in the guideline, is two directors. In the Board of Directors opinion, this number enables it to comply with the above duties imposed upon it, since it also ensures the involvement of a director with the above expertise in the process of approving the financial statements, even in the event of the absence of one of the two directors with such expertise. In addition, the Board of Directors noted that this determination took into account the fact that the Bank s financial statements are brought before the Audit committee, that conducts in-depth discussions on the statements before they are brought for the Board of Directors approval. Set out below are details of the directors with accounting and financial expertise, including education and experience in the banking sphere and in business and accounting matters, that enable them to understand financial statements of banking corporations in-depth: Mr. Jack Elaad has a Masters degree in Business Management and a Bachelors degree in Economics. Mr Elaad served as CEO of FIBI Bank (U.K.) Ltd and a director of FIBI Bank and chairman of the Board of Directors and CEO of Sadot Research & Development Fund Ltd. Mr Elaad serves as the chairman of the Bank s Board of Directors, the chairman of FIBI and engages in financial consultancy. Mr Elaad is a member of the Credit Committee. Mr. Yehuda Drori has a Master s Degree in Business managment and a Bachelor s Degree in Economics. Mr. Yehuda Drori has served previously as the Supervisor of the Capital Market and Savings in the Ministry of Finance, and has also served as acting Chairman of Poalim Capital Markets. Mr. Drori is a member of the Audit and Credit Committees.

103 The Board of Directors Report 2009 / 103 Mr. David Blumberg has a Master s Degree in Business Administration and a Bachelor s Degree in Economics. Mr. Blumberg served as General Manager of Bank Tefahot, General Manager of Bank Mizrachi and as Chairman of the Board of Directors of Bank Yerushalayim, and is presently the General Manager of Bar Mutav ltd.,chairman of the board of Directors of BSSH Israel credit insurance Company ltd. and Har el insurance company ltd. Mr. Blumberg is a member of the Credit Committee. Mr. Ben Zion Israel is a certified accountant, with a Bachelor s Degree in Economics and Accounting. Mr. Israel served as acting General Manager and Finance Manager of Inspire Investments Ltd. and also served as director and member of the Audit Committee which discussed the financial statements of Tadir-Gan (Precision Products) 1993 Ltd. Mr. Israel is a member of the Audit Committee. Dr. Shimon Ravid has a Ph.D. in economics. Dr Ravid was joint General Manager of Bank Hapoalim Ltd. for approx. 10 years (until 2000) and thereafter served as the chairman of the Board of Directors of Bank Otsar Hahayal Ltd. (until the end of the 2001). Dr. Ravid is a member of the Balance Sheet, Audit and Credit Committees. Dr. Ravid ceased being an external director in the Bank, after 6 years on 23 February, Even after the changes above the Bank keeps the minimum number of directors with accounting and financial expertise. Operation of the Board of Directors and Changes in Board Membership During 2009 the Bank s Board of Directors acted as obliged by its duties, in determining policy in various spheres, fixing guidelines as obliged by the various directives, approval of credit and supervision and control of current business activity. The Board of Directors plenum and its committees, the Audit Committee, Balance Sheet Committee and Credit Committee, held detailed discussions, each in its own sphere. Over the year there were 11 Board of Directors meetings and 14 meetings of the various committees of the Board of Directors. Members of the Bank s Board of Directors Set out below are the names of the members of the Board of Directors of the Bank at the time of publication of this Report, as well as members of the Board of Directors who served during 2009: Jack Elaad, Chairman Period of service: present. Membership of Committees: Credit Committee***. Internal or External Director*: Internal Education: BA Economics - Hebrew University Jerusalem, MA Business Administration (Finance) - Hebrew University Jerusalem. Employment during last five years: present: Director and Chairman of the Board of Directors of Ubank, present: Chairman of the Board of Directors of First International Bank of Israel, Financial Consultant. Memberships in additional Boards of Directors as at the date of publication of the reports: Jack Elaad Consultants Ltd., Spearcast Ltd. and Fibi ltd. and chairman of the board of Fibi Swiss. * External Director as defined in Proper Conduct of Banking Business Directive No ** As at the Balance Sheer committee was canceled. The responsibility for the discussion of the financial statements was transferred to the Audit Committee. *** As of , the name of the Credit Committee was changed to the Credit and Risk Management Committee. **** On , the Board of Directors of the Bank appointed Mr. Yoram Sirkis as a member of the Credit and Risk Management Committee, as of

104 104 / Annual Report 2009 Yehuda Drori Period of service: present. Membership of Committees: Audit Committee and Credit Committee***. Internal or External Director*: External. Education: BA Economics and History - Hebrew University Jerusalem, MA Business Administration - Hebrew University Jerusalem. Employment during last five years: Financial Consultant and membership of Boards of Directors and Investment Committees. Memberships in additional Boards of Directors as at the date of publication of the reports: None. Yehuda Botzer Period of service: present Membership of Committees: Credit Committee Internal or External Director*: Internal Education: BA Economics - Tel Aviv University. Employment during last five years: Deputy General manager, Manager of Credit Department in First International Bank of Israel. Memberships in additional Boards of Directors as at the date of publication of the reports: None. Yoram Sirkis Period of service: present. Membership of Committees: Audit and Credit Committee***. Internal or External Director*: Internal Education: BA Economics and Accounting - Hebrew University Jerusalem; MBA Business Administration - Hebrew University Jerusalem. Employment during last five years: present: Assistant General Manager and Head of Customers Assets Division in First International Bank of Israel; : Manager of Securities Department in First International Bank of Israel. Memberships in additional Boards of Directors as at the date of publication of the reports: First International Bank of Israel Nominee Company Ltd., TASE Ltd. and in Ma of. Clearing House Ltd.; Chairman of the Board of Directors of FIBI Insurance Agency (2005) Ltd. David Blumberg Period of service: present. Membership of Committees: Credit Committee***. Internal or External Director*: External Education: BA Economics - Hebrew University Jerusalem; MA Business Administration (Finance) - Hebrew University Jerusalem. Employment during last five years: Financial consultant; Owner and General Manager of the Bar Mutav Company; : Chairman of the Board of Directors of Bank Yerushalayim. Memberships in additional Boards of Directors as at the date of publication of the reports: Bar Mutav Ltd., Chairman of the Board of Directors of BSSH Israel Credit Insurance Company Ltd. and Har el insurance company ltd. Avi Kramer Period of service: present. Membership of Committees: Audit Committee Internal or External Director*: External Education: BA Economics - Tel Aviv University. Employment during last five years: : Deputy General Manager Sales and Member of Management - IBM Israel Ltd.; 2008: General Manager - B Safe Information Systems (1983) Ltd present: buisness and information systems consultant. Memberships in additional Boards of Directors as at the date of publication of the reports: None.

105 The Board of Directors Report 2009 / 105 Ben Zion Israel Period of service: Commencement of service present. Membership of Committees: Audit Committee Internal or External Director*: External Education: BA Economics and Accounting - Tel Aviv University, CPA. Employment during last five years: From October 2008: General Manager - Baker Tilly consultants (Israel) Ltd : acting General Manager and Deputy General Manager - Finance on Inspire Investments Ltd. Memberships in additional Boards of Directors as at the date of publication of the reports: Y.A. Yigal Investments (1990) Ltd., Ben Zion Israel Business and Financial consultancy Ltd. and Baker Tilly consultants (Israel) Ltd. Hadas Peled Period of service: Membership of Committees: Audit Committee. Internal or External Director*: External Education: LLB Law - Bar Ilan University. Studies for Masters Degree in Law - Tel Aviv University Employment during last five years: : Deputy General Manager and Legal Counsel of Reshet- Noga Ltd. Memberships in additional Boards of Directors as at the date of publication of the reports: None. Dr. Shimon Ravid Period of service: Membership of Committees: Audit Committee, Credit Committee, Balance Sheet Committee **,. Internal or External Director*: External Education: Ph.D. Economics - Hebrew University Jerusalem. Employment during last five years: Membership of Boards of Directors and Investment Committees Memberships in additional Boards of Directors as at the date of publication of the reports: Ramat Hagolan Winery Ltd., Mishkei HaNegev Central Agricultural Cooperative Society Ltd., Dolev Dvir Lahav Plastic Products (Partnership), Ardag Ltd., Algotechnologies Ltd., Iscor Ltd., Davik - Agricultural Cooperative Society Ltd., Or-Ad Ltd.

106 106 / Annual Report 2009 Members of the Bank s Management Members of the Bank s Management as at the date of the publication of this report and during 2009 are: Ilan Raviv, General Manager Period of service: Education: BA Economics - Ateneo de Manila; M.Sc. Operations Research/Management - University of London. Employment during last five years: Since 2004: General Manager Ubank Ltd. Avi Basson, Deputy General Manager and Head of Capital Market Division Period of service: present. Education: BA Economics - Tel Aviv University, MBA Finance and Accounting - Tel Aviv University. Employment during last five years: Since 2005: Deputy General Manager and Head of Capital Market Division : General Manager Clal Finance Members of the Clal Insurance Group. Yaacov Garten, Deputy General Manager and the Head of Central Services Division. Period of service: present. Education: BSc Chemical Engineering - Technion, MBA Business Administration -Tel Aviv University Employment during last five years: Since 2007: Deputy General Manager and the Head of Central Services Division, Ubank Ltd : Deputy General Manager Operations and Computers in Discount Mortgage Bank. Michal Goren, Manageress of Personal Banking Division Period of service: present. Education: LLB Law - Tel Aviv University, LLM Law - Tel Aviv University, M.Sc. Management Studies and Organizational Behavior - Tel Aviv University. Employment during last five years: : General Manager and Director of UBank Trust Co. Ltd.; : Head of Business Centers in the Legal Counsel Department of Bank Hapoalim Ltd.: : Legal Counsel (Counsel to Special Credits Department) in Corporate Division of Bank Hapoalim Ltd. Shimon Vaknin, Head of Finance Division Period of service: present. Education: BA Economics - Hebrew University Jerusalem; MA Business Administration (Finance) - Hebrew University Jerusalem. Employment during last five years: Since 2006: Head of Finance Division, Ubank Ltd : Manager Assets and Liability Department, Ubank Ltd : Manager of Interest, Product Development and Training Desk, and Alternate Dealing Room Manager, Mizrachi Tefahot Bank Ltd. Orit Itzcovitch, Manageress of the Chief Accountant Division and Chief Accountant. Period of service: present. Education: BA Accounting and Economics - Tel Aviv University, MBA Business Administration - Tel Aviv University, CPA. Employment during last five years: Since December 2006: Manageress of the Chief Accountant Division and Chief Accountant, Ubank Ltd. Prior to then: Various positions and managed the Manageress of the Accounting Department in Ubank Ltd. Changes in Members of Bank Management On December 13, 2009, Mr. Ilan Raviv notified the Chairman of the Board of Directors of his resignation from the position of General Manager of the Bank and from related duties. The resignation will come into effect on March 3, On January 3, 2010, the Board of Directors of the Bank approved the appointment of Mr. Ron Badany to the position of General Manager of the Bank. The date of commencement of his duties is from April 1, Between March 3, 2010 and April 1, 2010 Mr. Yaacov Garten, Deputy General Manager and the Head of Central Services Division, will serve as Acting General

107 The Board of Directors Report 2009 / 107 Manager. Below are details of Mr. Ron Badany: Education: BA Economics and Business Administration - Hebrew University Jerusalem; MBA Finance - Tel- Aviv University. Employment during last five years: Since 2006: Global Treasurer at Israel Discount Bank Ltd.; : Dealing Room Manager at Israel Discount Bank Ltd. Service on other Boards of Directors: Beit Lamed Dalet Ltd. It should be noted that the term of service concluded with the termination of his employment at Israel Discount Bank. Assessment of Controls and Procedures with Regard to the financial statement disclosure In accordance with the Directives on Reporting to the Public, and in accordance with the provisions of Proper Conduct of Banking Directive No. 309 published in September 2008, the Bank has maintained controls and procedures regarding disclosure for a number of years, and set up an internal control system over financial reporting. This was implemented for the first time in the financial statement for the year ending The Directives, which refer to Management s responsibility for the internal control over financial reporting and the external auditors opinion with regard to the audit of the internal control over financial reporting, were prepared in accordance with the provisions of Sections 302 and 404 of the law known as the Sarbanes-Oxley Act passed in the United States, and directives and guidelines decided upon in the United States, among others by the PCAOB. Attached to the Financial Statement are certifications by the General Manager and the Chief Accountant, on an individual basis, of their evaluation of controls and procedures with regard to disclosure. The Management of the Bank, together with the General Manager and Chief Accountant of the Bank, has made an evaluation, as at the end of the period covered by this Report, of the effectiveness of controls and procedures regarding disclosure in the Bank. On the basis of this evaluation, the General Manager of the Bank and the Chief Accountant have concluded that, as at the end of this period, controls and procedures regarding disclosure in the Bank are effective for the recording, processing, summarizing and reporting of the information that the banking corporation is required to disclose in its annual financial statements, in accordance with the Directives on Reporting to the Public of the Supervisor of Banks and on the date required in these Directives. During the quarter ending on March 31, 2009, there was a change in the Bank s internal control over financial reporting that materially affected or that may be reasonably anticipated to materially affect the Bank s internal control over financial reporting, deriving from conversion of systems to the computer systems of the First International Bank. Following the conversion of the systems, many working processes were changed in the Bank, and the internal audit system was adapted accordingly to the new processes. During the quarters ending June 30, 2009, September 30, 2009, and December 31, 2009, there were no changes in the Bank s internal control over financial reporting that materially affected or that may be reasonably anticipated to materially affect the Bank s internal control over financial reporting, with the exception of the process of updating and improving controls carried out for financial reporting purposes, following the systems conversion process mentioned above. For further information, see comments in the Chapter dealing information systems (page 16).

108 108 / Annual Report 2009 Details of the Amounts and Benefits paid to the Recipients of the Highest Salaries in the Bank Set out below are details of the benefits and amounts paid, or in respect of which a provision was recorded in the reported year 1, to the recipients of the highest salaries among the Bank s officers at reported amounts, in NIS thousands: For the year ended December 31, 2009 Details on the recipient of the benefit Benefits for services Position Scope of Fulltime Position Amount of Holdings in Capital of the Bank Salary Bonuses Value of Benefit 3 Severance, savings, continuing studies fund, vacation and social security Additions to reserves in respect of related expenses as a result of salary adjustments during the year Total salaries and related expenses Other payments Jack Elaad Ilan Raviv Avi Basson Shimon Vaknin Yaacov Garten Michal Goren Chairman of the Board of Directors ,073 General manager 100% - 1, ,747 - Deputy General manager and head of capital market Division 100% ,617 - Head of finance Division 100% ,501 - Deputy general manager and Head of central Services Division 100% ,139 - Mangerss of Personal Banking Division 100% Notes see on page 109.

109 The Board of Directors Report 2009 / 109 Salaries and bonuses Severance, savings, continuing studies fund, vacation and social security Additions to reserves in respect of related expenses as a result of salary adjustments during the year For the year ended December 31, 2008 Total salaries and related expenses Other payments Jack Elaad Ilan Raviv 1, , Avi Basson 1, , Shimon Vaknin , Yaacov Garten Orit Itzcovitch Excluding salary tax and information on loans granted on terms similar to all Bank s employees. 2 Including a provision for an adaptation grant of three monthly salaries. 3. Including the value of benefits for company car, cellular telephone, newspaper, and health insurance. 4. The scope of employment by the Group, as Chairman of the First International Bank and as Chairman of U-Bank, is 90% of a full-time position, of which at least two days per week at U-Bank. Notes: a. In determining the above payments of salary, bonuses, and benefits included in the report on salaries of members of Management, the considerations of the Board of Directors were based on the rank and duties of each officer and his contribution to the Bank s activities. The volume of business and the Bank s operating results were, among other things, also taken into account in considerations of the remuneration. b. The terms for the maintenance of accounts at the Bank for senior office holders, including all activity in them, are similar to the terms for other customers with similar characteristics.

110 110 / Annual Report 2009 Mr. Jack Elaad was appointed as Chairman of the Board of Directors as of December 23, 2004 for an unlimited period. Mr. Elaad serves also as Chairman of the First International Bank. The Chairman performs his duties in the Group as Chairman of First International Bank and as Chairman of the Bank, and the scope of his employment is 90% of a full-time position, of which at least two days per week at U-Bank. The terms of employment of the Chairman of the Bank were approved by the Audit Committee, the Board of Directors, and the General Meeting of the Bank. Each of the parties is entitled to end the agreement at any time and for any reason, by providing written notice three months in advance and in accordance with the terms agreed upon in the employment agreement. In consideration for the services the Chairman provides the Bank, he is entitled to a monthly payment and reimbursement of expenses against a tax invoice. It is provided and agreed that the agreement between the Chairman and the Bank is based on the provision of services by the Chairman, and an employeremployee relationship will not apply between the parties. The Chairman is also entitled to an annual bonus of a monthly salary for each percent of the return on capital from ordinary activities above a return threshold of eligibility determined by the Board of Directors for that calendar year. In 2009, the return threshold stood at 8%. The period of limitation of competition is for six months from the date employment at the Bank is terminated. Mr. Ilan Raviv has been employed as General Manager of the Bank since December 23, 2004 under terms of employment detailed in a personal agreement recently updated on July 5, Each of the parties is entitled to end the agreement at any time and for any reason, by providing written notice three months in advance and in accordance with the terms agreed upon in the employment agreement. On termination of his employment by the Bank, Mr. Raviv is entitled to severance compensation according to the sum that was provided in the individual compensation fund without the addition of reserves. The Bank reserves the right not to utilize the period of advance notice wholly or partially and to pay Mr. Raviv for the period not claimed. The period of limitation of competition is for six months from the date employment at the Bank is terminated. Mr. Raviv entitled for to an annual bonus of a monthly salary for each percent of the return on capital from ordinary activities above a return threshold of eligibility determined by the Board of Directors for that calendar year. In 2009, the return threshold stood at 8%. The payment of a bonus exceeding three monthly salaries requires the approval of the Board of Directors of the Bank. For purposes of calculation, components of the profit for the year with one-time characteristics will be eliminated. Mr.Raviv is also entitled to an adaptation grant upon termination of his employment by the Bank of three monthly salaries, and an additional grant that will calculated as follows: if he works until the end of 2009, he will be entitled to three salaries; if he works until the end of 2010, he will be entitled to four salaries; and if he works until the end of 2011, he will be entitled to five salaries. The payment is not cumulative and is a single grant paid at the end of the period. Mr. Raviv s salary is linked to the increase in the Consumer Price Index. In the event of a decrease in the CPI, the salary will not change until an increase that offsets the decrease in the CPI On December 13, 2009, Mr. Ilan Raviv notified the Chairman of the Board of Directors of his resignation from the position of General Manager of the Bank and from related duties. The resignation will come into effect on March 3, On January 3, 2010, the Board of Directors of the Bank approved the appointment of Mr. Ron Badany to the position of General Manager of the Bank. The date of commencement of his duties is from April 1, Between March 3, 2010 and April 1, 2010 Mr. Yaacov Garten, Deputy General Manager and the Head of Central Services Division, will serve as Acting General Manager. Mr. Avi Basson has served as a Member of Management and an employee of the Bank as of June 7, 2005, under a personal agreement for an unlimited period. Each of the parties is entitled to end the agreement at any time and for any reason, by providing written notice three months in advance and in accordance with the terms agreed upon in the employment agreement. On termination of his employment by the Bank, Mr. Basson is entitled to severance compensation according to the sum that was provided in the individual compensation fund without the addition of

111 The Board of Directors Report 2009 / 111 reserves. In addition, Mr. Basson is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Mr. Basson s salary is linked to the increase in the Consumer Price Index. In the event of a decrease in the CPI, the salary will not change until an increase that offsets the decrease in the CPI. Mr. Shimon Vaknin has served as a Member of Management as of March 1, 2006 under a personal agreement for an unlimited period. Each of the parties is entitled to end the agreement at any time and for any reason, by providing written notice three months in advance and in accordance with the terms agreed upon in the employment agreement. On termination of his employment at the Bank, Mr. Vaknin will be entitled to severance compensation of 100% of his last salary multiplied by the number of years of seniority. From these amounts will be deducted the redemption value of the provident fund for which the Bank has provided amounts in his favor. In addition, Mr. Vaknin is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Mr. Vaknin s salary is linked to the increase in the Consumer Price Index. In the event of a decrease in the CPI, the salary will not change until an increase that offsets the decrease in the CPI. Mr. Yaacov Garten has served as a Member of Management and an employee of the Bank since January 3, 2007 under a personal agreement for an unlimited period. Each of the parties is entitled to end the agreement at any time and for any reason, by providing written notice three months in advance and in accordance with the terms agreed upon in the employment agreement. On termination of his employment at the Bank, Mr. Garten will be entitled to severance compensation of 100% of his last salary multiplied by the number of years of seniority. From these amounts will be deducted the redemption value of the provident fund for which the Bank has provided amounts in his favor. In addition, Mr. Garten is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Mr. Garten s salary is linked to the increase in the Consumer Price Index. In the event of a decrease in the CPI, the salary will not change until an increase that offsets the decrease in the CPI. Mrs. Michael Goren has served as a Member of Management as of March 24, 2008 under a personal agreement for an unlimited period. Each of the parties is entitled to end the agreement at any time and for any reason, by providing written notice three months in advance and in accordance with the terms agreed upon in the employment agreement. On termination of her employment at the Bank, Mrs. Goren will be entitled to severance compensation of 100% of her last salary multiplied by the number of years of seniority. From these amounts will be deducted the redemption value of the provident fund for which the Bank has provided amounts in her favor. In addition, Mrs. Goren is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Mrs. Goren salary is linked to the increase in the Consumer Price Index. In the event of a decrease in the CPI, the salary will not change until an increase that offsets the decrease in the CPI.

112 112 / Annual Report 2009 Auditing Accountants Remuneration Reported amounts Consolidated The Bank NIS thousand NIS thousand NIS thousand NIS thousand Auditing Accountants Remuneration For audit work 4 1,901 1,863 1,714 1,583 For additional services: Additional services related to auditing Tax services Other services Total for additional services 193 1, Total 2,094 2,933 1,852 2,523 1 The Board of Directors report to the General Meeting of the auditing accountants remuneration for audit work and additional services, pursuant to sections 165 and 167 of the Companies Law The auditing accountants remuneration includes payments by the Bank and its consolidated subsidiaries and also includes payments pursuant to the Value Added Tax Law. 3 Includes paid remuneration and accrued remuneration. 4 Auditing annual financial statements and sox, tax reports and reviewing interim statements. 5 Including special audit work. 6 Including risk survey s fee. The Bank s auditor since its establishment is Somekh Chaikin. The Board of Directors expresses its gratitude to the General Manager of the Bank, Mr. Ilan Raviv, for his significant contribution to the Bank. The Board of Directors expresses its thanks to the Bank s management and its employees for their work, loyalty and professionalism and for the efforts invested to improve the Bank s profitability and its development Jack Elaad Chairman of the Board of Directors Yaacov Garten Acting General Manager March 23, 2009

113 The Board of Directors Report 2009 / 113

114 Following are the tables of detailed financial information according to the following subjects: A Consolidated Balance Sheet as at December 31, of the years 2005 to 2009 B Consolidated Statement of Profit and Loss for the years 2005 to 2009 C Income and Expense Ratios on a consolidated basis D Analysis of Exposure to Changes in the Rates of Interest on a consolidated basis E Total Credit Risk by Economic Sector on a consolidated basis F Exposure to foreign countries on a consolidated basis G Multi Quarter Data - Consolidated Balance Sheet H Multi Quarter Data - Consolidated Statement of Profit and Loss

115 Annual Report 2009 Management Review of the Bank s Financial Position and Operating Results

116 116 / Annual Report 2009 Addendum A: Consolidated Balance sheet as at December 31, of the years 2005 to 2009 Reported amounts December Assets Cash and deposits with banks 2, , , , ,663.8 Securities 2, , , , ,648.1 Borrowed securities Credit to the public 2, , , , ,168.9 Credit to the Government Equity basis Investments Buildings and equipment Other assets Total assets 9, , , , ,765.3 Liabilities and Shareholders equity Deposits of the public 7, , , , ,054.4 Deposits from banks Deposits of the Government Other liabilities 1, Total liabilities 8, , , , ,315.8 Shareholders equity Total liabilities and Shareholders equity 9, , , , , Less than NIS 0.1 million.

117 Management Review 2009 / 117 Addendum B: Consolidated Statement of Profit and Loss for the years 2005 to 2009 Reported amounts For the year ended December Profit from financing operations before provision for doubtful debts Provision for doubtful debts (3.9) (4.4) 1.3 (1.9) 3.7 Profit from financing operations after provision for doubtful debts Operating and other income: Operating commissions Profits (Losses) on investment in shares, net (2.7) (0.5) (0.3) Other income Total operating and other income Operating and other expenses: Salaries and related expenses Maintenance and depreciation of buildings and equipment Other expenses 80.8 Total operating and other expenses Profit from ordinary operations before taxes Provision for taxes on profit from ordinary operations Profit from ordinary operations after taxes Bank s share in profits (losses) from ordinary operations of investee companies, after tax effect (0.8) Net profit from ordinary operations Profit from extraordinary operations after tax Cumulative effect at the beginning of the year of change in accounting method, after tax Net profit Earning per share data Net earning per share of NIS 1 par value: NIS NIS NIS NIS NIS Net profit from ordinary operations Net extraordinary profit Net profit Reclassified. 2 Less than NIS 0.1 million.

118 118 / Annual Report 2009 Addendum C: Income and Expense Ratios on a consolidated basis Reported amounts For the year ended December 31, 2009 For the year ended December 31, 2008 Average Annual Balance 1 NIS million Financing income (expense) NIS million Rate of income (expense) excluding effect of derivatives % including effect of derivatives % Average Annual Balance 1 NIS million Financing income (expense) NIS million Rate of income (expense) excluding effect of derivatives % including effect of derivatives % Unlinked NIS: Assets 5, , Effect of ALM derivatives Total Assets 6, , Liabilities 4,612.8 (10.7) (0.23) 4,134.6 (89.0) (2.15) Effect of ALM derivatives (8.1) (12.5) Total liabilities 5,490.3 (18.8) (0.34) 4,602.8 (101.5) (2.21) Interest margin C.P.I. - Linked NIS: Assets Effect of ALM derivatives Total assets Liabilities 19.5 (1.4) (7.18) 5.2 (0.4) (7.69) Effect of ALM derivatives (7.8) (9.2) Total liabilities (9.2) (3.83) (9.6) (4.14) Interest margin (0.17) On the basis of monthly opening balances (excluding unlinked Israeli currency sector, which is on the basis of daily figures) after deducting the average balance of the specific provision for doubtful debts. 2 The interest margin in all the linkage sectors together cannot be compared between periods since it includes the weighted position in the linked sector. 3 Local activity Including Israeli currency linked to foreign currency. 4 The volatility in the foreign currency margin is a result of activity in shekel/foreign currency options, which are covered by transactions in the base asset. 5 Restated. 6 Hedging derivative instruments (excluding options), embedded derivatives that have been separated, and ALM derivatives which constitute part of the Bank s asset and liability management system. Notes: a. Complete data regarding the income and expense ratios in each segment, according to the various balance sheet items are available upon request. b. The data provides details before and after the effect of derivative instruments (including off-balance sheet effect of derivative instruments).

119 Management Review 2009 / 119 Reported amounts Average Annual Balance 1 For the year ended December 31, 2009 For the year ended December 31, NIS million Financing income (expense) NIS million Rate of income (expense) excluding effect of derivatives % including effect of derivatives % Average Annual Balance 1 NIS million Financing income (expense) NIS million Rate of income (expense) excluding effect of derivatives % including effect of derivatives % Foreign Currency 3 (Induding Israel currency linked to foreign currency) Assets 1, , Effect of derivatives 6 : Hedging derivatives Embedded and ALM derivatives 2, , Total assets 4, , Liabilities 2,241.6 (8.1) (0.36) 2, Effect of derivatives 6 : Hedging derivatives (45.9) (15.1) Embedded and ALM derivatives 2,033.6 (71.7) 1,624.7 (96.3) Total liabilities 4,456.4 (125.7) (2.82) 4,047.5 (73.8) (1.82) Interest margin Total Financial assets that produced financing income 7, , Effect of derivatives 6 : Hedging derivatives Embedded and ALM derivatives 3, , Total assets 10, , Financial liabilities that produced financing expenses 6,873.9 (20.2) (0.29) 6,383.6 (51.8) (0.81) Effect of derivatives 6 : Hedging derivatives (45.9) (15.1) Embedded and ALM derivatives 3,131.5 (87.6) 2,319.4 (118.0) Total liabilities 10,186.6 (153.7) (1.51) 8,882.0 (184.9) (2.08) Interest margin

120 120 / Annual Report 2009 Addendum C: Income and Expense Ratios on a consolidated basis (cont d) Reported amounts Average Annual Balance Financing income (expense) Average Annual Balance 1 Financing income (expense) In respect of options (2.3) 10.9 In respect of other derivatives (not including options, hedging derivatives, ALM derivatives and separated embedded derivatives) 2.1 (0.1) Commissions from financing business and other financing income Profit from financing activities before provision for doubtful debts Provision for doubtful debts (including general and supplementary provision) (3.9) (4.4) Profit from financing activities after provision for doubtful debts Total: Financial assets that produced financing income 7, ,782.7 Assets derived from derivative instruments Other financial assets General and supplementary provision for doubtful debts (10.5) (10.5) Total financial assets 7, ,976.5 Total: Financial liabilities that produced financing expenses 6, ,383.6 Liabilities derived from derivative instruments Other financial liabilities Total financial liabilities 7, ,557.6 Total excess of financial assets over financial liabilities Non-monetary items Total capital means On the basis of monthly opening balances (excluding unlinked Israeli currency sector, which is on the basis of daily figures) after deducting the average balance of the specific provision for doubtful debts. 2 Including profits and losses from the sale of bonds and adjustments to fair value of trading bonds. 3 Restated. 4 Local activity including Israeli currency linked to foreign currency. 5 Hedging derivative instruments (excluding options), embedded derivatives that have been separated, and ALM derivatives which constitute part of the Bank s asset and liability management system. 6 Average balances of derivative instruments (does not include average of off-balance sheet derivative instruments). Notes: a. Complete data regarding the income and expense ratios in each segment, according to the various balance sheet items are available upon request. b. The data provides details before and after the effect of derivative instruments (including off-balance sheet effect of derivative instruments).

121 Management Review 2009 / 121 Average Annual Balance 1 US$ million Financing income (expense) US$ million excluding effect of derivatives Rate of income (expense) % including effect of derivatives % Average Annual Balance 1 US$ million Financing income (expense) US$ million excluding effect of derivatives Rate of income (expense) % including effect of derivatives % Foriegn Currency 4 (including Israeli currency linked to foreign currency): Assets Effect of derivatives 5 : Hedging derivatives Embedded and ALM derivatives Total assets 1, , Liabilities (1.0) (0.18) (12.5) (2.06) Effect of derivatives 5 : Hedging derivatives 46.2 (11.7) 50.2 (4.3) Embedded and ALM derivatives (2.8) (13.9) Total liabilities 1,136.1 (15.5) (1.36) 1,123.0 (30.7) (2.73) Interest margin

122 122 / Annual Report 2009 Addendum D: Analysis of Exposure to Changes in the Rates of Interest on a consolidated basis Reported amounts Demand and up to one month Above one month up to three months Three to twelve months One to three years Unlinked NIS Financial assets 1,3 5, Derivative financial instruments (excluding options) Options (in terms of basis asset) Total fair value 5, Financial liabilities 1 4, Derivative financial instruments (excluding options) Options (in terms of basis asset) Total fair value 5, , The exposure to changes in interest rates in the segment (190.5) Comulative exposure in the segment Linked to the C.P.I. NIS Financial assets Derivative financial instruments (excluding options) Options (in terms of basis asset) Total fair value Financial liabilities Derivative financial instruments (excluding options) Options (in terms of basis asset) Total fair value The exposure to changes in interest rates in the segment (1.5) (51.0) Comulative exposure in the segment (1.5) Notes: a. Further details of the exposure to changes in the interest rates in each sector of financial assets and of financial liabilities, according to the various balance sheet categories, are available on request. b. In this table, the data for each period represent the present value of future cash flows of each financial instrument, discounted at the interest rate used for discounting to fair value included for the financial instrument in Note 15B to the Financial Statements, consistent with the assumptions according to which the fair value of the financial instrument was calculated. For further details of assumptions used in calculating fair value of financial instruments, see Note 15B to the Financial Statements. c. The internal rate of return is the interest rate at which cash flows expected from a financial instrument are discounted to fair value included for the financial instrument in Note 15B to the Financial Statements. d. The effective average duration of a group of financial instruments represents an approximation of the change in percentages in fair value of the group of financial instruments, which will be caused as a result of a small change (increase of 0.1%) in the internal rate of return of each of the financial instruments. 1. Excluding balance sheet balances of derivative financial instruments and fair value of off-balance sheet financial instruments. 2. Weighted average according to fair value of effective average duration. 3. Including shares shown in the No Maturity date column.

123 Management Review 2009 / 123 December 31, 2009 December 31, 2008 Three to five years Five to ten years Over ten years No Maturity date 1 Total fair value Internal rate of return % Effective average maturity Years Fair value Internal rate of return % Average maturity Years , , , , , , , , , , (61.0) (9.2) (83.7) (87.0) 95.0 (7.0) (90.7) (87.0) (87.0)

124 124 / Annual Report 2009 Addendum D: Analysis of Exposure to Changes in the Rates of Interest on a consolidated basis (cont d) Reported amounts Foreign Currency 4 Demand and up to one month Above one month up to three months Three to twelve months One to three years Financial assets 1,3 1, Derivative financial instruments (excluding options) 2, , , Options (in terms of basis asset) Total fair value 3, , , Financial liabilities 1 1, Derivative financial instruments (excluding options) 2, , Options (in terms of basis asset) Total fair value 4, , The exposure to changes in interest rates in the segment (866.9) (5.5) Comulative exposure in the segment (866.9) (343.0) Total exposure to changes in interest rates Financial assets 1,3 6, Derivative financial instruments (excluding options) 2, , , Options (in terms of basis asset) Total fair value 9, , , Financial liabilities 1 6, Derivative financial instruments (excluding options) 2, , , Options (in terms of basis asset) Total fair value 9, , , The exposure to changes in interest rates in the segment (488.8) (48.6) Comulative exposure in the segment (488.8) (113.2) Notes: a. Further details of the exposure to changes in the interest rates in each sector of financial assets and of financial liabilities, according to the various balance sheet categories, are available on request. b. In this table, the data for each period represent the present value of future cash flows of each financial instrument, discounted at the interest rate used for discounting to fair value included for the financial instrument in Note 15B to the Financial Statements, consistent with the assumptions according to which the fair value of the financial instrument was calculated. For further details of assumptions used in calculating fair value of financial instruments, see Note 15B to the Financial Statements. c. The internal rate of return is the interest rate at which cash flows expected from a financial instrument are discounted to fair value included for the financial instrument in Note 15B to the Financial Statements. d. The effective average duration of a group of financial instruments represents an approximation of the change in percentages in fair value of the group of financial instruments, which will be caused as a result of a small change (increase of 0.1%) in the internal rate of return of each of the financial instruments. 1. Excluding balance sheet balances of derivative financial instruments and fair value of off-balance sheet financial instruments. 2. Weighted average according to fair value of effective average duration. 3. Including shares shown in the No Maturity date column. 4. Including Israeli currency linked to foreign currency.

125 Management Review 2009 / 125 December 31, 2009 December 31, 2008 Three to five years Five to ten years Over ten years No Maturity date 1 Total fair value Internal rate of return % Effective average maturity Years Fair value Internal rate of return % Average maturity Years , , , , , , , , , , (3.8) (3.3) , , , , , , , , , , (74.0)

126 126 / Annual Report 2009 Addendum E: Total Credit Risk by Economic Sector on a consolidated basis Reported amounts December 31, 2009 Balance sheet credit risk 1 Off Balance sheet credit risk 2 Total credit risk to the public Annual expense of specific provision for doubtful debts Balance of problematic debts In respect of borrowers activity in Israel Agriculture Industry (2.5) 21.2 Construction and Real Estate (0.5) 5.3 Commerce Hotel, food and accommodation services (0.3) - Transport and Storage Communication and computer services (0.2) - Financial services 1, , , Other business services Community and public services Individuals (0.1) - Total 2, , ,042.6 (3.0) 33.2 In respect of borrowers activity abroad Industry (1.0) - Construction and Real Estate Transport and storage Communication and computer services Financial services Other business services Total (1.0) Includes: credit to the public, investments in bonds of the public ( NIS million, NIS million), and other assets in respect of derivatives instruments in bonds of the public ( NIS 77.1 million, NIS 70.7 million). 2 Off-balance sheet financial instruments credit risk, as calculated for the purpose of the restriction on credit to single borrower. 3 Restated. 4 Reclassified. Notes: a. The credit risk is presented before deductions permitted in accordance with Bank of Israel directives. b. The balance of problematic debt is presented after those deductions, including off balance sheet credit risk factors. c. The credit risk and balance of problematic debts are presented after deducting of the specific provisions for doubtful debts.

127 Management Review 2009 / 127 Reported amounts December 31, 2008 Balance sheet credit risk 1 Off Balance sheet credit risk 2 Total credit risk to the public Annual expense of specific provision for doubtful debts Balance of problematic debts In respect of borrowers activity in Israel Agriculture Industry (0.6) Construction and Real Estate (1.1) Electricity Commerce Hotel, food and accommodation services (0.1) - Transport and Storage Communication and computer services (1.2) 4.3 Financial services 3 1, , ,177.7 (1.0) 0.4 Other business services Community and public services (0.1) - Individuals Total 3 2, , , (2.9) In respect of borrowers activity abroad Industry (1.2) Construction and Real Estate Electricity Commerce Communication and computer services Financial services Other business services Community and public services Individuals Total (1.2)

128 128 / Annual Report 2009 Addendum F: Exposure to Foreign countries on a consolidated basis Reported amounts a. Information regarding total exposure to foreign countries and regarding exposure to countries, where total exposure for each country is the lowest 1 of over 1% of total assets on a consolidated basis or over 20% of total capital: Balance sheet exposure Governments 3 balance Banks Others Total sheet exposure NIS million NIS million NIS million NIS million Balance of problematic debts 4 NIS million Off Balance sheet exposure 2 Total off balance sheet exposure NIS million Of which: problematic off balance sheet credit risk NIS million December 31, 2009 Balance sheet exposure For repayment up to one year NIS million For repayment over one year NIS million Country U.S.A England Germany Vergin island Others Total foreign countries exposure , Total LDC countries exposure b. Information on countries whose total individual exposure is between 0.75% and 1% of total assets (in s): Balance sheet exposure Off Balance sheet exposure Total exposure Spain France On the basis of end-risk, after the effect of guarantees and liquid collateral. 2 Credit risk of off-balance sheet financial instruments as calculated for purposes of single borrower restriction. 3 Governments, official institutions and central banks. 4 Balance of problematic debts after deduction of debts covered by collateral permitted for deduction for purposes of single borrower and group borrower restriction. Not including off-balance sheet credit risk. 5 Reclassified. 6 Restated.

129 Management Review 2009 / 129 Addendum F: Exposure to Foreign countries on a consolidated basis Reported amounts a. Information regarding total exposure to foreign countries and regarding exposure to countries, where total exposure for each country is the lowest 1 of over 1% of total assets on a consolidated basis or over 20% of total capital: Balance sheet exposure Governments 3 balance Banks Others Total sheet exposure NIS million NIS million NIS million NIS million Balance of problematic debts 4 NIS million Off Balance sheet exposure 2 Total off balance sheet exposure NIS million Of which: problematic off balance sheet credit risk NIS million December 31, 2008 Balance sheet exposure For repayment up to one year NIS million For repayment over one year NIS million Country U.S.A England Switzerland Spain Others Total foreign countries exposure , , , Total LDC countries exposure b. Information on countries whose total individual exposure is between 0.75% and 1% of total assets (in s): Balance sheet exposure Off Balance sheet exposure Total exposure Canada Germany

130 130 / Annual Report 2009 Addendum G: Consolidated Balance Sheet as at the end of each Quarter in 2009 Reported amounts th Quarter 3rd Quarter 2nd Quarter 1st Quarter Assets Cash and deposits with banks Securities Borrowed Securities Credit to the public 2, , , , , , , , , , , ,898.9 Investment in Equity - basis investments Buildings and equipment Other assets Total assets , , , ,839.3 Liabilities and Shareholders' Equity Deposits of the public Deposits from banks Deposits of the government Other liabilities Total liabilities Shareholders' equity Total liabilities and shareholders' equity 7, , , , , , , , , , , , , , , , Reclassified. 2 Less than NIS 0.1 million.

131 Management Review 2009 / 131 Addendum G: Consolidated Balance Sheet as at the end of each Quarter in 2008 Reported amounts th Quarter 3rd Quarter 2nd Quarter 1st Quarter Assets Cash and deposits with banks Securities Borrowed Securities Credit to the public Investment in Equity - basis investments Buildings and equipment Other assets Total assets 2, , , , , , , , , , , , , , , ,892.2 Liabilities and Shareholders' Equity Deposits of the public Deposits from banks Deposits of the Government Other liabilities Total liabilities Shareholders' equity Total liabilities and shareholders' equity 6, , , , , , , , , , , , , Reclassified.

132 132 / Annual Report 2009 Addendum H: Quarterly Consolidated Statement of Profit and Loss in 2009 Reported amounts 4th Quarter For the year ended December 31, rd Quarter 2nd Quarter 1st Quarter Profit from financing operations before provision for doubtful debts Provision for doubtful debts (0.3) (0.9) (0.9) (1.8) Profit from financing operations after provision for doubtful debts Operating and other income: Operating commissions Profits (losses) on investments in shares, net (1.8) (1.3) (0.3) 0.7 Other income Total operating and other income Operating and other expenses: Salaries and related expenses Maintenance and depreciation of buildings and equipment Other expenses Total operating and other expenses Profit from ordinary operations before taxes Provision for taxes on profit from ordinary operations Profit from ordinary operations after taxes Bank s share in profits (losses) from ordinary operations of investee companies, after tax effect (0.2) (0.4) 1 - (0.2) Net profit Earning per share data NIS NIS NIS NIS Net earning per share of NIS 1 par value: Net profit Less than NIS 0.1 million.

133 Management Review 2009 / 133 Addendum H: Quarterly Consolidated Statement of Profit and Loss in 2008 Reported amounts 4th Quarter For the year ended December 31, rd Quarter 2nd Quarter 1st Quarter Profit from financing operations before provision for doubtful debts Provision for doubtful debts (1.0) 2 - (1.6) (1.8) Profit from financing operations after provision for doubtful debts Operating and other income: Operating commissions Profits (losses) on investments in shares, net (0.5) 0.1 (0.4) 1.7 Other income Total operating and other income Operating and other expenses: Salaries and related expenses Maintenance and depreciation of buildings and equipment Other expenses Total operating and other expenses Profit from ordinary operations before taxes Provision for taxes on profit from ordinary operations Profit from ordinary operations after taxes Bank s share in profits (losses) from ordinary operations of investee companies, after tax effect 0.4 (0.2) 0.7 Net profit NIS NIS NIS NIS Earning per share data Net earning per share of NIS 1 par value: Net profit Reclassified. 2 Less than NIS 0.1 million.

134

135 Annual Report 2009 Certifications of the General Manager and the Chief Accountant

136 136 / Annual Report 2009 Certification I, Yaacov Garten, declare that: 1. I have reviewed the annual report of Ubank Ltd (hereinafter referred to as the Bank ) for 2009 (hereinafter referred to as the report ). 2. Based on my knowledge, the report does not contain any incorrect representation of a material fact and it does not omit any representation of a material fact so that the representations contained therein, in view of the circumstances in which such representations have been included, shall not be misleading with regard to the period covered by the report. 3. Based on my knowledge, the financial statements and other financial information contained in the report correctly reflect, from all material aspects, the Bank s financial position, operating results and changes in the shareholders equity for the periods reported in the report. 4. I and other persons in the Bank who are making this declaration are responsible for the determination and performance of controls and procedures for the purpose of the required disclosure in the Bank s report; and also: a. We have determined such controls and procedures or have ensured the determination of such controls and procedures under our supervision, that are designed to ensure that material information relating to the Bank, including its consolidated corporations, has been brought to our knowledge by others at the Bank and at such corporations, and in particular during the course of the period of preparing the report; b. We have assessed the efficiency of the controls and procedures with regard to the Bank s disclosure and we have presented our conclusions with regard to the efficiency of the controls and procedures in respect of the disclosure, at the end of the period covered by the report, based upon our assessment; and also; c. We have given disclosure in the report of any change in the Bank s internal control of the financial report that occurred in the fourth quarter that materially affected, or is reasonably anticipated to materially affect, the Bank s internal control of the financial report; and also - 5. I and other persons in the Bank who are making this declaration have given disclosure to the Bank s auditing accountant, its Board of Directors and Board of Directors Audit Committee, based on our most current assessment with regard to the internal control of the financial report: a. All the significant deficiencies and material weaknesses in determining or operating the internal control of the financial report that can reasonably be anticipated to impair the Bank s ability to record, process, summarize and report financial information; and also - b. Any fraud, whether material or immaterial, in which the management of the Bank is involved or other employees are involved who have a significant function in the Bank s internal control of the financial report. The above does not detract from my responsibility, or that of any other person, under the law. March 23, 2010 Yaacov Garten Acting General Manager

137 Certifications of the General Manager and the Chief Accountant 2009 / 137 Certification I, Orit Itzcovitch, declare that: 1. I have reviewed the annual report of Ubank Ltd (hereinafter referred to as the Bank ) for 2009 (hereinafter referred to as the report ). 2. Based on my knowledge, the report does not contain any incorrect representation of a material fact and it does not omit any representation of a material fact so that the representations contained therein, in view of the circumstances in which such representations have been included, shall not be misleading with regard to the period covered by the report. 3. Based on my knowledge, the financial statements and other financial information contained in the report correctly reflect, from all material aspects, the Bank s financial position, operating results and changes in the shareholders equity for the periods reported in the report. 4. I and other persons in the Bank who are making this declaration are responsible for the determination and performance of controls and procedures for the purpose of the required disclosure in the Bank s report; and also: a. We have determined such controls and procedures or have ensured the determination of such controls and procedures under our supervision, that are designed to ensure that material information relating to the Bank, including its consolidated corporations, has been brought to our knowledge by others at the Bank and at such corporations, and in particular during the course of the period of preparing the report; b. We have assessed the efficiency of the controls and procedures with regard to the Bank s disclosure and we have presented our conclusions with regard to the efficiency of the controls and procedures in respect of the disclosure, at the end of the period covered by the report, based upon our assessment; and also; c. We have given disclosure in the report of any change in the Bank s internal control of the financial report that occurred in the fourth quarter that materially affected, or is reasonably anticipated to materially affect, the Bank s internal control of the financial report; and also - 5. I and other persons in the Bank who are making this declaration have given disclosure to the Bank s auditing accountant, its Board of Directors and Board of Directors Audit Committee, based on our most current assessment with regard to the internal control of the financial report: a. All the significant deficiencies and material weaknesses in determining or operating the internal control of the financial report that can reasonably be anticipated to impair the Bank s ability to record, process, summarize and report financial information; and also - b. Any fraud, whether material or immaterial, in which the management of the Bank is involved or other employees are involved who have a significant function in the Bank s internal control of the financial report. The above does not detract from my responsibility, or that of any other person, under the law. March 23, 2010 Orit Itzcovitch Chief Accountant

138 Annual Report 2009 Report of the Board of Directors and Management regarding internal control over financial reporting and Auditor s report to the shareholders of Regarding internal control over financial reporting

139 Report of the Board of Directors and Management on Internal Control over Financial Reporting / 139 Report of the Board of Directors and Management on Internal Control over Financial Reporting The Board of Directors and Management of (henceforth: "the Bank"), are responsible for establishing and maintaining appropriate internal control over financial reporting (as defined in the Directives for Public Reporting Directives concerning "The Directors' Report"). The internal control system of the Bank has been designed to provide a reasonable level of confidence to the Board of Directors and Management of the Bank concerning the preparation and appropriate presentation of financial statements published in accordance with accepted accounting principles and the Directives of the Supervisor of Banks and his instructions. Irrespective of the quality level of their design, all internal control systems have inherent limitations. Therefore even if it is determined that they are effective, they can only provide a reasonable level of confidence with reference to the preparing and presentation of a financial statement. Management, under the supervision of the Board of Directors, maintains a comprehensive internal control system designed to ensure that transactions are executed in accordance with the authorizations of Management, assets are protected, and that accounting entries are reliable. Furthermore, Management, under the supervision of the Board of Directors, takes steps to ensure that channels of information and communication are effective and monitor performance, including performance of internal control procedures. Management of the Bank, under the supervision of the Board of Directors, has evaluated the effectiveness of internal control of the Bank over financial reporting as at , based on the criteria determined in the internal control model of the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Based on this evaluation, Management believes that as at , the Bank's internal control over financial reporting is effective. The effectiveness of the Bank's internal control over financial reporting as at was audited by the Bank's Auditors (Somekh Chaikin), as stated in their Report on page 140, which includes an opinion regarding the effectiveness of the Bank's internal control over financial reporting as at Jack Elaad Yaacov Garten Orit Itzcovitch Chairman of the Board of Directors Acting General Manager Chief Accountant March 23, 2010

140

141 Annual Report 2009 / 141

142 145 Auditors Report to the Shareholders Financial Statements as at December 31, 2009 and for the year ended that date 146 Consolidated Balance Sheet 147 Consolidated Statement of Profit and Loss 148 Statement of Changes in Shareholders Equity 150 Consolidated Statement of Cash Flows 152 Balance Sheet of the Bank 153 Statement of Profit and Loss of the Bank 154 Statement of Cash Flows of the Bank 156 Notes to the Financial Statements

143 Annual Report 2009 Financial Statements as at December 31,2009

144

145