annual report 2011 u-bank ltd. · annual report 2011 \ ... – government bonds and makam in the...

$: ANNUAL REPORT 2011 U-BANK LTD. · ANNUAL REPORT 2011 \ ... – Government bonds and Makam in the amount of NIS 2,093.5 ... – Other corporate bonds in Israel and abroad in the amount$
ANNUAL REPORT 2011 U-BANK LTD.

ANNUAL REPORT 2011 \

UBANK LTD. AND CONSOLIDATED COMPANIES

2

Annual Report 2011 I Contents

Report of the Board of Directors to the General Meeting of Shareholders 5

Management Review of the Bank’s Financial Position and its Operating Results 133

Certifications of the General Manager and the Chief Accountant 153

Report of the Board of Directors and Management on Internal Control over Financial Reporting and the Report of the Auditors to the Shareholders of UBank Ltd. on Internal Control over Financial Reporting

157

Financial Statements as at December 31, 2011 163

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 2011 I Contents



4

Description of the General Development of Bank’s Business History of the Bank 6Profit and Profitability 6Developments in Balance Sheet items 8Holdings Structure Chart 11Principal Investee companies 12Information about the Parent Company 12Description of the Bank’s Operating Segments 12Dividend Distribution 13The Banks' Rating by a Rating Agency 13Human Capital 13Restrictions and Supervision of the Bank’s Activities 15Material Agreements 16Legal Proceedings 17 General Environment and Influence of External Factors on the Bank’s Activity Economic Developments in 2011 18Updates to Legislation relating to the Banking System in 2011 22 Description of the Bank’s Business by Operating Segments 43Fixed Assets and Facilities 56Taxation 56 Additional Information Risk Management Policy 57Accounting Policy on Critical Matters and Critical Accounting Estimates 108Community Activities and Donations 113Disclosure concerning the Bank's Internal Auditor 114Procedure for Approval of the Financial Statements 116Report on Directors with Accounting and Financial Expertise 117Activity of the Board of Directors and Changes in Board Membership 118Members of the Bank's Board of Directors 119Members of the Bank's Management 121Evaluation of Controls and Procedures concerning Disclosure in the Financial Statements 123Details of the Amounts and Benefits paid to Recipients of the Highest Salaries in the Bank 124Remuneration of the Auditors’ 129


5

Annual Report 2011 Report of the Board of Directors to the General Meeting of Shareholders



6

At the meeting of the Board of Directors held on February 26, 2012 the Board of Directors of UBank Ltd. resolved to approve and publish the audited consolidated financial statements of the Bank and its consolidated companies for the year ended on December 31, 2011. The financial statements were prepared in accordance with the directives and guidelines of the Supervisor of Banks. 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: “FIBI”). Upon 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 owned 100% by FIBI. Following the change in ownership, the Bank’s name was changed to “UBank Ltd.” in March 2005, operating as a separate and independent bank, specializing in the personal banking and capital market segments. Profit and Profitability Net profit in 2011 amounted to NIS 40.9 million, compared with NIS 49.0 million in 2010, a decrease of 16.5%. Net operating profit in 2011 amounted to NIS 39.4 million, compared with NIS 49.0 million in 2010, a decrease of 19.6%. In 2011, a profit from extraordinary activities after tax was reported of NIS 1.5 million – see detailed information in Note 25 to the financial statements. Net profit in the fourth quarter of 2011 amounted to NIS 6.8 million, compared with NIS 11.0 million in the corresponding quarter last year, a decrease of 38.2%. The decrease derives mainly from a decline in operating and other income, mainly because of a decline in income from activities in various area of the capital market, which was partly offset by a rise in profit from financing activities resulting mainly from an increase in income due to the effect of fair value adjustments of derivative financial instruments. Operating profit before taxes amounted to NIS 62.8 million in 2011, compared with NIS 79.6 million in 2010, a decrease of 21.1%. The decrease derives mainly from a decrease of 3.1% in operating and other income (NIS 4.2 million), and an increase of 7.4% in operating and other expenses (NIS 12.8 million). which was partially offset by an increase of 2.2% in profit from financing activities (NIS 2.4 million) See details of the effect of the above in the analysis of income and expenses below.

DIRECTORS' REPORT 2011 /


7

Provision for taxes on operating profit amounted in 2011 to NIS 23.3 million representing 37.1% of the profit before tax, compared with a provision of NIS 29.3 million, representing 36.8% of the profit before tax in 2010. The net return on equity amounted to 9.8% compared with 9.7% in 2010. The net return on equity from ordinary operations amounted to about 9.4% compared with 9.7% in 2010. The return on equity from ordinary activities before taxes amounted to about 15.0%, compared with about 15.7% in 2010. Net profit per NIS 1 par value of ordinary shares amounted in 2011 to NIS 13.1, compared with NIS 15.7 in 2010. Net operating profit per NIS 1 par value of ordinary shares amounted in 2011 to NIS 12.6, compared with NIS 15.7 in 2010. Income and Expenses (NIS million) 2011 2010 Change % Profit from financing activities 110.4 108.0 2.2 Operating and other income 132.0 136.2 (3.1) Operating and other expenses 184.6 171.8 7.4 Of which: other expenses 82.6 79.1 4.4 Of which: salary expenses 75.7 70.5 7.4 Profit from financing activities before income in respect of credit losses amounted to NIS 110.4 million in 2011, compared with NIS 108.0 million in 2010, an increase of 2.2%. The increase derives mainly from a rise in financing income in light of the increase in total credit to the public and in the financing margin on deposits of the public, as well as a rise in income from the effect of fair value adjustments of derivative financial instruments. The increase was partially offset by a decrease in profits from activity in the Bank’s trading portfolio, and a decrease in the current yield on bonds in the portfolio of Israeli securities available for sale, resulting mainly from a decline in the total portfolio and from a decrease in the realization of profits, net. In 2011, a provision was made for impairment of bonds of a nature other than temporary of NIS 0.5 million. In 2010, there was no impairment of bonds of a nature other than temporary. Income in respect of credit losses in 2011 amounted to income in the amount of NIS 5.0 million, compared with income in the amount of NIS 7.2 million in 2010. The income in both years derives from a decrease in the individual provision for credit losses, due mainly to the collection of debts for which a provision was made previously. As of 1.1.2011, the Bank applies the new directive on the measurement and disclosure of impaired debts. Regarding implementation of the directive, see Notes 1 and 4 to the financial statements. Operating and other income amounted to NIS 132.0 million in 2011, compared with NIS 136.2 million in 2010, a decrease of 3.1%. The decrease derives mainly from a decline in income from activity in various



8

areas of capital market, and from a decrease in profits of the severance pay fund of the Bank, which were partially offset by an increase in commissions from foreign currency dealing room activity. In addition, a provision was included for impairment of a nature other than temporary in shares in the available for sale portfolio in 2011 of NIS 2.7 million (2010 – NIS 0.8 million). Operating and other expenses in 2011 amounted to NIS 184.6 million, compared with NIS 171.8 million in 2010, an increase of 7.4%. Salaries and related expenses in 2011 amounted to NIS 75.7 million compared with NIS 70.5 million in 2010, an increase of 7.4%, deriving mainly from the updating of salaries of the Bank’s employees and losses by the severance pay fund in the current period compared with profits in the corresponding period last year. The increase was offset by a decrease in the provision for bonuses, due to the decline in profitability from 2010 to 2011. Maintenance expenses and depreciation of buildings and equipment, and amortization of intangible assets in 2011 amounted to NIS 26.3 million, compared with NIS 22.2 million during the corresponding period last year, an increase of 18.5%. The increase derives mainly from the updating of the lease agreement for the premises of the Bank in Tel-Aviv, the opening of new branches, and from a rise in expenses for amortizing intangible assets. Other expenses amounted to NIS 82.6 million in 2011, compared with NIS 79.1 million in 2010, an increase of 4.4%. The increase derives, among other things, from a rise in computer expenses and marketing and advertising that was partially offset by a decline in expenses for professional services. The percentage of cover of operating expenses by operating income was 71.5% in 2011, compared with 79.3% in 2010. The Bank’s share in the results of companies included on equity basis amounted to a loss of NIS 0.1 million in 2011, compared with a loss of NIS 1.3 million in 2010. Developments in Balance Sheet Items Total assets at December 31, 2011 amounted to NIS 7,506.0 million, compared with NIS 7,629.0 million at December 31, 2010, a decrease of 1.6%. Cash and deposits with banks at December 31, 2011 amounted to NIS 2,023.5 million, compared with NIS 2,154.0 million at December 31, 2010, a decrease of 6.1%. Investments in securities at December 31, 2011 amounted to NIS 2,433.9 million, compared with NIS 2,750.8 million at December 31, 2010, a decrease of 11.5%. Investments in securities consists of:

– Government bonds and Makam in the amount of NIS 2,093.5 million; – Bonds of foreign banks (“Eurobonds“) in the amount of NIS 48.7 million, spread over about 6

issuers; – Bonds of Israeli financial institutions in the amount of NIS 127.1 million; – Bonds of companies owned by the Israeli government in the amount of NIS 32.3 million; – Other corporate bonds in Israel and abroad in the amount of NIS 99.4 million, spread over about

26 issuers.



9

Below is information regarding the duration and rate of the decrease of fair value of available for sale securities, below their adjusted cost, which were recognized direchy in equity and not charged in profit and loss, as at 31.12.11 (in NIS million):

Rate of decrease Duration of decrease Up to 6

months 6-9 months

9-12 months

Over 12 months

Total

Up to 14.6% (3.6) (5.7) (1.2) (4.0) (14.5) 35% * - - - (1.4) (1.4) (3.6) (5.7) (1.2) (5.4) (15.9)

* The bank examined the need to make a provision for other-than-temporary impairment in the bond

in accordance with the accounting policy on critical matters and critical accounting estimates, the Bank Management is of the opinion that there is no need to make a provision. In addition, the decrease in fair value of the available for sale bond declined, approaching the date of approval of the financial statements to 16% and in 20.2.2012, 20% of the bond was redeemed.

Below is information regarding duration and rate of decrease in the fair value of bonds available for sale, below their adjusted cost, which were recognized directly in equity and not charged to profit and loss, as at 31.12.10 (in NIS millions):

Rate of decrease Duration of decrease Up to 6

months 6-9

months 9-12

months Over 12 months

Total

Up to 20% (1.5) (3.5) - (1.7) (6.7) 20.4% - - - (1.7) (1.7) (1.5) (3.5) - (3.4) (8.4)

The decrease in fair value of bonds as at 31.12.2011 includes: A decrease in fair value of NIS 8.4 million of government bonds and government bonds traded abroad. The overall rate of decrease in value of government bonds is up to 20%. An amount of NIS 2.2 million out of the decrease is for a period of up to 6 months, an amount of NIS 5.4 million is for a period of between 6-9 months, and the remainder is for a period of over 12 months. A decrease of NIS 0.7 million in the fair value of bonds of banks including foreign banks, rated A (see also the report on credit exposures to foreign financial institutions). The overall rate of decrease in value of bonds of banks is up to 20%. An amount of NIS 0.1 million is for a period of 6-9 months and the remainder is for a period of over 12 months. A decrease in fair value of NIS 6.8 million of corporate bonds. An amount of NIS 5.4 million out of the decrease in fair value is up to 20%, and the balance is decrease of 35%. An amount of NIS 1.4 million out of the decrease is for a period of up to 6 months, NIS 0.2 million is for a period of 6-9 months, NIS 1.2 million is for a period of 9-12 months, and the remainder is for a period of over 12 months. The negative capital reserve of the Bank increased from NIS 8.4 million at 31.12.10 to NIS 15.9 million at 31.12.11. The data are without the effect of a positive capital reserve and the effect of tax. The total capital reserve as at 31.12.11 is negative in the amount of NIS 8.5 million, including the effects mentioned above (see Note 3 – Securities and the report on changes in shareholders’ equity).



10

In an examination of the need to make a provision for impairment, in accordance with the accounting policy on critical matters and critical accounting estimates, a provision for impairment of a nature other than temporary was recorded in the Bank’s books in the amount of NIS 3.2 million (regarding the impairment, see Note 3 – Securities). The examination for impairment was made in accordance with that set out in detail in the section on Accounting Policy on Critical Matters in the Directors’ Report and in accordance with the circular of the Supervisor of Banks from 1.3.09. See the section dealing with Impairment of Assets in the Accounting Policy on Critical Matters. Credit to the public, net, amounted to NIS 1,773.3 million at the end of 2011, compared with NIS 1,751.4 million at the end of 2010, an increase of 1.3%. The average balance of credit to the public in 2011 was NIS 1,874.2 million, compared with an average balance of NIS 1,933.7 million in 2010, a decrease of 3.0%. Deposits of the public amounted to NIS 5,715.1 million at the end of 2011 compared with NIS 6,008.1 million on December 31, 2010, a decrease of 4.9%. The average balance of deposits of the public in 2011 was NIS 5,958.1 million, compared with an average balance of NIS 6,599.8 million in 2010, a decrease of 9.7%. Deposits from banks amounted to NIS 34.9 million at the end of 2011, compared with NIS 65.6 million at the end of 2010, a decrease of 46.8%. The changes in this item derive mainly from daily interbank activity. The capital of the Bank at December 31, 2011 amounted to NIS 431.9 million, compared with NIS 421.1 million at the end of 2010. The increase compared with the end of 2010 derives mainly from the net profit for 2011 in the amount of NIS 40.9 million, which was partially offset by the implementation of the new directive on Measurement and Disclosure of Impaired Debts, which led to a decrease in capital in the amount of NIS 20.5 million, and by a decrease in the capital reserve in respect of securities available for sale in the amount of NIS 9.6 million. The ratio of capital to total balance sheet at the end of 2011 amounted to 5.7%, compared with 5.5% at the end of 2010. The total capital ratio at December 31, 2011, calculated in accordance with the provisional directive - “Working Framework for Capital Measurement and Adequacy” (Basel II), reached 19.6% compared with 18.4% at the end of 2010. The ratio of Tier 1 capital to risk assets reached 16.2% compared with 15.2% at the end of 2010. On December 22, 2010, the Board of Directors of the Bank decided on capital targets up until the completion of the SREP process by the Bank of Israel. According to this decision, the minimal overall capital ratio determined will be 15%, and the minimal Tier 1 capital ratio will be 10%.



11

Holdings Structure Chart *

* Principal companies ** On May 1, 2011, the Bank sold all of its holdings in Manif Financial Services Ltd, a company

included on equity basis.



12

Principal Investee Companies A. "UBank Financial Assets Management Ltd." (hereinafter: “the Company”) is engaged in providing

investment portfolio management services for private and institutional customers. Total assets under management of the company as at December 31, 2011, is about NIS 0.5 billion. The company ended 2011 with a profit of NIS 0.3 million, compared with a profit of NIS 1.0 million in 2010.

B. "UBank Mutual Funds Ltd." (hereinafter: “the Company”) is engaged in the management of a range of mutual funds. The company ended 2011 with a net profit of NIS 0.2 million, compared with a profit NIS 0.7 million in 2010. Total assets under management of the company as at December 31, 2011, is about NIS 0.5 billion.

C. "UBank Trust Company Ltd." (hereinafter: “the Company”) is engaged mainly in providing trust

services for mutual funds, and in addition, as a trustee for series of bonds of special purpose companies (SPC), as well as private trusteeships in a variety of areas. At December 31, 2011, the company served as trustee for mutual funds with assets totaling about NIS 46.1 billion. The net profit of the company for 2011 amounted to NIS 18.6 million, compared with NIS 18.9 million in 2010.

D. "UBank Underwriting & Consulting Ltd." (hereinafter: “the Company”) dealt with underwriting

issues and financial counseling. The company’s profit amounted to NIS 0.1 million in 2011, compared with a loss of NIS 0.1 million in 2010. On 8.2.2011, the board of directors of the company decided to change the status of the company to inactive, under the provisions of the Securities Regulations (Underwriting), 2007.

E. "UBank Investments and Holdings Ltd." (hereinafter: “the company”) is engaged mainly in renting out premises, equipment and furniture for the Bank and related companies. The loss of the company for 2011 amounted to NIS 0.3 million (of which an operating loss in the amount of NIS 1.8 million and a profit of NIS 1.5 million from extraordinary activities of a company included on equity basis - Manif Financial Services Ltd), compared with a profit of NIS 0.3 million in 2010.

Information about the Parent Company The FIBI Group is one of the five largest banking groups in Israel. The Group operates in a wide range of financial activities: 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 abroad, FIBI Bank (UK) plc in London and FIBI Bank (Switzerland) in Zurich. The Group has 176 branches and units in Israel, of which 80 branches and units of the parent company. Description of the Bank’s Operating Segments The following is a short description of the operating segments of the Bank: 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 activities are in securities. In addition, the segment includes the activity of the financial asset management company of the Bank, the mutual fund management company of the Bank, and the customers of the Bank’s trust company, in the area of private and public trust services.



13

Corporate Banking Segment - includes all the institutional customers whose principal activity is in the financial area, such as groups engaged in the areas of insurance, pensions and provident funds, mutual funds, portfolio management companies, etc. These customers are allocated to the Capital Market Division. In addition, the segment includes customers of the trust company of the Bank in the area of trust services for mutual funds. Financial Segment - this segment incorporates the activities of the dealing rooms, the liquidity unit, and the Assets and Liabilities Management Department of the Bank. For detailed information, including financial analysis, see the chapter dealing with the description of the business of the Bank by operating segment. Dividend Distribution In 2011, no dividend was distributed. In December 2010, a dividend in the amount of NIS 100 million was declared and distributed. In March 2010, a dividend in the amount of NIS 75 million was declared and distributed. In 2009, no dividend was distributed. For further information, see Note 13A to the financial statements. The Bank's Rating by a Rating Agency The Midroog agency rated the Bank’s deposits as Aa3, and the short-term deposits with a rating of P-1. Human Capital Description of the organizational structure and the number of staff employed Six managers are directly subordinate to the Bank's General Manager, as follows: The Manager of the Personal Banking Division, to whom the Bank’s branches are subordinate. The average number of employees in the Personal Banking Division in 2011 amounted to 98 (in 2010 – 96 employees). The Manager of the Capital Market Division, to whom are subordinate the Israeli Securities and Foreign Securities Trading Departments, the Israeli Securities and Foreign Securities Back Office, and the banking team that provides services to the customers of the Division. The manager of the Capital Markets Division is also responsible for the following subsidiary companies: UBank Financial Assets Management Ltd., UBank Mutual Funds Ltd., and UBank Trust Company Ltd. The average number of employees in the Capital Market Division in 2011 amounted to 67 (in 2010 – 68 employees). The Manager of the Financial Division to whom the following departments are subordinate: Assets and Liabilities Management, the Liquidity Unit and the Dealing Room. The average number of employees in the Financial Division in 2011 amounted to 15 (in 2010 - 15 employees).



14

The Manager of the Headquarters Division, to whom the following departments are subordinate: Human Resources and Administration, Risk Management, Regulation and Processes, the Legal Department, Planning and Marketing, and the Computerization Liaison Officer. The average number of employees in the Headquarters Division amounted in 2011 to 41 (in 2010 - 40 employees). On January 12, 2011, the appointment of the Manager of the Headquarters Division as Chief Risk Officer of the Bank was approved. As a result, on January 13, 2011, the Credit Department, headed by the manager responsible for credit in the Bank, was transferred and reports directly to the general manager of the Bank. The Risk Management function remains subordinate to the Chief Risk Officer in the Headquarters Division. The average number of employees in the Credit Department amounted in 2011 to 13 (in 2010 - 12 employees). The Manageress of the Chief Accountant’s Division, to whom the following departments are subordinate: Accounting, International and Reconciliations and Bookkeeping and Payments. The average number of employees in the Chief Accountant’s Division in 2011 amounted to 20 (in 2010 - 20 employees). In addition, internal audit services rely for the most part on the Group Internal Audit function. For further information, see the chapter dealing with disclosure with regard to the Internal Auditor of the Bank. Below are data on the number of employees in the Bank and its subsidiaries at the end of the year and the monthly average during the year:

The Bank Subsidiaries Total

Permanent

Staff Other Staff*

Total Permanent Staff

Other Staff*

Total Permanent Staff

Other Staff*

Total

As at year end:

31.12.11 224 9 233 30 - 30 254 9 263 31.12.10 227 8 235 29 - 29 256 8 264

Monthly average:

2011 224 11 235 30 - 30 254 11 265

2010 224 4 228 27 - 27 251 4 255

* Includes hourly staff, staff from manpower agencies and outsourcing. Changes in Manpower 18% of the employees of the Bank commenced working for the Bank during 2011. Manpower turnover allows the Bank an influx of new professional personnel that suits its type of operations and the manpower requirements of the Bank. Employment Contracts All UBank employees are employed under personal employment contracts. 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 12.



15

Training Raising the level of professionalism in the Bank is a result of quality and focused recruitment, as well as of a personal and organizational training program that matches the needs of the Bank, and defined in the annual work program. The training program in the Bank includes professional teaching and training in different fields of routine banking activity and the subjects of management and the development of managers. The training program is derived from various changing factors, among which are the business policy of the Bank, developments expected in the market in general, and in the banking sector in particular, regulatory changes, and others. For training purposes, the Bank uses the training function developed by the First International Bank, with courses, seminars, supplementary learning, and training. The training program provides, as a motivating factor for employees, a solution for the development of personal skills and allows for the personal development of employees in different subjects. At the same time, the Bank encourages personal and professional development by means of, among others, participating in the funding of academic studies suitable for the Bank’s needs, and by assisting with vacation days during examinations. Remuneration programs for employees In accordance with the directives of the Supervisor of Banks from April 2009, the Board of Directors of the Bank discusses remuneration policy and the methodology for its implementation, with the aim of finding a balance between the desire to encourage motivation, creating identification among the managers with the long-term interests of the Bank, retaining and rewarding managers and their 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. In addition, the Bank strives to retain key employees and holders of key positions within the organization. Code of Ethics The Bank has a Code of Ethics that promotes ethics and social responsibility and incorporates appropriate norms of behavior among the Bank’s employees and its managers. The writing of the Code of Ethics was carried out with the participation of the Banks’ employees. Ethics functions have been created and activities are carried out for assimilation of the Code of Ethics by every employee on an ongoing basis. Restrictions and Supervision of the Bank’s Activities Proper Conduct of Banking Business Directive 313 - “Restrictions on the Indebtedness of a Borrower and a Group of Borrowers”, includes restrictions according to which the Bank is allowed to extend credit to a “single borrower”, to a “group of borrowers” and to the “six largest borrowers”. On 8.5.11, the Bank of Israel published an amendment to this Proper Conduct of Banking Business Directive, in which the restrictions set out in the directive were changed as of 31.12.11. The changes comprise a number of elements: 1. Limits on a single borrower and group of borrowers - the limit of 30% of the Bank’s equity was

changed to 25% of the Bank’s equity, or NIS 250 million, whichever the higher. The limit on the indebtedness of the six largest borrowers (135% of the Bank’s equity) was replaced with the limit that the indebtedness of all customers with indebtedness of over 10% of the



16

Bank’s equity, shall not exceed 135%. This percentage will decrease gradually by 31.12.12 to 120% of the Bank’s equity.

2. The inclusion of indebtedness of banks as customer indebtedness for single borrower purposes. 3. Changes occurred in the definition of indebtedness, for example futures transactions that were

included in the past at the nominal value multiplied by 10%, are multiplied by the add on rate in accordance with the Capital Adequacy Directives of Basel II multiplied by 3.

4. Eligible deductions – based partially on Basel II principles, both in recognition as eligible collateral and in changes in coefficients.

The abovementioned changes result in changes in the examination for compliance with limits such as exposures to sectors of the economy and others. The changes obliged the Bank to make changes in its deployment, including among others a significant reduction in credit facilities of large customers and a reduction in exposures to banks.

In Proper Conduct of Banking Business Directive 337 - “Activity in the Maof Market” there is a restriction, in accordance with which the total amount of the liabilities of a banking corporation vis-à-vis the Maof Clearing System (after eligible deductions) shall not exceed 30% of the Bank’s equity. In light of the large volume of activity of customers of the Capital Market Division in the Maof market, the Bank checks the said restriction on a routine basis. In Proper Conduct of Banking Business Directive 315 - “Supplementary Provision for Doubtful Debts”, it is stipulated that a provision is to be made in respect of concentration of credit by sector. The Bank is exposed to such concentration in the financial services sector. This concentration is in accordance with the business policy of the Bank, in which the capital market customers segment is one of the principal operating segments. The Bank is meticulous in implementing the restriction. In 2010 and 2011, there were no exceptions to the concentration limit in the sectors. In addition, on the subject of the capital market reform, see details in the chapter dealing with operating segments with reference to the activity of UBank Mutual Funds Ltd. Other than the aforementioned, there are no other restrictions and supervision that are unique or apply to the Bank in the relevant years or which are expected to have a significant effect on the activities of the Bank in the future. Material Agreements a. Computer services agreement As part of FIBI Group strategy, computer services, including operational and programming services, are provided by means of a subsidiary company - Mataf. The services are provided directly by the staff of Mataf. As part of this strategy, the employees of the computer unit of the Bank became employees of Mataf in 2005. As a result, all of the Bank’s computer services, including operations and programming services, are provided to the Bank by the Mataf Company. Mataf is engaged in developing advanced technology systems and maintaining the business applications of the Group and of the Bank, while striving to approve the effectiveness, quality, and efficiency of the Group’s computer services. Within the company operates the Methods and Process Analysis Department, which is responsible for drawing up and distributing working procedures and circulars. In accordance with the principles of the undertaking between the Bank and Mataf, until the end of 2009, Mataf bore the costs of the process of unifying applications between the banks, and the Bank paid Mataf



17

for ongoing computer services, and bore its share in the development of regulatory and Group applications as agreed, with the addition of an agreed increase. Commencing in 2010, a model was formulated to determine current payments for computer services based on the relative share of the Bank in all computer activities carried out in the FIBI Group.

b. 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 17(E). – With regard to the Bank’s liabilities to the Maof Clearing System - see Notes 16(C)(2) and

16(C)(3). – With regard to the Bank’s liabilities to the Stock Exchange Clearing System - see Note 16(C)(4). – With regard to the collateral agreement with Euroclear - see Note 16(C)(5). – With regard to indemnification of office holders - see Note 16(C)(8). – With regard to commitments between the Bank and the FIBI Group - see Note 16(C)(10). – With regard to pledges - see Note 16(D). – With regard to rental of buildings - see Note 16(C)(12).

Legal Proceedings

Set out below are details of claims against the Bank and its consolidated companies, in material amounts exceeding 1% of the Bank’s equity. In the view of Management, based on legal opinions, appropriate provisions have been made in the financial statements, if necessary, 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 Bank Management, based on the opinion of their legal advisers), the probability of additional risk exposure occurring to the Bank is very low, in all of the 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 on the Tel Aviv Stock Exchange (hereinafter: ”the company”), the Trust Company, Poalim Capital Markets and Investments Ltd., directors of the company, its controlling shareholders, the parent company of the company, and the accountants who audited the company’s accounts. The amount of damage claimed by the plaintiff is about NIS 32,000. Together with the action, a petition was filed in Court to recognize it as a class action on behalf of all the holders of the debentures issued by the company, in an estimated amount of some NIS 40.8 million. In March 2011, the Court dismissed the claim against the Trust Company and against the auditors of the company (the petition against the remaining defendants was approved). The plaintiff submitted an appeal against the dismissal decisions. 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 lawsuit against the Trust Company.

2. On July 27, 2003 two customers brought a claim in the Tel Aviv District Court for the award of a declaratory judgment to the effect that neither of the customers owes money to the Bank and that the pledge of shares of a company listed on the Stock Exchange 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 about NIS 28.6 million. The claim is in the pre-trial stage.

3. On December 22, 2005 a claim was brought in the Tel Aviv District Court against UBank Trust Co. Ltd. (hereinafter: “the company”) which was corrected on September 15, 2009 to an amount of some NIS 34.6 million (as estimated at 31.12.11) by three plaintiffs, which are companies related to each other. 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 company and its legal advisors, the company has a good defense against the lawsuit.



18

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 about NIS 11.1 million resulted from the Bank’s errors and negligence, was dismissed. The customer filed an appeal against the verdict in the Supreme Court. On 19.7.2011, the Supreme Court dismissed the appeal. 5. On March 18, 2009, a claim was filed in the Tel Aviv District Court in Tel- Aviv against the Bank by a customer in the sum of NIS 8.5 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. Economic Developments in 2011 The Global Environment During the second half of 2011, the debt crisis in Europe worsened significantly, and led to a slowdown in real activity and a sharp increase of risk in global financial markets. The slowdown in Europe spread to other developed countries and to emerging countries (mainly India, China and Brazil) - which responded by undertaking an expansionary monetary policy (mainly reductions in interest rates). In the US, data for business activity improved, although the rate of growth there remained relatively low with a high burden of debt. Europe: In the second half of the year, GDP in the euro zone declined by about 0.3%, compared with a moderate positive growth of about 2% in the first half of the year. Growth forecasts were revised downwards under the concern of deepening recession. Towards the end of the second half of the year, the markets calmed down somewhat in light of the steps taken to enhance fiscal discipline in the euro zone and monetary measures to increase liquidity. At the beginning of 2012, ratings were lowered again for several European countries: France, Italy, Spain, Portugal, Greece, Austria, Malta, Slovakia and Slovenia - this downgrading may hinder the ability of these countries to raise debt, which may lead to further deterioration of the crisis. US: In the second half of the year there was a recovery in real activity in the US, which was reflected in an increase in the rate of growth compared to the first half, and a decline in the rate of unemployment. Nevertheless, despite these positive signs, it should be noted that growth relied heavily on public sector demand, and was supported also by the monetary measures of the Fed which mainly provided relief to the credit market. Emerging markets: Unlike most developed countries, emerging markets reported attractive growth figures until the fourth quarter of the year, with China leading the economies with growth rates of about 10%. However, in the fourth quarter, the global slowdown spread to the emerging markets and growth projections for them were revised downward.

Economic developments in Israel Economic growth Despite moderation in the rate of growth in 2011, especially in the second half, the condition of the Israeli economy in 2011 was relatively good – the level of real activity was high and most indicators pointed to a situation approaching full employment. The Israeli economy grew in 2011 at a rate of approximately 4.8%. All the components of the economy enjoyed relative expansion: exports increased by 4.5%, private consumption increased by 4.0%, investments in fixed assets grew by 14.8%, and public consumption by about 4.5%. It is important to note, as already mentioned, that the rate of growth continued to decline during the year from about 4.9% in the first quarter to an estimated level of 3% in the fourth quarter.



19

Bank of Israel forecasts of growth for 2012 were cut during the year to a forecast of 2.8% (similar to the OECD forecast).

The unemployment level The level of unemployment rate dropped to a historic low and most of the indicators that support the assessment that the labor market is close to full employment. The growth of the economy in 2011 led to a rapid increase in the demand for workers. In the first nine months of 2011, employment grew by 3.3% (an increase of nearly a hundred thousand new employees). The unemployment rate fell from 6.5% at the end of 2011 to 5.5% in the second quarter, and to an estimate of some 5.4% in November. Although the Israeli economy is approaching a state of full employment, real wages in the economy rose from January-October by only about 0.3%.

State Budget The budget deficit reached some 3.3%, slightly higher than the target of 3% set in the budget for 2011. In the second half there was a decrease in revenues from taxes as a result of the slowdown in activity. In 2011, the Ministry of Finance conducted an expansionary fiscal policy. Although total revenues from taxes increased by 8.1% (not far from the target of 9.2%), but most of the growth occurred by the middle of the year. Beginning in July the increase in taxes came almost to a halt, mainly due to reduced taxes on consumption from a reduction in imports of consumer goods in general, and cars in particular. Tax rebates for the whole of 2011 were lower by NIS 2.5 billion compared with 2010 (about 0.3% of GDP). Funding the deficit of NIS 23 billion was made by privatization revenues of NIS 7.1 billion (mainly from the sale of land) and the net raising of funds in the domestic market of NIS 12 billion. In addition, the Treasury took advantage of surplus funding from previous years totaling NIS 3.8 billion. Government debt continued to decline from 76.6% of GDP in 2010 to an estimated 75% in 2011. The risk of an increase in the deficit in 2012 stems mainly from the possibility of a worsening of the slowdown in the real activity in the local economy leading to more moderate growth in tax revenues than forecast and/or the possibilities of increased defense spending against the backdrop of deterioration of the geo-political situation and the increasing expenses associated with the social protest. Inflation, monetary policy and the exchange rate The inflation rate in the Israel economy was affected by the slowdown that developed during 2011. By the second quarter, there was an acceleration in the rate of inflation from about 2.7% in December 2010 to about 4.2% in June 2011. After that, there was a consistent moderation every month to a level of 2.2% in December 2011. The core inflation rate dropped in the last months from about 3.6% in the first quarter to about 1.9% in December. The rate of increase in housing prices slowed in the second half of the year: the Housing Survey (which measures actual purchase prices according to purchase tax) indicated a cumulative decline of 1.5% in the three latest surveys of 2011. The change in the trend of housing prices stems from the raising of interest rates by the Bank of Israel, a sharp increase in construction starts, Bank of Israel restrictions on the percentage of mortgages at variable interest rates to one third of the total mortgage, and excess taxation on purchasing a second apartment. In view of the slowdown in economic growth in the second half, due to Europe slipping into recession and concerns of a more severe financial crisis and deepening of the global slowdown, the Bank of Israel, in the third quarter of the year, discontinued the trend of interest rate hikes that begin in mid-2009. From December 2010 to June 2011, the Bank of Israel raised the interest rate by 1.25%, to the level of 3.25%. The more the global environment continued to deteriorate, the more monetary policy changed to a reduction in interest rates, which led to two reductions in the last quarter of the year and a further reduction in late January 2012. The Bank of Israel interest rate at the end of January 2012 is 2.5%.



20

After appreciation of some 5% in the effective exchange rate in the first half of the year, the trend reversed in the second half and a depreciation was recorded of about 4.7% against the dollar and about 4.2% against the euro. This moderate depreciation of the shekel supported the improvement in the competitiveness of the trading sector, (after erosion in 2010) without the development of inflationary pressure. The exchange rate was influenced by three main factors that gave less support to the appreciation of the shekel compared with previous years: The current account surplus disappeared in 2011; a deterioration in geo-political conditions in the area; and, in contrast, net real investments in 2011 were positive and supported the shekel. Foreign currency purchases by the Bank of Israel were halted in August 2011 after acquiring about $ 5.5 billion by July 2011. This policy was terminated as soon as conditions were created for the depreciation of the shekel. Financial markets Israel's financial markets were affected by the development of the crisis in Europe, as well as local factors, of which the main ones are a high level of political uncertainty in the Middle East. The decline in stock indices in Israel was more moderate than in Europe, but more intense than in most other countries. The stock market After a sharp rise in world capital markets in 2009-2010, 2011 was a year of declines in stock markets in Israel and overseas (except in the US, where the S&P index remains stable). The Israeli capital market (the TA-100 index) decreased by 20% in 2011. The MSCI index of emerging markets decreased by 20.4% compared with a decrease of only 7.6% in the MSCI index of developed countries. Local events in Israel did not support the stock market. Fear of the effects of the vote in the UN in September caused investors to reduce risks. The social protest also hit the stock markets because of the damage expected to the profitability of food companies, the media and marketing chains. The last quarter of the year was characterized by increases in share prices in Israel. The sentiment that the leaders of Europe are moving towards a process of fiscal integration and increasing involvement of the European Central Bank in providing liquidity eased the credit crunch. In addition, better than expected economic data in the US contributed to the positive atmosphere of the markets. The corporate bond market Like the stock market, the corporate bond market is sensitive to a slowdown in economic activity. The same trends that impacted the stock market in 2011 affected corporate bonds. The bond market fell by 1.8% in 2011, in particular the lower rated bonds. The Tel-Bond 20 index rose by 0.7% in 2011 compared with a 1.6% decline the Tel-Bond 40 index, with a widening of margins observed between corporate bonds and government bonds (index-linked) which rose by some 4.3% during the same period. A sharp rise in yields on bonds of a number of companies may make it harder for debt recycling in 2012. The Government bond market In 2011, the bond market responded to two major developments: the trend of the monetary policy of the Bank of Israel and the trend in stock markets (and its impact on foreign bond yields). In the first half of the year, the Bank of Israel surprised the market with rapid interest rate hikes from 2% in late 2010 to a level of 3.25% (by June). Concerns about a continued rapid rise impacted the bond market in the first months of the year. In the third quarter, changing the direction to that of reducing interest rates had a favorable effect on the bond market, and the bond market reacted with price rises in the second half of the year. The Israeli bond market was supported by long-term yields in the US, which declined mainly due to the flight from the stock market.



21

Updates in Legislation and Rulings affecting the Banking System in 2011 Legislation

Joint Investment Trust Law (Amendment No. 14), 2010

This amendment became effective upon the rules coming into force on the conducting of the required tender, which were published on 28.6.11 and came into force on 28.12.11, which is the effective date of coming into force of this amendment. On 16.2.2010, an amendment was published to the law in the Official Gazette (Reshumot), which was mainly a change to section 69 of the Joint Investment Trust Law. The following are the main points: an obligation to conduct a tender was imposed on the fund manager concerning brokerage commissions with "a trading company" (member of the stock exchange); the board of directors of a fund manager is to establish a procedure for conducting a tender, which is to be approved by the trustee; entering into an engagement with a member of a foreign stock exchange can be done without a tender (under the terms of the law); the engagement of a fund manager in a brokerage agreement with a stock exchange member that controls the fund manager or fund trustee can be done without a tender subject to the following conditions: 1. Compliance by the stock exchange member with the threshold conditions set out in the tender. 2. The commission for each transaction type does not exceed the commission paid to the winner of

a tender for making a similar transaction. 3. The engagement was approved by the audit committee and board of directors of the fund

manager. A fund manager will not make payments out of the fund's assets to stock exchange members related to the fund manager or the trustee during the period of 12 months beginning on the date set out by the fund manager in the prospectus, for executing transactions in the fund for more than 20% of total commissions (of any kind) paid out of the fund's assets during that fiscal year. The Bank and UBank Trust Company Ltd. (a subsidiary company) completed preparations for the implementation of the legislation mentioned above. As a result of implementing the directive, the Bank anticipates a decrease in its income that will not significantly affect the Bank's ongoing operations. Regulations for conducting a tender for engagement with a trading company and conditions for engagement with a related company or an affiliated company with an affinity (hereinafter: “the rules") The rules were published on 28.06.11 and came into force on 28.12.11. Following Amendment No. 14 of the Joint Investment Trust Law, rules were published for public comment according to which it is proposed to oblige the fund manager to carry out a tender for engagement in an agreement to receive brokerage services. It is proposed to exempt companies related to the fund manager from participation in the tender, but to limit the scope of brokerage transactions which can be paid for out of the fund's assets to related companies, so that the fund manager will be required to outsource most of the brokerage activity for which the consideration is paid out of the fund's assets to assets that are not related to him. These proceeds will be limited to 20%. A trading company related to a trustee shall be entitled to participate in the tender and in the event of its winning, it can receive proceeds up to 20% of the commissions that the fund pays per year, or alternatively to end the term of office of the trustee and serve as a trading company without restriction.



22

Improvement of Efficiency of Enforcement Procedures in the Securities Authority (Amendments to Legislation) Law, 2011 On 27.1.11, the law was published in the Official Gazette (Reshumot), and came into force on 27.2.11, apart from certain matters within the framework of the law, which will come into force later, as set out in detail in the law. The aim of the law is to enforce more efficiently the provisions of the Securities Law, 1968, the Regulation of Investment Counseling, Investment Marketing and Investment Portfolio Management Law, 1995, and the Joint Trust Investments Law, 1994; to shorten the period of time between the violation and the imposition of punishment; and to adapt the punishment to the severity of the violation. In this context, a new scale of violations was determined, and punishment was made more severe for certain violations. It should be pointed out that the law stipulates a duty of supervision on the chief executive officer of the corporation, under which the chief executive officer of the corporation has to supervise compliance and to take all steps that are reasonable under the circumstances of the matter, as detailed in the relevant paragraph, to avoid violations by the corporation or by any of its employees. The law stipulates that if a violation was committed (except for certain violations), it is presumed that the chief executive officer violated his said duty of supervision, and he will be subject to enforcement measures as if he were the violator, unless the chief executive officer acted to prevent the violation and /or its recurrence, including by deciding on appropriate procedures. The law allows for three parallel tracks of enforcement, at the discretion of the Chairman of the Israel Securities Authority: (1) the imposition of a monetary sanction by the Authority; (2) an administrative enforcement process by means of an administrative enforcement committee; (3) criminal proceedings;

The law also authorizes the Chairman of the Securities Authority to enter into an arrangement with the violator not to start proceedings or to discontinue proceedings, instead of carrying out criminal or administrative proceedings. Entering into an arrangement as mentioned above will be published in a similar manner to the aforementioned in reference to a demand for payment.

On 7.4.11, as part of the implementation of this law, five of the six members of the administrative enforcement committee were appointed. The amendment came into force on 27.2.11, but due to the fact that its coming into force is contingent on the making of regulations (including with regard to discounts in the rates of fines prescribed by law, etc.), it will come into force gradually. The Bank is carrying out a project for preparing an internal compliance plan for the Bank and for the subsidiary companies, with the assistance of external consultants. List of circumstances for examining a defect in the reliability of entities supervised by the Authority – Binding version The list was published on 4.12.11, as the result of the publication of the Improvement of Efficiency of Enforcement Procedures in the Securities Authority (Amendments to Legislation) Law, 2010 (hereinafter: "Administrative Enforcement Law"). Thelist came into effect 30 days after publication. Any change in the list will not apply to a pending proceeding. The main purpose of the law is to establish the administrative enforcement procedure, and at the same time, further amendments were made aimed at improving protection for the public investing in securities, unit holders of mutual funds, and clients of permit holders. Under the Administrative Enforcement Law, the competence of the Securities Authority was clarified with regard to the non-granting of a permit because of the discovery of a defect in reliability, as well as its withdrawing a permit already issued, due to the disclosure of such a defect as mentioned above. The Authority was authorized to cancel permits due to a defect in reliability, including a defect in reliability of related entities, as detailed below, but it is stipulated that such withdrawals would be done on the basis of a list of circumstances which attest to a defect in reliability, in light of which alone the Authority will review such a decision. To this end, the Authority was required to determine and publish a list of circumstances the existence of which is prima facie evidence of a possible defect in reliability.



23

Publication of this list will help in creating clarity of how the Authority will use its discretion in these cases. Examination of reliability is with regard to a fund manager, a fund trustee, license holders and those having permits to control a fund manager. In the event of existence of one or more of the circumstances, the role of the individual whose reliability is assessed is to be taken into account for purposes of selecting the entity and various considerations such as the length of time between actions and the date of the examination, the manner of conduct of the supervised entity during the period elapsed, and the degree of impact expected from the action and the reaction of the Authority on the capital market capital, public confidence in it in general, and those entities managing public funds in particular. The existence of such circumstances will not necessarily determine that there was a defect in reliability, and will certainly not automatically lead to a decision that there was a defect that justifies the withdrawing of the permit. Below is the list of circumstances that may constitute a defect in reliability, subject to examination by the Authority: 1. Conviction for an offense, an indictment or criminal investigation in connection with the

commission of an offense; 2. Determination that a disciplinary offense was made, the filing of disciplinary claims, or the

commencement of proceedings for investigation the committing of an offense, as mentioned above;

3. Imposition of administrative enforcement measures, including imposition of monetary sanctions, issuing a demand for payment of monetary sanctions or an administrative claim, or commencing an administrative enquiry in connection with the committing of a violation;

4. Engagement in administrative arrangements of an alternative nature to an indictment or the conducting of administrative proceedings, such as payment of a fine, an agreed order, or engagement in an agreement for a conditional discontinuation of proceedings, due to the performance of an offense or violation;

5. Withdrawal of a permit due to a defect in reliability – cancelation of a license, refusal to grant or denial of a permit to practice any profession or in any other area because of a defect in reliability, whether the permit was granted by law or by a trade union;

6. Findings in civil legal proceedings of an infringement that was prescribed in a procedure in which the supervised entity was given the opportunity to present its position - whether as a party to the proceeding or in any other way (such as giving testimony or an affidavit in court);

7. Audit findings and customer complaints – findings of an audit by the Authority, another supervised entity, an independent auditor, internal auditor, the findings of an internal compliance system or mounting complaints by customers - pertaining to significant issues and provided that they are based on facts;

8. Dismissal following the discovery of findings indicating allegedly improper behavior, when they have a connection with activities supervised by the Authority and provided that they are based on facts;

9. Liquidation due to insolvency, declaration of bankruptcy or failure to meet material financial obligations related to the supervised practice.

Criteria for recognition of an internal compliance program in the area of securities Following publication of the Improvement of Efficiency of Enforcement Procedures in the Securities Authority (Amendments to Legislation) Law, 2011, the Israel Securities Authority (hereinafter: "the Authority "), published on 15.8.11 the criteria it formulated for recognition of an internal compliance program in the area of securities – which is a voluntary mechanism adopted by the corporation to ensure compliance by the corporation and the individuals in it with securities laws. In addition, the Authority issued the reliefs an internal compliance program can give individuals and corporations, and the criteria



24

by which the effectiveness of an internal compliance program is examined for purposes of deciding on granting relief. Among the criteria determined by the Authority for recognition of an enforcement program as effective: responsibility of the board of directors and management for the formulation, adoption and implementation of the enforcement program; adapting the program to the corporation and its special circumstances after reviewing its business activities and mapping risks involved in them in the area of securities law; adoption of procedures and methods of treatment that will provide a response to the risks that have been mapped, applying the program at all levels of the corporation, appointing an officer in charge of enforcement, proper assimilation of the program at all levels, ongoing monitoring and reporting on the maintenance of the program, proper treatment of failures and violations and learning lessons from them (the burden of claim and proof for the existence and effectiveness of the enforcement program is on the person claiming it). Effective internal compliance means the practical application of internal compliance procedures and not just an enforcement program "on paper". Effective internal compliance that meets the criteria issued by the Authority can serve as a basis for proving that the CEO (who has supervisory responsibility for enforcement) has fulfilled his obligations under the law. The Companies Law (Amendment No. 16), 2011 The Companies Act (Amendment No. 16), 2011, was promulgated on 15.3.11. The purpose of the amendment is to streamline corporate governance prevailing in Israel in accordance with the principles practiced worldwide. Among other things, special emphasis was placed on the principles of independence of the board of directors in general and the external director in particular, strengthening the standing of institutional entities and minority shareholders of public companies in appointing external directors, in order to weaken the power of the controlling shareholder of the company to influence management and to direct its activities in light of his personal goals. In addition, the majority required was amended for approval of transactions in which a controlling owner has a personal interest, the majority required was amended for the appointment an external director, the extension of the maximum term of office of an external director and the determination of provisions regarding the independence of the external director, emphasis was placed on the duty of a director to exercise independent discretion, setting of provisions regarding the possibilities of prohibiting the dual appointment the Chairman of the Board of Directors and CEO of a public company, provisions regarding the Audit Committee – its composition, its methods of decision-making and expanding its roles and responsibilities; granting powers to the Securities Authority to impose financial sanctions on an individual or corporation in the event of breach of certain provisions of the Companies Act, and laying down best practices for corporate governance. The effective date for most of the sections of the Law is 60 days after its publication, and for some of them (mainly relating to the audit committee) within six months of publication, and for others with the coming into force of the Improvement of Efficiency of Enforcement Procedures in the Securities Authority (Amendments to Legislation) Law, 2011. In addition, see also the Amendment to Proper Conduct of Banking Business Directive No. 301. 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, prohibiting the charging of types of populations with certain commissions, prohibiting the charging of certain types of commissions and so on. In addition, there are private member’s bills tabled in the Knesset seeking to oblige banking corporations to pay interest on credit balances in the current accounts of their customers. The Bank is monitoring developments in the legislative process of those proposals, which are still in the preliminary stages of legislation.



25

Securities Law (Amendment No. 44) (Postponement of Repayment of an Obligation of a Public Company to a Controlling Shareholder), 2010 The law was published in the Official Gazette (Reshumot) on 12.1.11. The law stipulates that, if a public company that issued debt certificates became insolvent or announced that it is unable to repay the debt certificates, repayment of the obligations to the controlling owners of the company holding debt certificates is to be postponed until repayment in full of the obligations to other holders of debt certificates. Postponement of repayment will also be with regard to the holder of a debt certificate that is controlled by the controlling shareholder by means of a corporation. Antitrust Law (Amendment No. 12), 2010 The law was promulgated on 25.7.11. According to the amendment, a section is added on concentration group to the Antitrust Law and the Commissioner’s authority to declare that a limited group constitutes a concentration group was amended. In addition, the Commissioner was authorized to issue a concentration group directives intended to prevent harm to competition between members of the group or the sector in which they operate. With regard to concentration groups in the banking sector, a special arrangement was made that will impose an obligation on the Commissioner to inform the Governor of the Bank of Israel and the Supervisor of Banks of his intention to declare a concentration group or of his intention to issue directives to a concentration group, and if the Governor or the Supervisor was of the opinion that the giving of the directive would jeopardize the stability of the banking corporation or the stability of the banking system, the Commissioner would refrain from giving the directive. Orders regarding Financial Sanctions (Reduction of Amounts of Monetary Sanction) by virtue of various legislation empowering the Governor to impose financial sanctions The orders were published on 28.6.11. In the orders were set out instances, circumstances and considerations because of which it will be possible to reduce the moneytary sanction prescribed in various laws (Bank of Israel Law, Payment Systems Law, Banking Law (Licensing), Banking Law (Service to the Customer), the Banking Ordinance), according to maximal reduction rates as prescribed in the orders. For example, a reduction of up to 50% of the amount of the sanction if the violation is a first violation, a reduction of up to 15%, if the violator has ended the violation on his own initiative and reported it to the Supervisor or if the violator has taken steps to prevent recurrence of the violation and reduce the damage. Banking Law (Service to the Customer) (Amendment No. 15), 2011 The amendment came into force on 1.11.11. The amendment stipulates that on issuance of checks to an individual customer (not a corporation) the checks will be crossed and a restriction to their negotiability printed on them, unless the customer asked for checks to be issued to him without crossing and without the restriction, as stated. Property Taxation Law (Appreciation and Acquisition) Amendment No. 70, 2011 The amendment came into force on 31.3.11. The amendment imposes on a purchaser of land an obligation to make a payment to land betterment tax to pay in accordance with that stipulated in the law on account of the tax for which the seller is liable ("down payment"), after the purchaser has paid the seller 40% of the proceeds for the rights to the land. The down payment shall be deemed paid to the seller by the purchaser on account of the consideration determined between them, even if provided otherwise by law and/or the contract of sale. The amendment applies to the sale of rights to land that was carried out after 31.3.11. The obligation to deliver the down payment does not apply in two cases: when



26

the right to the land is a "qualifying apartment" for which exemption was requested, and when the consideration for the right to the land is not monetary. Banking Law (Licensing) (Amendment No. 18), 2011 The amendment was published in the Statute Book on 15.8.11. It is determined that the clearing of transactions executed by means of debit cards, will only be by a person who has obtained a license for this from the Governor of the Bank of Israel, and that the clearers will be under the supervision of the Supervisor of Banks. In addition, the Supervisor has been granted authority in consultation with the Antitrust Commissioner to oblige a clearer with a wide scope of operations (as defined in the Law), to clear transactions of debit cards issued by a certain issuer as well as allow additional clearers to clear transactions made by means of debit cards issued. Securities Regulations (Dates for Filing Notice of an Interested Party or a Senior Office Holder) (Amendment), 2011 The regulations came into force on 2.10.11. On 13.7.11, the amendment to the law was published in the Official Gazette (Reshumot) that replaces the original section 4, and instead added a new section 4 of which the essence is: a person holding securities of a corporation by means of members of an institutional reporting group under his management/control, shall once a month give the corporation written notice specifying the percentage of the holding in securities of the corporation, including that held by members of the reporting group under his management/control. In addition, if section 33(d) of the Regulations of Periodic and Immediate Reports takes place, regarding the cumulative change in the holdings of a bank or insurance reporting group in the corporation, the institutional group holding securities as aforesaid, is to submit written notice when the change in holdings amounted to 1% of the issued capital of the corporation or 5 % of the total nominal value of the series issued, no later than two business days from the date of the cumulative change, as stated. Corporate Governance Law for Fund Managers and Portfolio Managers (Legislative Amendments), 2011 The law amends the Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management Law, and the Joint Investment Trust Law. Most of the changes deal with the obligations applicable to the board of directors; for example the composition of the board of directors, the appointment of the chairman of the board of directors shall be as customary in a public company, and the chairman cannot be a relative of the CEO, the powers of the chairman of the board of directors, the functions of the board of directors, arrangements for managing meetings of the board of directors, the powers of the Minister of Finance to determine the qualification of directors, the determination that the number of directors that may serve as directors of another financial entity shall not exceed one third, and the prohibition of a director serving in more than two financial institutions at the same time. In addition, the number of directors who are employees of the company shall not exceed one third. Other changes relate to the approval of an Internal control function and approval of an internal compliance program, the addition of adding procedures such as a risk management procedure, proper management of the board of directors, emergency deployment and and ensuring business continuity, and a procedure for engaging with a trading company, the appointment of an audit committee (its duties, composition, arrangements of meetings, etc.), and appointment of an internal auditor. In the Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management Law, the abovementioned amendments were incorporated in a new section, which refers to a “large



27

portfolio management company", defined as a group with a license that has over 50 clients and total assets in excess of NIS 5 billion, or a group with a license that has over 1,000 customers on which the above amendments apply. The amendment to the Joint Investment Trust Law includes, in addition to the principles set out above, the prohibition of discrimination between those with different units in various funds managed by the fund manager, and seeks to ensure the independence of the fund trustee from the fund manager, clarifications of the duties of supervision imposed on the trustee and increased mechanisms for control, monitoring and audit of the fund manager and of large portfolio management companies. Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management Law (Reports), 2011 The regulations were published on 29.11.11 and tabled in the Finance Committee. The regulations set out the dates for the quarterly report and the manner it is submitted to the customer, the manner it is presented to the customer, and the method of calculation of the yield in the report. In addition, the regulations stipulate the date and manner of submitting the annual report to the public, and the details to be included in the report. The regulations mandate the filing of an immediate report to the Authority if certain events occur as specified in the regulations, the submission of quarterly and annual report to the Authority, dates for reports and the manner of their submission, and include an appendix with the text of the reports mentioned in the regulations. Regulations of Sale (Apartments) (Assurance of Investments of Persons Acquiring Apartments) (Reduction of the Monetary Sanction to a Banking Corporation), 2011 The regulations were published in the Official Gazette (Reshumot) on 13.11.11. The regulations allow the Supervisor of Banks to a reduce financial sanction imposed on a bank when the circumstances specified in the regulations exist, by the percentage in the regulations specified for the same circumstance, and on the existence of a number of circumstances – by the cumulative amount of percentages specified for them in the regulations, provided that the cumulative reduction will not exceed 85%. Amendment to the Order for Prohibition of Money Laundering (Obligations for Identification, Reporting, and Recordkeeping of Banking Corporations for the Prevention of Money Laundering and the Financing of Terror) (Amendment), 2011 The amendment was approved by the Knesset Constitution, Law and Justice Committee on 6.11.11. Instructions were added for the opening of an account in a closed system, whose aim is to make it easy for customers to deposit funds or execute transactions in mutual funds in a banking corporation which does not handle their daily banking activities. The following provisions shall not apply to the abovementioned accounts: identification in person, instructions for verifying details and document requirements, and the requirement for a declaration of beneficiaries. Prohibition on investment in corporations maintaining business links with Iran On 8.04.08, the Prohibition on Investment in Corporations maintaining Business Links with Iran Law, 2008, was approved. The law prohibits investing, including through the holding of securities or by way of granting certain loans, in a corporation that maintains a material business relationship with Iran as defined in the law. It is also stipulated that a prohibited investment in a corporation, which was declared by law as a corporation as aforesaid, and not selling earlier holdings, are crimes. On 15.6.11, the



28

Prohibition on Investment in Corporations maintaining Business Links with Iran Bill (Amendment – Prohibition on Communications), 2011, was approved in preliminary reading, which imposes the prohibition also on public and private entities and on private individuals, as well as expanding the sanctions for the offenses. In this context, the Supervisor of Banks issued a draft circular on 26.12.11, regarding risks involved in engagement with entities appearing in international lists as helping Iran's nuclear program and related plans. The circular directs banking corporations to lists issued by international bodies containing the names of the bodies that have been as maintaining contact prohibited with Iran, and it is stipulated that banking corporations are to establish a policy on the risks involved in communicating with parties appearing in the abovementioned lists. Proper Conduct of Banking Business Directive No. 411 was amended on 26.12.11, in accordance with the circular. Proposed Legislation and Law Memoranda Draft Securities Regulations (Offer of Securities to the Public) (Amendment), 2011 The draft was published on 25.9.11 and tabled for approval of the Finance Committee. It is proposed, among other things, that investors who are eligible to purchase securities by prior commitment will be those who manage monies for others only (mutual funds, provident funds and insurers). It is further proposed to establish a new and more restricted definition of an “institutional investor", to include the aforementioned entities and replace the current definition of a "classified investor", which includes, inter alia, sophisticated investors listed in the First Schedule to the Securities Law, including banking corporations and their auxiliary corporations buying for themselves or for other sophisticated investors. This means that banking corporations and auxiliary corporations can no longer purchase securities by prior commitment. Proposed Checks Without Cover Law (Amendment - Notification of insufficient account balance), 2011 Draft private member’s bill, published on 25.7.11. It is proposed that when a customer's account balance is not sufficient to pay a check that the customer has given, the Bank will be required to send notification by registered mail to the account holder, informing the customer of its refusal to pay the check because of an insufficient balance and the customer is to be given two weeks during which they can deposit money in their account. Proposed Banking Law (Customer Service) (Amendment - Obligation to Give Prior Notice Before Taking Action), 2011 A private member’s bill, tabled in the Knesset on 25.7.11. It is proposed to require the Bank, before making a loan immediately repayable or commencing legal proceedings against a customer, is to give notification to the customer in simple language clarifying the main meanings and implications of taking such action and the reasons for it, and that at least two notices be sent by registered mail. Proposed Execution Law (Amendment No. 35) (Execution of a Judgment to Evacuate a Leased Property), 2011 The draft was published on 1.8.11. The purpose of the draft is to simplify the procedures established by law and to shorten the periods of time with regard to execution of a judgment for the evacuation of leased property for which the Tenant



29

Protection Law does not apply. It is also proposed that a judgment for the evacuation of leased property for which the Court has not set the date for its implementation can be served by the Execution Office immediately. Proposed Banking Law (Customer Service) (Amendment - Prohibition on Charging a Fee for Managing a Securities Investment Account), 2011 A private member’s bill tabled in the Knesset on 1.8.11. It is proposed to prohibit the Governor from including in the schedule of fees any fee that will enable a banking corporation to charge its customers fees for managing a securities investment account. Proposed Joint Investment Trust Law (Amendment No. 15), 2010 The proposed law was passed at its first reading on 14.6.10. The main amendments proposed are: a public offering of foreign mutual funds; expanding supervisory obligations imposed on the trustee and tightening the supervision of fund managers; giving authority to the Israel Securities Authority to withdraw or not to grant approval to a company to act as trustee or fund manager for reasons related to its reliability; prohibition on a company to act as trustee to a fund if it meets one of the following options: 1. If the company is controlled by the fund manager, a person controlling it or a company controlled

by any of them with more than 10% of the issued share capital of the company. 2. If a company or person who controls it has a business relationship with the fund manager or a

substantial business relationship with a person who controls the fund manager or a corporation in his control.

3. The revenues of the company together with the revenues of a person controlling it, and a corporation controlled by a person, as aforesaid, which originate from a business relationship with a fund management group, including trust income for funds managed by the fund management group, from certificates of indebtedness issued by a corporation belonging to a fund management group and providing usual banking services, exceed 15% of its revenues together with the revenues of a person controlling it and a corporation under a person's control, as stated. In this regard a business relationship is defined as including a supplier-customer relationship, giving / receiving service, giving / receiving loans and more, with the exception of contact resulting from providing services to mutual funds or certificates of indebtedness and usual banking services during the normal course of business of the bank, and at market conditions only, that the income of which does not exceed 5% of the bank's revenue; a substantial business relationship is defined as a business relationship including providing usual banking services, of which the total income, including income from all business relationships with the fund management group, exceeds 5% of the revenues of the company together with the revenues of a person controlling it and a corporation controlled by a person, as stated; setting out directives regarding participation of a fund manager in meetings of public companies whose securities are held by the mutual funds; allowing the charging of differential management fees in a fund with differing populations of unit holders; changing the format of liquidating a fund and granting authority to the Israel Securities Authority to order the liquidation of a fund, in addition to obliging the fund manager to liquidate a mutual fund with a low asset value. Various other issues are regulated in the proposed law that are related to how mutual funds are managed, the collection of management fees, the transfer of vital information to the unit holders, fund liquidation, civil enforcement powers of the Israel Securities Authority and the like.



30

Status: At this stage, the chapter dealing with opening up the market to foreign funds will be taken out of the proposed law. Since the proposal was formulated, significant economic developments have occurred in the capital markets that may have implications for a variety of areas relevant to the Israel Securities Authority in general, and the supervision of mutual funds in particular. Among other things, the Authority was not convinced that, in the current situation, the proposal provides adequate protection to investors in Israel. Accordingly, the Authority intends to undertake a reexamination of the issue of opening the market to a public offering in Israel by foreign mutual funds to ensure adequate protection of Israeli investors in foreign mutual funds. Draft Joint Investment Trust Regulations (Distribution Fees) (Amendment), 2011 The draft regulations were approved in the plenum of the Authority on 19.1.11 and promulgated for comments by the public until 25.2.11. It is proposed to amend the Joint Investment Trust Regulations (Distribution Fees), 2006, (hereinafter: the "Regulations"). The main amendment is the application of the regulations to a foreign fund and the making it possible to set different rates of distribution fees in agreements to distribute funds of the same type. As part of the reform, categories of fees imposed on various types of funds as specified in the draft will be canceled and be consolidated, foreign funds will all be classified in a uniform category, and banks can charge a maximum distribution fee of only 0.45%. Proposed Regulation of Investment Advice, Investment Marketing and Investment Portfolio Management Law (Amendment – Investment Counseling Activity), 2011 The proposed law was approved at its preliminary reading in the Knesset plenum on 6.7.11 and passed to the Finance Committee for discussion. The essence of the proposed law in defining a separate and distinct arrangement for activities of general investment advice and general investment marketing (as opposed to individual counseling/marketing, tailored to specific customer needs); the exclusion of training funds from the definition of "financial assets" and, placing obligations on a licensee, even if the result of the service is a recommendation to the customer regarding assets that are not securities or financial assets. Proposed Securities Law (Amendment No. 48) (Certificates of Indebtedness), 2011 The proposed law was published on 16.11.11. The proposed law is intended to strengthen the role and standing of the trustee and holders of certificates of indebtedness and to expressly establish the trustee's duty to regularly monitor the compliance of the issuer with its obligations to holders of certificates of indebtedness. The proposed law for the most part is actually clarifying the duties of the trustee for certificates of indebtedness, and it is also proposed to empower the Finance Minister to make regulations and to establish within the framework prescribed a statutory registry of trustees to be administered by the Israel Securities Authority, and to determine minimum requirements and qualifications required of the trustee for registration in this registry (as of today there are no statutory requirements for a trustee of debt securities, as opposed to existing requirements for a trustee of mutual funds for example). In addition, the bill proposes adding a determination concerning the cases and the manner in which a general meeting be convened of the holders of certificates of indebtedness, and a determination that at each annual meeting of holders, the ending of the term of office of the trustee will be brought for approval. It is proposed to authorize the Finance Minister to make regulations regarding the reporting requirements of the Trustee to the Securities Authority (hereinafter: the "Authority") and holders of certificates of indebtedness.



31

The Foreign Account Tax Compliance Act – FATCA Strict legislation was enacted in the US applicable to non-American entities, including banks and financial institutions around the world. The purpose of the legislation is to increase tax collection from US entities (including private account holders) that own assets outside the US. Every bank that has clients that are US entities or that makes investments in the US for itself or for other parties, will be required to perform due diligence and provide information to the US Internal Revenue Service under regulations to be promulgated. The law stipulates that the bank is to sign an agreement with the US tax authorities, under which if a bank decides not to sign the agreement, various sanctions will be imposed on it, including withholding tax of 30% on income in the US or on the income of its US clients. The law will become effective in January 2013, but due to the reactions of audited parties, execution was postponed in part to 1.1.14, and in part to 1.1.15. The Bank will make preparations for the implementation of the law in the framework of deployment by the Group. The subject Is also being dealt with within the framework of the Association of Banks in Israel, which is being assisted for this purpose by a local law firm and a US law firm. Proposed Antitrust Law (Amendment No. 13) (Concentration Groups), 2011 The proposed law was published on 25.7.11. The proposal seeks to undo Amendment No. 12 (see the chapter on Updates in Legislation on page 25) to the law determining a special arrangement for banking and insurance business. Proposed amendment to the Securities Regulations on reducing the number of players who can participate in the framework of prior commitments The bill was approved and the plenum of the Authority and tabled in the Finance Committee. The main amendments are: 1. In the Securities Regulations (Offer of Securities to the Public) (Amendment), 2011 – it is

proposed to amend regulations on the manner of an offer to the public, so that investors who are eligible to purchase securities by prior commitment, will only be those who manage monies for others (mutual funds, provident funds and insurers). As a byproduct of this amendment, it is proposed to make a technical correction in several places in the Securities Regulations, to adapt the terms in the proposed change. Among other amendments, definitions were added / modified in section 1 of the Regulations, including deleting the definition of a classified investor and, in place of this definition, to update the definition of an institutional investor.

2. In the Securities Regulations (Supplemental Notice and Draft Prospectus) (Amendment), 2011 - Section 1(5)(f) the term "classified" will be replaced by the term “institutional".

Final recommendations of the Inter-Ministerial Committee for the regulation of custodian services in the Israeli capital market The recommendations were published on 29.12.11 by the Inter-Ministerial Committee for the regulation of custodian services in the capital market (hereinafter: the "Committee"). In the report of the committee the term “custody” refers safekeeping services for securities for their owners in a manner documenting and protecting the ownership rights of an investor. The Committee concluded that a comprehensive framework is required for regulating the provision of custodian services in Israel, including with regard to investments of Israeli investors abroad. The Committee recommends imposing uniform minimum requirements to all those who provide custodian services for securities and financial assets in the capital market in Israel, directly or indirectly.



32

In addition, the Committee emphasizes that the depositing of securities and funds with a custodian that is not particular about proper separation between client assets and custodian assets may expose the client to significant risk, and certainly in time of crisis. When choosing a third party custodian, it is recommended to impose a duty on the intermediary, when considering the criteria in selecting a third-party custodian, to establish rules regarding the implementation of the criteria in the selection process. In this regard, it is proposed to apply an extensive disclosure requirement regarding the selection and engagement policy with third party custodians, the implementation of this policy and the methodology for monitoring activity of the custodian. The Committee recommends the adoption of comprehensive, clear and uniform regulation of custodian on all those who provide custodian services for securities and financial assets, directly or indirectly, which will be implemented by the three financial supervisors in Israel (the Israel Securities Authority, the Capital Markets Division at the Treasury, and the Banking Supervision Department). Draft Directive of the Database Registrar on the use of surveillance cameras and data storage of photos taken by them The draft was published on 6.12.11. The draft clarifies the application of the laws of privacy and data protection to the use of surveillance cameras and photographic data storage in computerized databases, and presents the principles of the use of cameras in light of the Privacy Protection Act. Among other things, the directive requires the performance of an orderly decision-making process in installing surveillance cameras, and stipulates that it is not possible to make use of photographs for any purpose other than that which justified the installation of the camera in the first place, and emphasizes that the public is to be informed about the operation of the camera using appropriate signs and other means. The system operators are to make sure that any harm caused as a result to privacy is minimal as possible, for example by taking care of the location of the cameras installed and the photographic angle, the number of cameras installed and the times photographs are taken. The draft also deals with the person photographed and issues of the security of data captured and restrictions on its use. Circulars and Regulations Circular - Amendment of Banking Contracts in accordance with the judgment of the Standard Contracts Court and the Supreme Court The circular was published on 5.12.10, following the judgments of the Standard Contracts Court on the petition by the Attorney General to revoke or change discriminatory terms in the contract "General Conditions for Managing Accounts/Deposits" of Bank Leumi Le-Israel (18.2.10) and the petition of the Supervisor of Banks to revoke or change terms discriminatory terms in the Housing Loan Contract of the First International Bank Ltd. (5.5.09). the Supervisor of Banks ordered commercial banks to amend various sections of the current account contract and the housing loan contract, and adapt the, to the above judgments by the dates prescribed in the directive, and to amend other agreements with sections similar to those discussed in the judgments. For existing customers, the Supervisor gave an order to publish the judgments on the websites of the major banking corporations. The Bank has implemented the directive on publishing the judgments on the Internet and amended the General Conditions for Managing Current Accounts in accordance with the dates stipulated in the directive. In addition, the Bank has amended agreements relating to various aspects, including credit, guarantees, securities and liens. The amendment of the remaining agreements will be made by the end of February 2012 , in accordance with the extension approved by the Bank of Israel for the FIBI Group.



33

New instructions on leveraged floating-rate housing loans The instructions were published on 28.10.10. In the context of the new rules, banking corporations are required to increase the capital allocated in respect of housing loans at variable interest rates approved after 26.10.10, whose percentage of financing at the date the loan was made (the loan to value ratio), exceeds 60%, and the percentage of the part of the loan made at variable interest rates to the total loan is 25% or more. Loans meeting these criteria that are weighted at 35% or at 75% will be weighted for capital allocation purposes commencing from this date at 100%. However, with the intention of not harming the public buying apartments as a whole, these rules shall not apply to housing loans that at the date they were made amounted to less than NIS 800 thousand. Moreover, they shall not apply to housing loans taken by anyone eligible for a discount when receiving a mortgage, under the criteria determined by the Ministry of Construction and Housing. The Bank implements the provisions of the circular. Circular on leveraged floating-rate housing loans The circular was published on 3.5.11. The directive stipulates that a banking corporation is to approve a housing loan, only if the percentage of the part of the loan made at variable interest rates to the total loan does not exceed 33.3%. The restriction shall apply to loans granted that were approved after 5.5.2011, and loans for which the banking corporation approved refinancing as of this date, except for a refinancing in which the weighting of the floating-rate component of the housing loan and its amount were reduced. A banking corporation is allowed not to apply the 33.3% limit on the ratio between floating rate housing loans, and the total of housing loans as stated above, which were granted during each calendar quarter, for: housing loans in foreign currency granted to a nonresident, bridging loans whose original repayment period is up to three years, and loans for any purpose in a sum of up to NIS 100,000. In addition, the directive stipulates that notification is to be given to borrowers of whom the floating-rate unlinked Prime-based component of the housing loans they took is 33.3% or more, within 45 days of the publication of the directive, of the implications associated with a possible future rise in interest rates that will apply to their loans. The Bank applies the provisions of the circular. Bank of Israel Circular - Information Technology Management (Proper Conduct of Banking Business Directive No. 357) The circular was published on 30.1.11. The directive applies from the date of publication. The major amendments to Proper Conduct of Banking Business Directive No. 357 are: 1. Revoking the prohibition on downloading files via links of employees to the Internet. 2. Determining that a banking corporation should apply certain monitoring and security measures

regarding links to the Internet on all of the sites of the bank, including its marketing website. Personal information used to convey information to the customer can be updated through on-line banking.

3. Possibility of executing an online agreement by telephone subject to the conditions specified in the directive. The banking corporation will be required to ensure that the client signed an agreement at a branch in the past, no matter how many years prior to the signing of the online agreement.

4. A banking corporation may send any notice on which there is a duty of confidentiality via e-mail or the corporation website, without derogating from the obligation of the banking corporation to send the notice by other means.



34

Bank of Israel Order (Information on Foreign Currency Derivatives Transactions and Short-Term Debt Instruments), 2011 On 1.7.11, a Bank of Israel Order came into force that imposes a duty or reporting to the Bank of Israel on the future conversion transactions, foreign currency swaps and option transactions, with Israeli residents or nonresidents. The bank shall be exempt from this requirement for transactions for which it already gives ongoing reports, even if in a different format. In addition, the reporting obligations imposed on transactions in debt securities of the Government of Israel, Treasury Bills (Makam) and repurchase transactions in the said securities, with foreign residents or on their behalf. Circular to fund managers regarding the extract of significant changes that are to be detailed in "Request to Allow the Publication of a Repeat Prospectus for Funds Managed by a Fund Manager - Part II" The circular was published on 21.8.11. The Israel Securities Authority will allow publication of a repeat if it specifies the material changes in the Fund Manager, such as the appointment and termination of term of office of officers and accountants of the Fund, a change in trustee, changes in the holdings of a fund manager, changing the name of the fund manager and the trustee, a civil fine, indictment, conviction for an offense, a contingent class action, a judgment in a class action, termination of engagement and a material event. Bank of Israel Circular in connection with the Public Reporting Directives regarding the Corporate Responsibility Report The circular was published on 3.10.11. Banking corporations will be required to make a report to the public on corporate responsibility as of financial statements for the year 2012 on matters pertaining to the their activities, such as business ethics, corporate governance, commercial integrity, commitment to the environment, fair working environment, preserving human and civil rights, and community involvement. A requirement was added that a banking corporation will publish a report to the public for a period of up to two years on corporate responsibility as set out in the directive, a requirement that is to be implemented at the highest level of the banking group. A banking corporation shall publish a report on corporate responsibility, in accordance with this circular, for the period beginning on 1.1.12. Bank of Israel Circular in connection with an Amendment to the Proper Conduct of Banking Business Directive No. 462 on "Customer Investments in Financial Assets by means of Portfolio Managers' The circular was published on 20.9.11. An addition was made to the Directive of the definition of an "eligible customer" - as defined in section 1 of the Regulations of Investment Counseling, Investment Marketing and Investment Management (Amendment No. 14), 2010 (hereinafter "the Advisory Law"), which defined the term. The definition of "eligible customer "includes, inter alia, institutional clients and private clients who have knowledge of and proficiency in the capital market, as well as a significant investment portfolio. In the Advisory Law, a person giving investment advisory or portfolio management services to an “eligible customer” is not required to have a license. In light of the fact that an "eligible customer” is a client with expertise and knowledge, it is proposed to exempt the banking corporation from the obligation providing explanations as required by law, provided the “eligible customer" gave a waiver in writing for the receipt of explanations, as stated. The application of the amendments to the directive according to this Circular is from the date of their publication.



35

Circular to license holders, banking corporations engaged in investment advice, licensed corporations, fund managers and issuers of ETF’s, regarding the definition of a “sponsored conference” in the directives to investment advisers in connection with participation in conferences and receiving advertising products from managers of financial assets (new version - 2010) The circular was published on 1.1.12. Pursuant to the directives to investment advisers regarding participation in conferences and receiving advertising products from managers of financial assets (new version - 2010), that were published in January 2010 and set out, inter alia, rules regarding the participation without full payment of investment advisers at conferences held under the sponsorship of managers of financial assets, the above circular was published on 1.1.12, stipulating that as of the date of publication of this circular, an investment adviser is expected to refer to every invitation received to a conference, where it is not indicated explicitly that the conference is not sponsored by the investment house, as an invitation to a “sponsored conference", as defined in the January 2010 directive on participation in conferences (subject to any rules set out in the directives). An investment adviser participating in a “sponsored conference” in which the conditions set forth in the directive were not met, will be deemed as breaching the provisions of the law, even if he did not know before arriving at the conference that it was a “sponsored conference”, unless the invitation stated that the conference is not sponsored by any investment house whatsoever. Proper Conduct of Banking Business Directives Proper Conduct of Banking Business Directive No. 301 on the Board of Directors The directive came into effect on 1.1.12, except for several sections whose application was postponed to 1.1.13. The directive was published on 29.12.10 and updates the existing procedure, mainly in accordance with the Basel Committee Guideline “Strengthening Corporate Governance in Banking Corporations”. The directive encompasses a wide range of subjects connected with the responsibility of the board of directors, its duties, authorities, and how it operates, with the aim of strengthening the independent status of the board of directors and the efficiency of its operations. Following are the main changes included in the directive: adding a number of matters to the process of approving office holders, inter alia, the “fit & proper” procedure; defining the principal duties of the board of directors, its composition and types of committees (overall responsibility, outlining strategy and approving policy, supervision of implementation of policy, responsibility and reporting, organizational culture and suitability to the regulatory environment); matters which the board of directors is to discuss and decide on; and matters in which the board of directors is to act in a manner that will reduce its involvement in approving transactions and focusing on approving policy in the various areas. In this connection, it was stipulated that the banking corporation is to submit, by 1.7.2011, a plan for reducing the involvement of the board of directors in approving the granting of credit, and the adaptation required in controls. Implementing the plan will be done gradually over two years. In addition, responsibility of the board of directors was determined with reference to supervision and control and group supervision. The Bank applies the directive. Proper Conduct of Banking Business Directive No. 313 regarding restrictions on a single borrower and a group of borrowers On 8.5.11, the Bank of Israel published Amendment to Proper Conduct of Banking Business Directive No. 313 regarding restrictions on a single borrower and a group of borrowers. The following are the main points of the significant changes to the procedure:



36

1. A group restriction shall not exceed the higher of 25% of the equity of the bank (instead of 30% currently) or NIS 250 million. This provision took effect from January 2012. In order to meet the new limit, credit facilities were reduced in the Bank for several groups of borrowers.

2. It was decided to apply the liability limit also on exposures to banks, and a separate definition was added of a "banking group of borrowers" (as opposed to non-banking "real" groups of borrowers). Only the group of borrowers restriction will apply to a banking group of borrowers. It should be clarified that corporations belonging to the banking group granting credit are exempt from the restrictions. This directive took effect as of 31.12.11. The Bank's exposures to banking groups of borrowers were adjusted immediately on this directive coming into effect.

3. The total net indebtedness of borrowers, groups of borrowers, and banking groups of borrowers, whose net indebtedness to the banking corporation is more than 10% of the banking corporation's capital, shall not exceed 135% of the capital of the banking corporation at December 31, 2011. In addition, it is stipulated that, from January 2012 until December 31, 2012, the limit will be reduced each quarter by 3.75% until it reaches 120%.

4. The bank is required to discuss and set strict internal limits on maximum credit exposures and consider, among other things, factors such as the characteristics of the banking corporation, exposure characteristics, credit rating levels, and the overall level of concentration of credit in the banking corporation and in the banking group.

5. The definition of "capital" was changed - instead of "capital" according to Proper Conduct of Banking Business Directive No. 311, the definition is in accordance with Proper Conduct of Banking Business Directive No. 202.

Following the changes in the directive, the Bank made preparations for its implementation. Its preparations included, among other things, reducing credit facilities of large customers and reducing exposures to banks. Proper Conduct of Banking Business Directive No. 420 - Provision of Information by Electronic Means The directive was published on 30.1.11. The directive includes a list of message types that can be sent to customers via the Internet. The directive will be the platform for discussion about all types of messages that banks are require banks to give their customers, in order to determine which ones should continue to be sent mail and which can be sent by electronic means only. Draft Update of the Provisional Directive on the Description of the Business of the Banking Corporation - Environmental Reporting The draft was published on 12.4.11. Starting with the financial statements for the year 2011, banking corporations will be required to make a disclosure about environmental issues, such as significant repercussions of the provisions of environmental laws on the bank, details concerning activity of the bank likely to cause damage to the environment, a description of material legal / administrative proceedings in connection with the environment to which the bank / office holder is a party , details of the bank's policy in managing environmental risks that may materially affect the bank.



37

Proper Conduct of Banking Business Directive No. 307 - The Internal Audit Function The directive was published on 25.12.11. Its aim is to regulate the internal audit function based on the Basel Directives on this topic, relevant local legislation and regulation, and international sources. Proper Conduct of Banking Business Directive No. 355 on the subject of "Business Continuity Management" The directive was published on 25.12.11. In August 2006, the Basel Committee on Banking Supervision published principles on business continuity, in the framework of the update of Proper Conduct of Banking Business Directives and their adaptation to the Basel working framework, and with the aim of ensuring the adoption and implementation of practices appropriate for managing business continuity by banking corporations . The directive states that, in accordance with principles of corporate governance, the Board of Directors and senior management will be responsible for implementing a framework for managing business continuity and for maintaining suitable controls. The directive requires, inter alia, the appointment of a business continuity manager, a crisis management team consisting of senior management members. setting a framework for managing business continuity, drafting business continuity plans, setting conditions for banking corporations to include in agreements for engagement with suppliers that provide outsourcing services for essential processes or services, and the preparation of an alternate site in case of need. Draft Amendment of Proper Conduct of Banking Business Directive No. 417 regarding the operations of a banking corporation in a closed system (hereinafter: the "draft"). The draft amendment was published on 11.1.12. On 13.12.11, an Amendment was published in the Official Gazette (Reshumot) to the Order for Prohibition of Money Laundering (Duties of Identification, Reporting, and Recordkeeping by Banking Corporations for the Prevention of Money Laundering and the Financing of Terror), 2001 (hereinafter: the "Order") within which was defined a closed system account, as well as determining various reliefs mainly in relation to identification and authentication requirements specified in the Order, when opening an account in a closed system in which deposits can be made or participation units purchased as defined in the Order. In the draft it is proposed to amend the Directive and add definitions to adapt it to the wording of the Order. In addition, it is proposed to allow the signing of an online agreement with a customer who wishes to act in a closed system, as defined in Proper Conduct of Banking Business Directive No. 357 on Information Technology Management. It is further proposed that the transfer of funds to an account in a closed system can be made in all the usual ways of transferring money, provided that the transfer is from the account of an individual in a banking corporation, and that the transferee bank can verify this. Taxes on Income 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 fiscal year 2010 and thereafter. 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 fiscal year 2016 and thereafter. Pursuant to the aforesaid amendments, Companies Tax rates applicable from 2009 are as follows: in fiscal year 2009 - 26%, in fiscal year 2010 - 25%, in fiscal year 2011 - 24%, in fiscal year 2012 - 23%, in fiscal year 2013 - 22%, in fiscal year 2014 - 21%, in fiscal year 2015 - 20%, and in fiscal year 2016 and thereafter the applicable tax rate will be 18%.



38

On December 5, 2011, the Knesset passed the Law for the Amendment of the Tax Burden (Legislative Amendments), 2011. In accordance with the Law, the reduction in tax set out in the Economic Efficiency Law as mentioned above is to be canceled, and the rate of Companies Tax applicable from 2012 and thereafter will be 25%. Pursuant to the aforesaid amendments, the statutory tax rate applicable to the Bank is 34.48% for fiscal year 2011. The statutory tax rate applicable to the Bank for fiscal year 2012 is 35.34%, and in fiscal year 2013 and thereafter – 35.06%. Current taxes for the periods reported in these financial statements are calculated in accordance with the rate of tax set out in the Economic Efficiency Law. The balances of deferred taxes at 31.12.2011 were calculated in accordance with the new rate of tax, as set out in the Law for the Amendment of the Tax Burden, According to the rate of tax expected at the turnover date, the effect of the change in the tax rate on the balance of deferred taxes at December 31, 2010 represents income in the amount of NIS 0.4 million. Miscellaneous Basel II Background The Basel Committee for International Convergence of Capital Measurement and Capital Standards (hereinafter: Basel II), in June 2006, published its recommendations to be implemented in accordance with the instructions of central banks in every country. The instructions refer to credit, market, and operational risks, and include three pillars with reference to each of the types of risks: First Pillar - minimum capital requirements, calculated separately for each type of risk, while for credit risks, the main approaches are: 1. The standardized approach based mainly on credit rating data of external rating agencies. 2. Advanced approaches based on internal ratings, calculated in accordance with models developed

by the Bank (Internal Ratings Based). Second Pillar – in the framework of this Pillar, the Bank implemented 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 Supervisor of Banks expects banking corporations to implement an appropriate internal process combining principal components of capital planning and management, showing the appropriateness of the capital to the risks identified. The above process includes, among others, having structured mechanisms for identifying risks and risk areas and carrying out an evaluation of the appropriateness of capital based on scenarios and stress scenarios, having internal processes for implementing proper corporate governance, improving and enhancing control and audit systems, and having a proper stress scenario, including holistic stress scenarios. The process includes dealing with the range of risks to which the Bank is exposed, including risks not covered by the First Pillar, including concentrations of credit, interest-rate risk in the banking portfolio, inflation risk, compliance risks, money laundering, and the finance of terrorism risks, regulatory risks, and others. Third Pillar - market discipline, requirements for disclosure and reporting to the public. The Pillar includes disclosure requirements in the financial statements of the banking corporation.



39

Bank of Israel Directives Implementation of the directive was applicable as of December 31, 2009. In 2010, the Bank of Israel incorporated the Basel II guidelines in the framework of new Proper Conduct of Banking Business Directives on the subject of Measurement and Capital Adequacy. The principal directives and additional drafts published during 2011 and up until publication of this report are as follows 1. Proper Conduct of Banking Business Directive No. 355 - Business Continuity Management – this

directive is combined with supervisory activities to strengthen operational risk management and emergency preparedness in banking corporations.

2. Proper Conduct of Banking Business Directive No. 307 - “Internal Audit Function”. 3. Proper Conduct of Banking Business Directive No. 350 - “Operational Risk Management”. 4. Draft Proper Conduct of Banking Business Directive No. 339 - “Risk Management”. 5. Draft Proper Conduct of Banking Business Directive No. 342 - “Liquidity Risk Management”. 6. Processes for the recognition of external credit ratings, and the mapping of their rating to risk

weightings, for purposes of calculating capital adequacy – a document with instructions to the Banking Supervision Department and to external credit rating agencies concerning submitting an application for recognition, and for the examination of their compliance with eligibility requirements.

7. Validation of models – Against the backdrop of the increasing use of various models by the banking system, the Banking Supervision Department published an instruction, in accordance with which banking corporations are to map all the models used by them and approve a policy for validating them within the timetables that were decided upon. Against the background of the instructions of the Banking Supervision Department, the Bank made the requisite preparations within the framework of preparations by the parent company, and carried out mapping for all the models used for risk management and control in the Bank. Based on this mapping, a multi-year policy for the validation of models was approved by the Board of Directors on 22.3.2011.

Preparations by the Bank The Bank relies in many areas on the operational systems and specialized units of the Headquarters Division of the parent company, the First International Bank of Israel Ltd., and therefore, implementation of the directives by the Bank is carried out in parallel with their implementation in the parent company, while making adaptations as required. Accordingly, below are details of implementation of directives in the Bank, as part of the preparations of the First International Bank, the parent company: First Pillar – as mentioned above, the Bank commenced implementation of the Basel II Provisional Directive on a quarterly basis as of December 2009. Credit risks - the Bank implements the standardized approach under Bank of Israel directives. Operational risks - the Bank has decided to implement the Basic Indicator Approach (BIA). The Bank has made preparations for implementing what is required on the subject of operational risk management as required in the directive, including preparations for the future implementation of the standardized approach. Additional information on the subject is detailed in the chapter of operational risk management. Market risks - the Bank has elected to implement the standardized approach. In this context, a calculation was also made of allocation of capital required in respect of the specific risk in the trading portfolio. As part of the examination of the stability of the Bank and the Group under Bank of Israel directives on the subject of market risks, a Group gap survey was carried out in view of the guidelines of the Banking Supervision Department in the matter.



40

Second Pillar – Implementing the Internal Capital Adequacy Assessment Process (ICAAP) in the Bank. In the framework of the Second Pillar, the Bank was required to set up an internal capital adequacy assessment process (the ICAAP process). This process is intended to ensure the maintaining of an adequate level of capital means to support all the risks embodied in the activities of the Bank, including taking into account future strategic plans, apart from the minimum capital requirements that the Bank has to maintain in accordance with the First Pillar. In addition, it is required under the Second Pillar to examine if the Bank has sufficient capital means to protect itself in times of recession and economic crises that may occur and impact the Bank (Stress Tests and Stress Scenarios). As part of the process for assessing capital adequacy and as part of improving the risk management function, stress scenarios have become an important tool that is an integral part of these processes in the Group. The following process was carried out in the Group and in the Bank: - In accordance with Bank of Israel directives, on May 15, 2011, FIBI submitted the ICAAP document

to the Banking Supervision Department for December 31, 2010, that was approved by management and the Board of Directors of the Bank. The document summarizes the findings of the ICAAP process on a group basis and based on data for December 31, 2010. In the context of this document, the Group made an assessment of the level of capital required to match the risk profile of its current business activities and those planned in accordance with the strategic plan. The document is a product of a range of internal processes carried out to strengthen the identification of risks and the capital required for them.

The results of the ICAAP carried out by the Group as at December 31, 2010, indicate that the Group has sufficient capital to support the risks to which it is exposed both during the normal course of business and in varying stress scenarios and different degrees of intensity. Attached to the ICAAP document submitted to the Banking Supervision Department were the findings of an independent survey carried out by internal audit that supported the results of the capital adequacy assessment carried out by the Group during the normal course of business and in stress scenarios.

- In accordance with the instructions of the Supervisor of Banks, a banking subsidiary is exempt from

submitting a document summing up the findings of the Internal Capital Adequacy Assessment Process, but has to carry out an internal capital adequacy assessment process. The Bank carried out an internal capital adequacy assessment process and on January 15, 2012, the management and the board of directors of the Bank approved the ICAAP document based on data as at June 30, 2011. The capital adequacy process infrastructure approved by FIBI served as a basis for the internal process carried out by the bank with the adjustments needed to the process carried out by the parent company, and based on the specific risk profile of the Bank. After approval of the ICAAP document by the authorized bodies of the Bank for data as at June 30, 2011, the Bank has a structured methodological infrastructure for the capital adequacy assessment process, including a methodology linking the risk profile with the capital. Based on data as at June 30, 2011, the Board of Directors of the Bank decided that the capital buffer (“cushion”) of the Bank (the difference between internal capital and capital means) is sufficient to support dealing with the risks identified.

In the framework of carrying out the ICAAP, the Bank set out long term capital targets in terms of capital ratios and capital composition.



41

Conducting gap surveys and building up the Group map of gaps - The Group, at the parent company level and at the Bank level. completed the carrying out 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 parent company completed the carrying out during the year of four new gap surveys in accordance with the directives of the BIS adopted by the Banking Supervision Department, on the subject of credit risk management with an emphasis on the proper measurement of impaired debts, liquidity risk management, stress scenarios, and the work of the Compliance Officer. The parent company is examining ways of closing the gaps identified.

- Bank Management, together with the Group, approved a work plan for closing the gaps identified in the gap survey. The main principles at the basis of the work plan were a high prioritization for closing gaps in corporate governance and gaps in policy, as well as a high prioritization of gaps in which high exposure was identified and a relatively low level of managerial quality.

- 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.

Third Pillar – In accordance with the Provisional Directive, the Bank decided on a disclosure policy according to which the frequency of quantitative disclosure is quarterly and the frequency of qualitative disclosure in the Directors’ Report is half-yearly. The report set out in detail below incorporates the reporting directives in the Provisional Directive in reporting on risk management. Basel III Directives In December 2010, the Basel Committee for Banking Supervision published new directives on the subject of “A Global Regulatory Framework for More Resilient Banks and Banking Systems” which include focusing on share capital, which is the most qualitative component of the Bank’s capital, against the backdrop of the global banking system entering the crisis with an insufficient level of high quality capital. The crisis revealed also a lack of consistency in defining capital worldwide, and a lack of disclosure of information (transparency) that would have enabled the market to fully measure and compare the quality of capital worldwide. In this context, the core capital ratio will be raised gradually from 2% to 7% by the end of 2018. In addition, Tier 1 capital will be raised gradually from 4% to 8.5% by the end of 2018. The Bank of Israel has determined capital policy for the interim period, according to which the core capital ratio will not be less than 7.5% already in 2010. The Supervisor of Banks has declared that the banking system in Israel is to adopt the recommendations of Basel III, after the formulation and adaptation of directives by the Banking Supervision Department in Israel, as applicable. Accordingly, working teams have been set up recently in the Banking Supervision Department, to make professional recommendation concerning the manner of adoption. In the context of preparations for adoption of Basel III guidelines, the Bank of Israel published a draft translation of the original directives and a draft translation of the framework for Measurement and Capital Adequacy with reference to market and derivative risk.



42

In accordance with the Directives of the Supervisor of Banks concerning the 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 1 - - Commencement of implementation Note 13 B

(d) 228

2. Table 2 Report of Changes in Shareholders’ Equity 168-169 Capital Structure - Note 13A, 13B 226-227 3. Table 3 a. Capital Adequacy - Risk Assets and

Capital Requirements in respect of Credit Risks, Market Risks, and Operational Risk. b. Note 13 B - Capital Adequacy in accordance with Directives of the Supervisor of Banks.

74

227

Basel II - The Bank’s approach to the Assessment of Capital Adequacy to support its activities.

38

4. Table 4A, 4B

Total Gross Credit Risk Exposures and Average Gross Exposure during the Period - Classified by Main Classes of Credit Exposure.

83 a. Chapter on Risk Management Policy: Section 5 - Credit Risk Management b. Accounting Policy on Critical Matters: Section 1 – Measurement and Disclosure of Impaired Debts and the Allowance for Credit Losses

74-94

108

Table 4C Addendum F to Management Review - Exposure to Foreign Countries

146 - -

Table 4D

Distribution of Exposure by Type of Sector or Counterparty, Classified by Main Types of Credit Exposure

84 - -

Table 4E

Distribution of the Portfolio by Remainder of Contractual Period to Repayment, Classified by Main Types of Credit Exposure

85 - -

Table 4F

Balances of Allowances for Credit Losses. Addendum E - Overall Credit Risk by Economic Sector

144 - -

Table 4G

Addendum F to Management Review - Exposure to Foreign Countries, Problematic Debts column

146 - -

Table 4H

Change in Balance of Allowance for Credit Losses: Note 4 – Credit to the Public and the Allowance for Credit Losses

212 - -

5. Table 5 Credit Risk, Disclosure Regarding Portfolios Treated in Accordance with Standardized Approach

86 Chapter on Risk Management Policy Section 5 C: Chapter on Capital Allocation in Respect of Credit Risks, Market Risks, and Operational Risk.

75-76

6. Table 7 Reduction of Credit Risk: Disclosures under the Standardized Approach.

78 a. Chapter on Risk Management Policy - Collateral Management Policy b. Note 1D(10) - Offset of Financial Instruments

77-78

191

7. Table 8 General Disclosure Regarding Exposures Connected with Counterparty Credit Risk

88 a. Counterparty Credit Risk Management b. Collateral Management Policy

89 75-76

9. Table 10 Market Risk - Disclosure of Banking Corporations using the Standardized Approach

60 Chapter on Risk Management Policy: Section 2 - Market Risks

59-70

10. Table 12 - - Chapter on Risk Management Policy: Section 8 - Operational Risks

96-98

11. Table 13 Disclosure Regarding Positions in Shares in the Banking Portfolio: Note 3 – Securities

208 a. Chapter on Risk Management Policy: Discussion of Risk Factors b. Accounting Policy on Critical Matters: Impairment of Assets

104-107

112

12. Table 14 Interest Rate Risk in the Banking Portfolio 65 Chapter on Risk Management Policy: Section 2 F - Exposure to Changes in Interest Rates

63



43

Description of the Bank’s Business by Operating Segment The Bank’s operations are focused in three operating 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 operating 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. In addition, 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. In addition, 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. In addition, the segment’s income includes income from activity of the dealing rooms regarding the management of the Bank’s base and interest-rate exposure and profits closes of companies included on equity basis.

b. Intersegmental income: - Intersegmental profit from financing activity before income in respect of credit losses:

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 operating segments that provide services for the activity of that customer.

c. Allowance for credit losses:

Allowances for credit losses (on individual and collective basis) relating to the customers attributed to a segment are ascribed to each segment.



44

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 operating segments, as

part of the implementation of the model (central services include all the departments in the Headquarters Division and the Chief Accountant’s Division, the Bank’s Corporate Secretary, Internal Audit and Information Systems).

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 a multiplier of the segment’s expenses.

g. Risk assets are reported in accordance with Basel II directives. 2. The results of the segments are shown in detail in Note 27 to the Financial Statements. In

Note 27.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 areas of credit cards, mortgages and construction and real estate.

4. The division between operating segments is based on types of customers or defined areas of

activity. It is derived from the strategy of customer-focused activity in accordance with which the Bank operates. The results of the activity of the segments, classified according to the main operating segments, are shown in detail as mentioned in Note 27 to the Financial Statements. Since there are no uniform criteria in the banking sector for attributing customers to operating segments as above, each bank attributes its customers to operating segments that reflect its management concept and business strategy. Data of the results of the segments has been prepared in accordance with the Directives of the Supervisor of Banks on the matter of “Principal Operating Segments”. In the framework of preparing the Note, inter alia, adjustments are made between management reports relating to the above operating segments based partly on the Management’s review of the operating segments, and reporting in accordance with accepted accounting principles.



45

Below is a summary of the net profit by operating segments, in reported amounts: Year ended December 31 2011 20101 Percentage change NIS millions NIS millions

Private banking2 0.6 0.1 500.0 Corporate banking 28.7 31.9 (10.0) Financial segment 9.8 14.7 (33.3) Unallocated amounts and adjustments 1.8 2.3 (21.7) Total 40.9 49.0 (16.5)

1 Reclassified. 2 Excluding losses related to the opening of branches for affluent customers, the profit of the segment for 2011 is NIS 12.0 million

(2010 - NIS 11.0 million). 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, specialized, 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 affluent neighborhoods in Israel built so far in Ra’anana, Rishon-Letzion, Rehovot, Malha, Ramat Hasharon, and Kikar Hamedina in Tel-Aviv, and branches that are to be opened in the near future in further strategic locations. Services are provided by professional and experienced teams of bankers and investment counselors. Operating within this segment is the Bank’s Trust Company, which offers private and public trust services (and 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.’ Customers of the Segment The segment includes all the Bank’s private customers and their businesses. These are both private customers belonging to the personal banking division and 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, including customers with managed portfolios referred by Family Offices. With the opening of the new branches, the Personal Banking Division has broadened its customer base. New customers now joining the Bank want professional and focused service, and to be offered value suitable to their type of banking needs.



46

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 is 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. Investment counselors in the Division engage only in investment counseling for select customers. The ratio of counselors to this group of customers enables the Bank to extend professional service at a high level. Legislative Restrictions and Standards 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 more comprehensive information, see the chapter on Updates in Legislation and the ruling with reference to the banking system in 2011. 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 the Internet. In order to distinguish 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 The Bank uses the counseling system of the First International Bank, which is an advanced counseling 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 counselors of a high professional level. - Wide range 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.



47

Principal barriers to entrance and exit of the sector Activity in the private banking sector requires investment and capabilities in the following subjects: - Training of skilled investment counseling 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. - Creation of appropriate control system to ensure compliance with provisions of the Consultancy Law

and ofher regulatory provisions. 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 special 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 non-banking financing 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 provides administration services to hedge funds and private investment funds, including trusteeship for purposes of the deduction of taxes in these funds. The company also acts as trustee for insurance agencies in accordance with insurance circulars of the Commissioner of the Capital Market, Insurance and Savings Department. 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 in 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 specialized in private banking 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 counselor 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 Ltd. 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. UBank Mutual Funds Ltd. manages a variety of mutual funds that invest in markets in Israel and overseas. Total funds managed by both companies at the end of 2011 amounted to about NIS 1.0 billion, of which about NIS 0.5 billion is in investment portfolio management, and some NIS 0.5 billion in mutual fund management.



48

The Companies 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 of UBank Asset Management. 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 counselors 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, which will end for the Bank in August 2013. The Bank chose not to sell its mutual funds, but to continue to hold them for the period permitted by law. Future Objectives The private banking sector is expected to grow and focus in 2012 on growth in the market share 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 high level service. In the field of managing financial assets, the company aims to increase the number of managed portfolios and asset share. In the field of managing mutual funds, the company, which is positioned as an expert in foreign markets, will continue to focus on overseas niche funds, and at the same time will continue to expand the products in the solid channel in Israel in improving yields and increasing marketing efforts with the aim of increasing asset share. Human Capital The number of employees serving this sector amounted in 2011 to 152 employees on average (in 2010 - 144 employees on average). Operating Results The net profit of the Private Banking Segment amounted to NIS 0.6 million, compared with a net profit of NIS 0.1 million in the corresponding period last year. After excluding the loss in respect of the branches for affluent customers, the segment would have made a profit of NIS 12.0 million, compared with a profit of NIS 11.0 million in the corresponding period last year. The increase in the net profit derives mainly from an increase in net interest income from activity by the customers in the segment, which was partially offset by a decrease in profitability from the activity of the financial assets management company and the mutual funds management company of the Bank, an increase in operating and other expenses of the segment and other expenses attributed to the segment, concurrent with an increase in the expenses of the Bank and pursuant to the opening of the Ramat Hasharon Branch in April 2010 and Kikar Hamedina Branch that was opened in October 2011.



49

Below is a summary of the results of activity of the Private Banking Segment (in NIS millions):

Banking and

Finance

Capital Market

Total Banking and

Finance

Capital Market

Total

Year ended December 31, 2011 Year ended December 31, 20101 Profit from financing activity before income from credit losses:

From external entities 27.0 0.9 27.9 18.4 0.6 19.0

Inter-segment 18.6 0.5 19.1 20.2 0.3 20.5

Total profit from financing activity 45.6 1.4 47.0 38.6 0.9 39.5

Operating and other income:


Inter-segment (5.1) 2.6 (2.5) (4.5) 2.4 (2.1)

Total income 61.3 31.2 92.5 54.4 30.4 84.8

Income from credit losses (3.5) - (3.5) (1.2) - (1.2)

Operating and other expenses (including depreciation) 65.7 29.2 94.9 59.7 26.1 85.8

Net operating profit (loss) before taxes (0.9) 2.0 1.1 (4.1) 4.3 0.2

Provision for taxes on operating profit (0.3) 0.8 0.5 (1.4) 1.5 0.1

Net profit (loss) (0.6) 1.2 0.6 (2.7) 2.8 0.1

Net return on equity (0.6%) 6.0% 0.6% (3.0%) 13.2% 0.1%

Average balance of assets 969.1 - 969.1 855.4 - 855.4

Average balance of liabilities 2,728.1 - 2,728.1 2,839.3 - 2,839.3

Average balance of risk assets 869.0 25.4 894.4 740.0 22.0 762.0

Average balance of mutual fund assets - 713.0 713.0 - 782.3 782.3

Average balance of other assets under management - 558.0 558.0 - 741.9 741.9

Components of profit from financing activity before income from credit losses:

Margin on credit granting activity 20.8 - 20.8 17.7 - 17.7

Margin on deposit taking activity 21.6 - 21.6 17.5 - 17.5

Other 3.2 1.4 4.6 3.4 0.9 4.3 Total profit from financing activity before income from credit losses 45.6 1.4 47.0 38.6 0.9 39.5

1 Reclassified.



50

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), 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 customers of the Capital Market Division. Customers of the Segment The customers of the Corporate Banking Segment include leading institutions in the capital market, including mutual funds, insurance companies, pension and provident finds, hedge funds and portfolio managers. The income of several companies in the areas of insurance, pension, and provident funds account for approx. 27% of the income of the segment. 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, arbitrage traders and day traders. Private customers’ activity is classified within the framework of the Private Banking Segment. Legislative Restrictions, Standards, and Special Constraints 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. With regard to the update to Proper Conduct of Banking Business Directive No. 313, see the chapter on Updates to Legislation and Rulings relating to the Banking System in 2011. On 16.2.2010, the amendment to the Joint Investment Trust Law (Amendment No. 14), 2009 was published in the Official Gazette (Reshumot), whose main subject 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 engagement with a stock exchange member overseas can be made without a tender (within the terms of the law); an engagement 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 engagement was approved by the Audit Committee and the Board of Directors of the fund

manager.



51

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 Bank and UBank Trust Co. Ltd. (a subsidiary company) have completed preparations for implementing the provisions of the above-mentioned legislation. As a result of implementing the directive, the Bank anticipates a decrease in its income that will not have a significant effect on the Bank’s current activity. For details of various legislative directives applicable to the Bank and proposed laws likely to impact the Bank, see the chapter on Updates to Legislation and Rulings relating to the Banking System in 2011. 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 The segment uses a unique trading system of the Bank, 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.



52

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 transactions and finance transactions, trading in shares and bonds in stock exchanges overseas, and trading and clearing of mutual funds and hedge funds overseas. The customers of the segment operate, inter alia, through the Bank’s unique trading system, 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 and London Stock Exchanges, and trading in futures abroad. The Bank invests substantial resources in developing and improving the system and adapting them to the changing needs of its customers. The trading system allows for carrying out online controls for fund managers by means of the Investment Policy Control System integrated in the U-TRADE system. Trusteeship 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 2011, the Company acted as trustee for 469 funds managed by 16 different entities (about 37% of the mutual funds in Israel), of which some 45.8% of the income derives from 126 funds that are managed by three entities. Total assets of all the funds for which the Company served as trustee at the end of 2011 amounted to about NIS 46.1 billion (approx 32.4% of the market). The Company is trustee for a wide range of funds specializing in various investment channels in the capital market in Israel and abroad. 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 aspires to maintain and increase its market share while utilizing the strong reputation it has earned. Human Capital The number of employees working in this sector amounted in 2011 to 73 employees on average (in 2010 - 77 employees on average). Operating Results The net profit of the Corporate Banking Segment amounted to NIS 28.7 million, compared with NIS 31.9 million in the corresponding period last year, a decrease of 10.0%. The decrease in net profit is due mainly to an decrease in operating and other income from capital market activity in all its areas, an increase in operating and other expenses of the segment, and in other expenses attributed to the segment concurrent with an increase in the expenses of the Bank.



53

Below is a summary of the results of the activity of the Corporate Banking Segment (in NIS millions):

Banking and

Finance

Capital Market

Total Banking and

Finance

Capital Market

Total

Year ended December 31, 2011 Year ended December 31, 20101 Profit from financing activity before income from credit losses:

From external entities (20.3) 2.7 (17.6) (10.3) 2.7 (7.6)

Inter-segment 45.1 - 45.1 35.3 - 35.3

Total profit from financing activity 24.8 2.7 27.5 25.0 2.7 27.7

Operating and other income:


Inter-segment (0.3) - (0.3) (0.2) - (0.2)

Total income 28.0 73.5 101.5 28.2 76.3 104.5

Operating and other expenses (including depreciation) 11.5 46.2 57.7 11.9 43.2 55.1

Profit from ordinary activity before taxes 16.5 27.3 43.8 16.3 33.1 49.4

Provision for taxes on profit from ordinary activity 5.7 9.4 15.1 5.8 11.7 17.5

Net profit 10.8 17.9 28.7 10.5 21.4 31.9

Net return on equity 22.3% 35.4% 29.0% 32.8% 37.9% 36.0%

Average balance of assets 771.4 - 771.4 1,039.7 - 1,039.7

Average balance of liabilities 3,072.7 - 3,072.7 3,595.6 - 3,595.6

Average balance of risk assets 403.3 346.0 749.3 269.4 395.3 664.7

Components of profit from financing activity before income from credit losses:

Margin from credit granting activity 2.3 - 2.3 1.9 - 1.9

Margin from deposit taking activity 19.9 - 19.9 21.7 - 21.7

Other 2.6 2.7 5.3 1.4 2.7 4.1 Total profit from financing activity before income from credit losses 24.8 2.7 27.5 25.0 2.7 27.7

1 Reclassified.



54

Financial Segment Description of Area of Activity The Segment is divided into three sub-segments: the asset and liability management department (hereinafter: “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 results of companies included on equity basis. Customers of the Segment 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 Constraints 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 Asset and Liability Management (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 limits approved by the Board of Directors of the Bank. 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 as a market maker for government unlinked shekel fixed-interest bonds on the Stock Exchange. In 2011, the Bank was ranked 7th by the Ministry of Finance out of 14 trading market makers.



55

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. 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 Capital The number of employees working in this sector amounted in 2011 to 29 employees on average (in 2010 - 30 employees on average). Operating Results The net profit of the Financial Segment amounted to NIS 9.8 million in 2011, compared with NIS 14.7 million in the corresponding period last year, a decrease of 33.3%. After excluding the items relevant to the activity of the company included on equity basis in the results of the segment, the net profit for the segment amounted to NIS 8.0 million, compared with NIS 14.0 million in the corresponding period last year, a decline of 42.9%. The decrease derives mainly from a decrease in profits from activity in the trading portfolio of the Bank, and a decline in the current bond yield of bonds in the available for sale portfolio of Israeli securities resulting mainly from a decrease in the total portfolio and a decline in the net realization of profits in this portfolio. In 2011, a provision was made for impairment of bonds of a nature other than temporary in the sum of NIS 0.5 million, and impairment of shares of a nature other than temporary in the sum of NIS 2.5 million. In 2010, there was no impairment of a nature other than temporary. The decrease was offset by an increase in income in respect of fair value adjustments of derivative financial instruments.



56

Below is a summary of the results of the Financial Segment (in NIS millions):

For the year ended December 31 2011 20101

Profit from financing activity before income from credit losses 30.8 38.2 Operating and other income 9.7 10.5 Total income 40.5 48.7 Income from credit losses - (2.7) Operating and other expenses 27.7 26.7 Profit from ordinary activity before taxes 12.8 24.7 Provision for taxes on profit from ordinary activity 4.4 8.7 Profit from ordinary activity after taxes 8.4 16.0 Bank’s share in losses of company included on equity basis (0.1) (1.3) Net profit from ordinary activity 8.3 14.7 Profit from extraordinary operations after tax 1.5 - Net profit 9.8 14.7 Net return on equity 3.8% 5.1% Average balance of assets 4,846.4 5,457.3 Average balance of liabilities 341.1 256.1 Average balance of risk assets 948.0 859.7

1 Reclassified. Fixed Assets and Facilities

The Bank conducts activities in eight branches. Jerusalem Branch - the Bank is the owner of the Branch building. In the Bank’s other branches, the Bank utilizes rented properties, including the building that serves as the Bank’s headquarters and the Tel Aviv Branch.

Rental contracts for the rented premises are for different periods, and for the most part the Bank has options to extend the rental period. In December 2010, the Bank signed an update to the rental agreement for the building that serves as the Bank’s headquarters, (retroactively from November 2010). In the context of the update, the rental period was extended by 30.9.2029 and rental rates were updated. Taxation

- The Bank and some of its subsidiary companies are defined as assessee financial institutions for the purpose of VAT law. In accordance with this law, a salary and profit tax is levied from 2011 on the activities in Israel of a financial institution, at the rate of 16.0% on salaries paid and profits earned, respectively. For information in respect of the tax assessments of the Bank and consolidated companies, see Note 24(C).

- Contacts are currently taking place between the banks and the Tax Authority regarding the treatment of implementation of new directives on impaired debts and allowance for credit losses. The new directives are not expected to have any material effect on the financial statements of the Bank.

- The Bank has the status of Qualified Intermediary (QI), as defined in the regulations of the US Income Tax Authorities. 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 the income of its non-US customers, in respect of activities in US securities (see also the chapter on Taxes on Income).



57

Additional Information Risk Management Policy 1. General a. The Bank’s activity is accompanied by exposure to risks, of which the most material are: credit risk,

market and, liquidity risk, operational risks and legal risks. Each of these risks is managed by appointed members of management and under their responsibility. In respect of credit risk, market risk and operational risks, there is an existing regulatory capital adequacy requirement in the context of the First Pillar of Basel II. In respect of the remaining risks to which the Bank is exposed, the Bank performs allocation of capital in the capital adequacy assessment process carried out in the framework of implementing the provisions of the Second Pillar of Basel II – the ICAAP process (Internal Capital Adequacy Assessment Process).

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 Supervisor of Banks has determined a number of directives in the Proper Conduct of Banking Business Directives relating to the subject of risk management. These directives establish, inter alia, basic principles of risk management and their control, including proper involvement and understanding of risk management by the Bank's Board of Directors and management, fixing risk policy and risk policy, receiving periodic reports on developments in exposure to risks, and the existence of supervision and control mechanisms appropriate to the Bank's risk profile.

d. The Bank’s overall concept of risk complies with the framework defined by the Supervisor of Banks, which is based on the principle that, for every banking activity involving risk, the following will be defined and characterized: risk policy and appetite, limits for delineating and defining the scale of the exposure, control and audit cycles, a reporting system, and a mechanism for quantifying, measuring and reporting the profit, in accordance with acceptable standards.

e. Risk management and control are conducted through an appropriate infrastructure of control, supervision, monitoring, and audit mechanisms, and implemented by means of three main control cycles: the first cycle of those responsible for creating and managing the risk, and maintain various controls when taking the risk ; the second cycle of independent control units carrying out controls after, but closely following, the taking of the risk – these units report to the Chief Risk Manager; and the third cycle of the internal audit function and the external auditors.

f. In December 2009, the Banking Supervision Department published a Proper Conduct of Banking Business Directive on "Chief Risk Manager and the Risk Management Function”, based on the principles of Basel II, which regulates the status, roles, and responsibilities of the risk management function in a banking corporation and the person at its head. The Directive states that the risk management function will have a significant status in the organization. It will be headed by an independent chief risk manager, who will not make business decisions involving the taking of risk, and will be a member of management directly subordinate to the General Manager. The Board of Directors approved the establishment of a risk management function in the Bank, including the definition of the function's responsibilities, appropriate to the Bank’s risk profile, and appointed Mr. Yaacov Garten, VP, as Chief Risk Manager at the Bank. The appointment was approved by the Supervisor of Banks and the Chief Risk Manager took up his office on January 12, 2011.

g. In August 2011, the Bank of Israel published two new draft directives: (1) Proper Conduct of Banking Business Directive No. 339 – Risk Management. (2) Proper Conduct of Banking Business Directive No. 342 – Liquidity Risk Management.



58

These directives expand existing Proper Conduct of Banking Business Directives. The Bank, in cooperation with the Group, is studying the new directives and making preparations for them.

h. The following persons are responsible for risk management in the Bank: Mr. Yaacov Garten, VP and Head of the Head Quarters 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, the manager responsible for credit, is the Credit Risk Manager of the Bank. Ms. Michal Tilo, Manager of the Regulation and Processes Department, is the Operational Risks Manager of the Bank. Adv. Aya Ashtar, the legal counsel of the Bank, is the Legal Risks Manager of the Bank.

i. The additional risks to which the Bank is exposed (see the chart of the discussion of risk factors on page 104) are also managed and supervised as part of overall business management, and by each of the members of Management in the area under his responsibility.

Corporate Governance and Involvement by Management and the Board of Directors In December 2010, the Banking Supervision Department published an amendment to Proper Conduct of Banking Business Directive No. 301 on the work of the board of directors that adopted the Basel principles on corporate governance and risk management. In August 2011, the Board of Directors of the Bank Board approved the foundation document on corporate governance principles of risk management in the Group in accordance with Proper Conduct of Banking Business Directive No. 301, the Basel II principles, and the other Bank of Israel guidelines. The document defines the working format of effective corporate governance that supports the functioning of management and the Board of Directors, and allows them to determine the Bank's strategy and objectives, to formulate a risk appetite, to manage the Bank’s current business, and protect the interests of depositors, shareholders and other risk takers. The document serves as a binding platform for the Bank with regard to its perception of corporate governance and the risk management format. The document is implemented through Board of Directors and management procedures, the relevant policy documents, and the main cycles comprising the fabric of corporate governance at the Bank - led by the Board of Directors and management. 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. In this framework, the Board of Directors adapts overall exposure policy to the various risks to changes and shifts in financial markets and the operating environment of the Bank.

b. Every meeting of the Board of Directors follows up and monitors developments in the financial markets, principal financial exposures, and carries out an examination of the appropriateness of the limits and compliance with them. The Board of Directors also performs an examination of the appropriateness of the system of risk management and control in the Bank.

c. The Board of Directors established its own Risk Management Committee that is convened every quarter to coordinate the subjects mentioned in paragraph b. above.



59

d. The Board of Directors of the Bank approves new activities and new products that may create new exposures, while examining the risk created by the activity, and the ability of the Bank to manage, measure and perform independent control over the risks of the activity.

e. The Credit Committee of the Board of Directors also meets every quarter to discuss credits. With regard to the cancelation of the Credit Committee as of 2.10.11, see the chapter on the Operations of the Board of Directors and Changes in Board Membership, and the discussion of Proper Conduct of Banking Business Directive No. 301 in the chapter on Updates to Legislation.

f. 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.

g. There is a meeting of the Audit Committee of the Board of Directors at least six times a year. The Audit Committee discusses and approves the Internal Audit work plan and monitors its implementation. In addition, the Committee discusses material audit reports and the other reports of the Internal Auditor.

h. Once a quarter a discussion takes place with Management, the Risk Management Committee of the Board of Directors, 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 limits set by the Board of Directors.

i. Once a week, the Credit Committee is convened, chaired by the General Manager. j. The Operational Risk Management Forum is convened at least once a quarter, to conduct ongoing

monitoring of the state of exposure to operational risks, based, inter alia, on the findings of the various risk surveys, and on actions taken by the various units to minimize these exposures. The Forum serves also as a forum for the subject of the prevention of embezzlement and fraud risks.

k. The units for market and liquidity risks and credit risks that report to the Chief Risks Manager, carry out autonomous and independent risk controls of credit risks and financial risks.

l. The unit for Risk Management and Supervision of Subsidiary Companies in the parent company is responsible, among other things, for the implementation and assimilation of the overall Group policy for risk management that is compatible with Group targets and goals, and for the execution of ongoing supervision and monitoring of the banking subsidiary companies.

m. The Basel II Implementation Unit in the parent company that reports to the Chief Risks Manager 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.

n. The Management of the Bank, 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.

2. Market Risks (Financial Risks) a. Market risk (financial 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-



60

section of individual risk, principles for activity and limits on the level of the various instruments and the various desks in the Financial Division.

c. Once a quarter, a discussion takes place in Management, the Risk Management Committee, and the Board of Directors, of the exposure document to the range of risks of the Bank and the Group, in the framework of which the Bank’s and the Group’s exposures to risks are reported, compared with the limits set. In addition, an examination is made of the changes required pursuant to changes in the Bank’s activities, and/or changes in the environment of the Bank or the financial markets.

Capital Requirements in respect of Market Risks pursuant to Directives of the Banking Supervision Department As part of the implementation of Basel II directives and the Provisional Directive of the Supervisor of Banks, the Bank, in coordination with the Group, to implement the Standardized Approach for exposure to market risks. Regulatory capital adequacy is calculated on interest rate risks, option risks, share risks and specific risk in areas of trade only, and on currency risks in all operations. In respect of interest rate risks and shares risk in the banking portfolio, the Bank allocates capital in the frameworkk of the capital adequacy assessment process in the implementation of the provisions of the Second Pillar of Basel II – the ICAAP process. Below are the capital requirements in respect of market risks in accordance with directives of the Banking Supervision Department:

31.12.11 31.12.10 NIS millions NIS millions Specific risk General risk Total Specific risk General risk Total Capital requirement in respect of:

Interest risk 8.0 19.6 27.6 10.3 12.7 23.0 Share risk -1 -1 -1 0.1 0.1 0.2 Foreign currency risk - 0.7 0.7 - 3.7 3.7 Total capital requirement for market risks 8.0 20.3 28.3 10.4 16.5 26.9

1 Amount less than NIS 0.1 million.



61

d. Methodology for estimating market risk exposure The Bank makes use of several conventional tools and models for market risk management, by means including Value at Risk (VaR) and by running stress test scenarios, as follows: - The VaR (Value at Risk) measures the maximum expectancy of loss of fair value of the

Bank (assets and liabilities, including derivative financial instruments), in a given investment horizon (10 business days), given a particular level of significance (99%) and on fulfillment of normal market conditions.

- The current VAR calculated by the Bank is based on the Variance Co-Variance method. In addition, the Bank run models when needed - including historical simulation.

- VaR data are calculated daily by the Bank on the financial assets and liabilities of the Bank (the banking portfolio, the trading portfolio). The VaR system is an integral part of the work of the Risk Management Department that updates the Financial Division on the exposures.

- Back Testing – the predictive quality the VaR model is examined by the Risk Management Department by retroactive measurement.

Risk appetite The Board of Directors determined that the total market risk exposure as expressed by the Value at Risk (VaR) shall not exceed 3.6% of the capital and up to NIS 15 million, according to a 10-day horizon by the parametric method. At December 31, 2011, the amount of the VaR of the Bank stood at NIS 6.6 million compared with NIS 9.4 million at December 31, 2010. During 2011, the Bank complied with the overall VaR limit. Stress scenarios - stress scenarios for examining the maximum level of erosion of fair value: The Board of Directors of the Bank set limits on the maximum level of erosion of the Bank's fair with regard to the running of several stress scenarios for the realization of market risk. This limit was set at up to 15% of the Bank’s capital. Stress scenarios for examining capital adequacy and the impact of realization of stress scenarios on the ratio of capital to risk assets: As part of preparations for the implementation of the provisions of the Second Pillar of Basel II, and the promotion of risk management in the Group, the Bank formulated a stress scenario outline to examine capital adequacy. The outline includes scenarios in the area of market, liquidity and credit risk (including in the shekel and foreign currency securities portfolio) and scenarios that combine the realization of several risks simultaneously. Scenarios run by the Bank include sensitivity analysis-type scenarios, historical scenarios, hypothetical scenarios and macro-economic scenarios. The scenario infrastructure includes both parametric scenarios integrated in the form of a matrix and holistic scenarios. The results of stress scenarios and their implications are discussed, at least once a quarter, by Management and the Risk Management Committee of the Board of Directors. In addition, the Bank applies various tools for managing interest rate exposure, including various models implemented in the Bank the results of which are reviewed on a daily basis, such as average duration, fair value and analyses of sensitivity to changes in the interest curve.



62

e. 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 investment of available capital 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 limits regarding the positions allowed (long or short) in assets and liabilities and in capital exposure for each sector.

- Stress scenarios - The Board of Directors of the Bank has set a limit 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 limit was determined as up to 15% of equity. The results of the scenarios and their significance are reported four times a year to Management and the Board of Directors.

The surplus of assets over liabilities totaled as follows:

December 31

2011 NIS millions

2010 NIS millions

Maximum permitted limit NIS millions

Type of linkage Unlinked 376.5 359.2 Consumer Price Index 16.6 (37.6) 450.0 ± Foreign currency or linked thereto (0.9) 46.0 105.1 ± Non-monetary items 39.7 53.5 Total equity 431.9 421.1



63

Sensitivity of capital to changes in the rate of exchange

The Bank operates in the currency market by means of spot and forward transactions, and by means of options for its own account and for its customers. The Bank operates in currencies negotiable worldwide and the total currency exposure of the Bank is low.

Below is a description of the sensitivity of the capital of the Bank to theoretical changes in the rates of exchange of the major currencies (in NIS millions):

December 31, 2011 December 31, 2010 Percentage change in rate of exchange

Dollar

Euro

All currencies

Dollar

Euro

All currencies

Decrease of 5% 0.1 0.3 1.1 (1.7) (0.3) (2.3) Decrease of 10% 0.2 0.6 2.3 (3.5) (0.7) (4.6) Increase of 5% (0.1) (0.3) (1.1) 1.7 0.3 2.3 Increase of 10% (0.2) (0.6) (2.3) 3.5 0.7 4.6

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 a negligible

effect on the profits of the Bank. 3. The statistics show the effect of changes in the rates of exchange after tax. Capital requirements in respect of basis risks In the framework of implementation of Basel II provisions, the Bank applies the standardized approach in respect of exposure to market risks. The Bank makes a supplementary allocation of capital in respect of basis risks deriving from exposure to basis risks in the CPI-linked segment (inflationary risks) in the framework of implementation of the provisions of the Second Pillar of Basel II. During 2011, the Bank complied with all the limits of basis exposure approved by the Board of Directors.

f. 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 capital 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



64

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 limits on the overall exposure to interest rate

risks, by demarcation of the maximum exposure to erosion of the capital, with a corresponding change of 1% in the interest rate curve of the CPI-linked segment, the unlinked shekel segment and the foreign currency segment. According to the limits, the maximum exposure allowed for erosion in the fair value of the capital is 5.50% in the unlinked shekel segment, 3.50% in the CPI-linked segment, and 1% in the foreign currency segment.

– In addition to setting limits on the overall risk appetite to exposure to interest rate risks at the level of exposure of the fair value, the Board of Directors of the Bank set individual limits, at the dealing room level and at the level of various business units creating interest rate risks, on total exposure to interest rates.

– 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 shall not exceed 3.6% of capital up to the amount of NIS 15 million.

- Stress scenarios - The Board of Directors of the Bank has set a limit 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 limit was determined as up to 15% of equity.

In addition, the Bank implements a stress scenario outline for examining capital adequacy, in the framework of which the Bank examines a stress scenario outline also in the area of interest rate risks (and scenarios that combine the realization of interest rate risks with several other risks simultaneously). In this connection, the impact of the realization of the risk is examined on the capital base, the ratio of capital to risk assets, and the capacity of the Bank to raise capital. The results of the scenarios and their significance are reported once a quarter 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.

Below is a description of the sensitivity of the capital of the Bank to corresponding rises in interest rate curves – the theoretical economic change resulting from a corresponding rise of 1% in the interest rate curve:

December 31, 2011 December 31, 2010

% change in capital % limit1 % change

in capital % limit

Unlinked shekel 3.68 5.50 3.42 5.00 CPI linked shekel 0.05 3.50 1.09 4.00 Foreign currency or linked to foreign currency 0.45 1.00 0.53 1.00

1 The limits were updated in October 2011 and approved by the Board of Directors in the framework of the approval of

risk management policy.



65

Interest rate risk in the banking portfolio: Below is the effect of an increase/decrease in the interest rate on the banking portfolio of the Bank (as a percentage of fair value):


Increase of 1% Decrease of 1% Increase of 1% Decrease of 1%

Shekel curve (3.78) 4.22 (4.34) 4.84

CPI linked curve (0.32) 0.26 0.87 (0.85)

Dollar interest (0.11) 0.20 (0.76) 0.67

Euro interest 0.04 (0.01) (0.06) 0.03

Foreign currency interest (all currencies) (0.01) 0.05 0.08 0.16

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.

Capital requirements in respect of interest rate risks In the framework of implementation of Basel II provisions, the Bank applies the standardized approach in respect of exposure to market risks. In this context, the Bank requires regulatory capital adequacy in respect of interest rate risks only in the areas of trading. The Bank makes a supplementary allocation of capital in respect of interest rate in the banking portfolio in the framework of implementation of the provisions of the Second Pillar of Basel II.



66

Analysis of sensitivity to the effect of exposure to changes in interest based on the fair value of financial instruments Below is information on assets and liabilities exposed to changes in interest rates according to their fair value, including a sensitivity analysis of the effect of theoretical changes in interest rates on the fair value of financial instruments. Below are details of the effect of changes in interest rates on the fair value of the surplus of assets in the segment: 1. The fair value of financial instruments, except for non-monetary items (before the effect of

theoretical changes in interest rate), in NIS millions:

December 31, 2011 NIS Foreign currency2

Unlinked Linked Dollar Euro Other Total Financial assets1 4,951.1 1,214.1 686.3 200.2 232.1 7,283.8 Amounts receivable in respect of derivative financial and off-balance sheet instruments3

719.4 -

2,672.6 349.4 485.8

4,227.2

Financial liabilities1 (3,288.4) (1,103.3) (2,092.9) (258.1) (189.4) (6,932.1) Amounts payable in respect of derivative financial and off-balance sheet instruments3

(2,021.6) (94.6)

(1,268.1) (297.8) (522.1)

(4,204.2)

Net fair value of financial instruments 360.5 16.2

(2.1) (6.3) 6.4 374.7

December 31, 2010 NIS Foreign currency2

Unlinked Linked Dollar Euro Other Total Financial assets1 5,168.7 715.6 1,120.4 152.5 231.4 7,388.6 Amounts receivable in respect of derivative financial and off-balance sheet instruments3

1,750.9 -

3,176.6 381.3 513.7

5,822.5

Financial liabilities1 (4,021.3) (689.3) (1,758.1) (220.3) (283.0) (6,972.0)

Amounts payable in respect of derivative financial and off-balance sheet instruments3

(2,525.2) (67.2)

(2,504.1) (306.9) (457.8)

(5,861.2)

Net fair value of financial instruments 373.1 (40.9)

34.8 6.6 4.3 377.9

1. Including hybrid financial instruments. Not including balance sheet balances of off-balance sheet financial instruments. 2. Including Israel currency linked to foreign currency. 3. Amounts receivable (payable) in respect of derivative financial instruments and in respect of off-balance sheet financial

instruments, discounted at interest rates used for calculating fair value shown in Note 16.B to the Financial Statements.



67

2. The effect of theoretical changes in interest rates on the net fair value of the Bank’s financial instruments, except for non-monetary items, in NIS millions: December 31, 2011

Net fair value of financial instruments, after effect of changes in interest rates1 Change in fair

value

Israeli currency Foreign currency2 NIS millions %

Unlinked Linked Dollar Euro Other Offsetting effects Total Total Total

Change in interest rates

Corresponding immediate increase of one per cent

346.1 14.2

(3.1) (7.4) 5.6 -3 355.4

(19.3) (5.2)

Corresponding immediate increase of 0.1 per cent

359.0 15.9 (2.2) (6.4) 6.3 -3 372.6 (2.1) (0.6)

Corresponding immediate decrease of one per cent

376.7 17.8 (0.7) (5.0) 7.4 -3 396.2

21.5 5.7

December 31, 2010

Net fair value of financial instruments, after effect of changes in interest rates1 Change in fair

value

Israeli currency Foreign currency2 NIS millions %

Unlinked Linked Dollar Euro Other Offsetting effects Total Total Total

Change in interest rates Corresponding immediate increase of one per cent

356.7 (37.5)

31.1 6.2 4.6 -3 361.1

(16.8) (4.5)

Corresponding immediate increase of 0.1 per cent

371.4 (40.7) 34.3 6.5 4.7 -3 376.2 (1.7) (0.5)

Corresponding immediate decrease of one per cent

391.4 (44.2) 38.2 6.9 4.9 -3 397.2

19.3 5.1

For further details of the assumption used for calculating the fair value of financial instruments, see Note 16.B. 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 16.B. Figures for the end of the quarter represent the exposure existing for the Bank during the fourth quarter of 2011. The effect of hypothetical change in interest rates on the net profit is not materially different from the net effect on the fair value. During 2011, the Bank complied with all interest exposure limits approved by the Board of Directors. 1 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 16.B to the financial statements

2 Including Israeli currency linked to foreign currency. 3 Less than NIS 0.1 million.



68

g. Option risks General Option risks are the risk of loss deriving from changes in the parameters affecting the value of the options, including standard deviations. 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 daily limits set 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 $250 thousand. c. Vega (change of 1% in the interest rate) of maximum amount of $50 thousand. d. RHO (exposure to change of 1% in the interest rate) of maximum amount of $100 thousand. e. Gama (change in the value of the delta deriving from a change of 1 point in the underlying

asset – with a maximum amount of $750,000. Managing the exposure Tools for managing exposure to option risks include the Vol-Spot sensitivity matrix that 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. During 2011, the Bank complied with all limits approved by the Board of Directors.

h. Supervision and Control over the Management of Market Risk Exposure

The Bank maintains an appropriate system of control, supervision, and audit mechanisms on the market risk management process. The Bank’s management and 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, at Board of Directors. Management and mid-management levels, of which the main ones are: - Once a year, the Board of Directors of the Bank determines the overall exposure policy to

market risks including, inter alia, the overall risk appetite, risk frameworks and exposure ceilings allowed in the various area of activity and segments, and also fixes standards for the management, measurement, control and reporting of exposure to market risks.



69

– The Risk Management Committee of the Board of Directors - the said committee has been operating since 2010. It is a committee of the Board of Directors specially designated for the areas of risks in the Bank, and how they are managed. The committee holds 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. The Committee follows up and monitors developments in exposure to the various financial risks and the Bank’s compliance with exposure limits prescribed. The Committee follows up developments in financial markets in Israel and abroad, and the business environment of the Bank, and holds a discussion on the implications on exposure levels and recommended limits. In addition, the Committee follows up and monitors the appropriateness of the risk management function, including the risk control function.

– Once a quarter, a discussion is held by Management and the Board of Directors on the Bank’s overall exposures document, when a report is made on the Bank’s compliance with the limits set by the Board of Directors.

– 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.

– A committee chaired by the General Manager meets once a quarter to discuss impairment and the need for provisions for impairment in the nostro portfolio.

– The Middle Office – the unit is integrated into the Risk Management Department reporting to the Chief Risks Manager, specializing in performing controls on the activity of the dealing rooms in the Finance Division of the Bank. The unit identifies various risks close to their creation, as far as possible, and develops controls and working procedures to reduce the exposure of the bank. As part of its activities, the unit checks compliance with the limits set at the level of the various positions on a daily level, and performs stress tests in specific portfolios.

– The Market Risk and Liquidity Management Control Unit - which is integrated into the Risk Management Department - the unit 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. 339 - “Risk Management”, and Proper Conduct of Banking Business Directive No. 342 – “Liquidity Risk”. 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. In addition, the Market Risk and Liquidity Management Unit participates in a steering committee of the parent company dealing with validation of models for market and liquidity risk.

– Internal Audit - the Internal Audit Department of the Bank is the Internal Audit Department of the parent company, which integrates auditing the subject of financial 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 processes and procedures for managing risks in the Bank, and 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 processes.



70

i. 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 summarized in the quarterly “Exposures Document”, as required under Proper Conduct of Banking Business Directive No. 339. The document is discussed once a quarter by Management, the 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 Risk Management Division 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 at the Bank of Israel.

– In accordance with requirements of the directive of the Supervisor of Banks, the Board of Directors of the Bank approved an overall policy for liquidity risk management, 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 ongoing liquidity risk management.

– The Bank carries out routine monitoring of the liquidity position in Israeli currency and foreign currency, while operating tools for the management, control, and supervision, with the aim of ensuring its ability to deal with exceptional situations of demand and supply in the financial markets.

– In September 2008, the Basel Committee, the BIS, issued an updated guideline (Sound Practice) dealing with liquidity risk management. The guideline was drafted pursuant to the lessons of the financial crisis and include a list of new guidelines for managing liquidity, including: the need for pricing liquidity risk, the need for maintaining a security buffer (cushion), a list of principles of risk measurement with extensive use of stress scenarios, intra-day liquidity management, contingency plans, and others. The Bank has completed the carrying out of a comprehensive gap survey to examine compliance with the directive. The Bank is currently examining ways to close the gaps identified as part of implementing the provisions of the Second Pillar of Basel II.



71

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, both in a scenarios of a normal business situation and in implementing stress scenarios.

Internal model for Israeli and foreign currency

– For purposes of overall liquidity management, the overall liquidity risk is measured and managed by means of an internal model developed by the Group, with the aim of examining and monitoring of the liquid means of the Bank under different scenarios. 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 in both scenarios. In each of the scenarios, the liquidity position is examined based on two quantitative metrics: the liquidity gap and the liquidity ratio by repayment periods.

– The principles behind the model argue that, the more liquid assets the Bank has relative to liabilities expected to be realized under the Internal model, the better the Bank ensures its ability to meet any liquidity needs. For this purpose, assets are classified in the model by level of liquidity, in accordance with Bank of Israel directives, and liabilities according to their likelihood of realization. The model is supported by different tests made by the Bank, which rely on an historical examination of the behavior of the Bank’s balance sheet and off-balance sheet balances.

- The model uses a dynamic management tool, 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.

- The model, which is managed by the Market and Liquidity Risk Manager, is being validated by the parent company. In the framework of the validation, an examination is being made of the methodology on which it is based, and the accuracy and integrity of the data, at the inout , output, and the model formula level.

Zahav - RTGS system for daily management of the liquidity of the portfolio in Israeli currency In addition, for purposes of managing ongoing liquidity in shekels, the Bank uses an internal system 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. “Short-long” model in the foreign currency segment Activity of the banking system in the area of asset-liability management in foreign currency is characterized by creating long-term uses of funds that are funded from short-term sources. This activity derives mainly from the lack of availability of long-term sources of foreign currency. Such activity exposes the Bank to financial risks of two types – liquidity and margin. In the framework of the model, limits were set on the total long-term uses of funds as a function of total short-term sources of funds, while managing foreign currency liquidity and margin risks.



72

Security buffer in foreign exchange The Board of Directors of the Bank has set a limit for a minimum security buffer of immediately liquid assets in foreign currency for short repayment periods. 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 24 months’ data. 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 on an ongoing basis, both by those managing exposures and by independent control and audit functions. Liquidity-risk exposure management is examined and monitored on a routine basis by designated committees and forums, at Board of Directors, Management and mid-management level, the main ones of which are (see also further information and details in the section above dealing with Control and Supervision over the Management of Market Risk Exposure): – The Board of Directors of the Bank, which outlines the overall policy for the management of

liquidity risk, risk appetite, and the relevant limits. – The Risk Management Committee of the Board of Directors. – The ALM (Asset and Liability Management) Committee. – The Internal Audit Department of the Bank, which integrates audits on the subject of liquidity

risk management into its annual work plans. d. Reporting Liquidity Risk Exposure

- 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. 339. The Exposures Document is discussed

once a quarter by Management, the Risk Management Committee of the Board of Directors, and the Board of Directors.

- A quarterly report four times a year to Management, the Risk Management Committee, and the Board of Directors, on the results of the stress scenarios.

- In addition, Bank Management and the Board of Directors are updated on a routine basis and whenever necessary on developments in the Bank’s exposures to liquidity risks.

During the fourth quarter of 2011, there were some deviations to the internal liquidity ratio in the foreign currency segment. However, the overall liquidity ratio as required by the Bank of Israel was significantly higher than that required. The deviations derived from certain sections of the liquidity model run by the Bank. As a result, the Board approved a temporary update of the limits relating to foreign currency liquidity, until



73

the liquidity model would be updated again. This model is subject to examination and revalidation by the FIBI Group. The said process should be completed in the first quarter of 2012 during which certain topics are to be dealt with so that a true representation will be obtained of the foreign currency liquidity position of the Group and the Bank.

4. Risk management in the securities portfolio overseas - market and indebtedness risks

a. The securities portfolio of the Bank overseas 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, subject to various limits set out in the Risk Management Policy of the Bank.

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 overseas. The 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 learned.

c. The Bank has three independent control and support systems backing up investment activity: - The Middle Office. - The Market Risk and Liquidity Risks Control Unit. - The Credit Risk Review Unit of the parent company. 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 regard to the major part of investments in the portfolio, the measurement of fair value is made based on quotations of an international supplier of prices outside the Bank – a leading international that provides revaluation services to many hundreds of large financial institutions worldwide, with more than 25 years experience. The company is engaged in the business of providing quotation and revaluation services and not in the business of securities trading.

e. As 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 Overall Exposures Document to Bank

Management, the Risk Management Committee of the Board of Directors, and the Board of Directors.



74

5. 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

In the framework of implementation of the Basel II directives, and the provisional directives of the Banking Supervision Department, the Bank, in coordination with the Group, implements the standardized approach in respect of exposure to credit risks.

Below are the risk assets and capital requirements in respect of credit risks, market risks and operational risk deriving from the various exposures:


Risk assets

Capital requirements

(9%) Risk assets

Capital requirements

(9%) NIS millions NIS millions NIS millions NIS millions

Type of exposure Sovereign 17.1 1.5 37.8 3.4 Public sector entities 9.9 0.9 - - Banking corporations 183.4 16.5 293.9 26.4 Corporations 1,280.1 115.2 1,406.8 126.6 Secured by commercial real estate 90.3 8.1 46.5 4.2 Retail to individuals 166.2 15.0 81.4 7.3 Mortgage loans 31.5 2.8 13.0 1.2 Other assets 117.9 10.6 116.6 10.5 Total in respect of credit risk 1,896.4 170.6 1,996.0 179.6 Market risks 354.0 31.9 336.3 30.3 Operational risk 417.8 37.6 435.5 39.2 Total risk assets 2,668.2 240.1 2,767.8 249.1

December 31, 2011

December 31, 2010

Ratio of core capital to risk assets 16.2% 15.2% Ratio of Tier 1 capital to risk assets 16.2% 15.2% Ratio of overall capital to risk assets 19.6% 18.4%

See details in section I below on the distribution of the allocation of capital in the different risk cross-sections.



75

For purposes of rating the credit exposure of sovereign risks and banking corporations under Basel II, the Bank made use in 2011 of public ratings of the S&P agency (in 2010 the Bank made use of public ratings of the agencies Moody’s, S&P, and Fitch according to the lower of their secondary ratings.

c. Risk Policy and Appetite

General - The Bank’s policy for managing credit risk, as discussed an approved by Management and

the Board of Directors once a year, is based on the proper distribution 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.

- The credit risk management policy of the Bank comprises various limits on the credit

portfolio, including a maximum limit for groups of borrowers and single borrowers, limits on exposure by industry and various business sectors, limits on exposure to countries and foreign financial institutions, as a function of the level of risk evaluated by the Bank. The Bank’s credit policy is examined and updated in accordance with changes and shifts in the financial markets and the Israeli economy.

- The credit management function is based on different levels of credit authority in the Bank, determined and approved by the Board of Directors, and credit procedures that define credit approval processes and the control process.

- In recent years, the Bank made updates to its credit policy, and in this context increased controls over the credit portfolio and segments likely to be significantly affected by changes and shifts that occurred in recent years in the financial markets and in the domestic economy.

Credit policy guidelines of the Bank In the framework of the credit policy, the Board of Directors of the Bank outlined a strategy for reducing unwanted exposure to credit risk, including guidelines as to directions of activity, including target markets. - The Bank’s credit 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 and the quality of the collateral.

- During recent years, the Bank’s concept of credit risk was widened, and its credit policy was broadened accordingly 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 intended, inter alia, to reduce exposure to the size of a single borrower or group of borrowers.

- The Bank reviews periodically the limits it imposed on itself, and updates the Bank’s policy and its concept of risk on a dynamic basis in accordance with developments in the state of the economy.

- 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, his cash flow and asset and liability structure, the quality of the collateral, the industry sector in which he operates, and parameters such as high dependence on customers, suppliers, etc.

- The Bank has taken 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



76

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 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 Measurement, Assessment, and Management of Credit Risks

- The Bank bases itself on internal models developed by the Group for rating the credit risk inherent in the activity of the customer. The models are based on objective parameters connected with the condition of the customer (customer characteristics, collateral mix, the financial strength reflected in the financial statements of the customer, industry statistics, other data, etc.). 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 improve 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.

- In addition, the Bank regularly reviews its compliance with regulatory directives in the matter of concentration limits: single borrower/group of borrowers, or exposure to sectors of the economy.



77

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. In the framework of the policy, principles and rules were set out for appraising collaterals by the type of collateral and the nature of the credit it is securing, which take into account various variables and economic indicators.

- In addition, procedures were determined for the handling of collaterals and monitoring of changes in them, and control systems in the area of management and operation of the collateral system.

The main types of collateral the Bank relies on: securities, deposits, pledges of real estate and bank guarantees.

- As part of preparations by the Group, the computer system was upgraded in the area documenting legal form creating pledges on assets given as security in customer files, and the system that manages the monitoring of the value of the assets is in the process of being replaced, so that when the system assimilation is complete, data required for credit risk management will be fully computerized and available to all the different control functions.

Supervision and Control - All the liabilities of the Bank’s customers, including the value of the collateral available

against them, are concentrated in the obligo system - through which the Bank performs daily monitoring 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 purposes of handling a significant part of 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 individual customer level, supervision and control work is performed also in the Credit Department.



78

Distribution of exposure by type of exposure and cover by eligible financial collateral as at 31.12.2011 (in NIS millions):

Gross exposure (after allowance for credit losses)

Exposure covered by guarantees (before multiplying by credit conversion coefficients)

Additional amounts

Exposure covered by eligible financial collateral under standardized approach after multiplying by collateral coefficients

Balance of exposure after specific provision for doubtful debts and after reduction of collateral

Type of exposure Sovereign 3,396.0 - - - 3,396.0 Public sector 19.8 - - - 19.8 Banking corporations 707.1 - 17.3 - 724.4 Corporations 3,059.6 17.3 31.9 1,287.5 1,786.7 Secured by commercial real estate 97.4 - - 2.0 95.4

Retail to individuals 347.3 - 8.4 78.5 277.2 Mortgage loans 91.9 - - 2.0 89.9 Other assets 207.6 - - 12.2 195.4 Total 7,926.7 17.3 57.6 1,382.2 6,584.8

Distribution of exposure by type of exposure and cover by eligible financial collateral as at 31.12.10 (in NIS millions):

Gross exposure (after allowance for specific doubtful debts)

Exposure covered by guarantees (before multiplying by credit conversion coefficients)

Additional amounts

Exposure covered by eligible financial collateral under standardized approach after multiplying by collateral coefficients

Balance of exposure after specific provision for doubtful debts and after reduction of collateral

Type of exposure Sovereign 3,606.0 - - - 3,606.0 Banking corporations 1,145.3 - 14.9 - 1,160.2 Corporations 4,258.3 14.9 33.7 1,436.2 2,840.9

Secured by commercial real estate 63.7 - - 12.5 51.2

Retail to individuals 97.5 - - 8.7 88.8 Mortgage loans 37.5 - - 0.2 37.3 Other assets 181.9 - - 26.9 155.0 Total 9,390.2 14.9 48.6 1,484.5 7,939.4



79

Distribution of exposure by economic sector as at 31.12.11: Credit is generally divided as follows: 50% of the credit at the Bank’s risk, including off-balance sheet items, is granted to customers in the financial services sector (after offsetting eligible deductions according to Bank of Israel directives, credit in this sector is less than 20%); 9% to the other business services sector; 8% to customers in industrial sectors; 12% to construction and real estate sectors and 7% to private persons. The aggregate balance of the allowance for credit losses, pursuant to Bank of Israel directives, as at December 31, 2011, constituted about 4.0% of total credit and credit risk to which the provision relates. f. Policy for problematic debts and allowances for credit losses

- There are structured processes in the Bank, set out in working procedures, for the early identification and location of problematic borrowers. In addition, there are defined work processes referring to the process for making an allowance for credit losses, which reflect a conservative assessment of the credit loss expected for the Bank.

As mentioned in the chapter on Accounting Policy and Accounting Estimates on Critical Matters, in accordance with the new directive of the Supervisor of Banks on “Measurement and Disclosure of Impaired Debts, Credit Risk, and Provision for Credit Losses”, the Bank implements, as of January 1, 2011, the US accounting standards (ASC 310), and the staff positions of the US banking supervisory authorities and the Securities and Exchange Commission (SEC) in the US, as adopted in the Public Reporting Directives.

With regard to the implementation of the directive and its effect, see Notes 1 and 4 to the financial statements.

Below is the distribution of overall credit risk relating to problematic borrowers according to the new directive (in NIS millions):

December 31, 2011 December 31, 2010 (pro-forma data)

Balance Sheet

Off-balance Sheet Total Balance

Sheet Off-balance

Sheet Total

Impaired credit risk 25.6 - 25.6 229.3 - 229.3

Substandard credit risk 3.1 - 3.1 - - -

Special mention credit risk 1.7 - 1.7 1,27.4 - 1,27.4

30.4 - 30.4 36.7 - 36.7

1 Restated. 2 Reclassified.



80

Below is information on non-performing assets, impaired debts accruing interest income, problematic commercial credit risk, and unimpaired debts in arrears of 90 days or more:

Reported amounts

Balance at 31.12.2011

Balance at 31.12.101

(Pro-forma data) NIS million NIS million On consolidated basis 1. Non-performing assets

Impaired credit to the public not accruing interest income:

Examined on individual basis 20.1 20.2 Examined on group basis - - Impaired bonds not accruing interest income - - Other impaired debts not accruing interest income - - Total impaired debts not accruing interest income 20.1 20.2 Assets received in respect of loans repaid - - Total non-performing assets 20.1 20.2

2. Impaired debts with restructuring of problematic debt

accruing interest income 5.5 59.1

3. Problematic commercial credit risk3

Balance sheet credit risk in respect of the public 29.3 534.8 Off-balance sheet credit risk in respect of the public4 - - Total problematic commercial credit risk in respect of the public 29.3 534.8

Balance sheet credit risk in respect of others - - Off-balance sheet credit risk in respect of others - -

Total problematic commercial credit risk in respect of others - -

Total problematic commercial credit risk 29.3 534.8 4. Unimpaired debts in arrears of 90 days or more - -

Of which: Housing loans for which there is a provision according to extent of arrears - -

Housing loans for which there is no provision according to extent of arrears - -

Unimpaired bonds in arrears of 90 days or more - -



81

1 Data at 31.12.10 are pro-forma amounts only and are shown in accordance with the new directives on Measurement and Disclosure of Impaired Debts, Credit Risk, and the Allowance for Credit Losses, if they would have been implemented for the first time as at 31.12.10.

2 Regarding the division of impaired debts into sectors of the economy, see Addendum E to the Management Review.

3 Balance sheet credit risk (loans, bonds, other debts recognized in the balance sheet, and assets in respect of derivative instruments) and off-balance sheet credit risk which is impaired, inferior, or under special supervision, except for balance sheet and off-balance sheet credit risk in respect of private individuals.

4 As calculated for purposes of restrictions on debt of a single borrower and a group of borrowers, except in respect of guarantees given by the borrower to secure the indebtedness of a third party, before the effect of collateral eligible for deduction.

5 Restated. 5. Below are data on credit risk metrics according to the Impaired Debts Directives:

December 31 2011

December 31 2010

(Pro-forma data) Percentage Percentage a. Ratio of balance of impaired debt to the public not accruing

interest income, to balance of credit to the public 1.1% 11.7% b. Ratio of balance of credit in respect of unimpaired credit to the public in arrears of 90 days or more, to balance of credit to the public

0% 0%

c. Ratio of balance of the allowance for credit losses in respect of credit to the public, to balance of credit to the public

0.8% 0.9%

d. Ratio of balance of the allowance for credit losses in respect of credit to the public, to balance of impaired credit to the public not accruing interest income

67.7% 151.9%

e. Ratio of problematic commercial credit risk in respect of the public, to overall credit risk in respect of the public 0.8% 10.8%

f. Ratio of income in respect of credit losses, to average balance of credit to the public 0.3%

g. Ratio of net write offs in respect of credit to the public, to average balance of credit to the public 0%

h. Ratio of net write offs in respect of credit to the public, to balance of allowance for credit losses in respect of credit to the public

0%

Note: Balance sheet credit risk appears before the effect of the allowance for credit losses, and before the effect of deductible collateral for purposes of debt of a single borrower and a group of borrowers.

1 Restated.



82

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. The administrative and control concept of the Bank is the ongoing identification, quantification and estimation of credit risk exposure and control of compliance with the limits prescribed. Credit risk exposure management is reviewed and controlled on a routine basis by designated committees and forums at the level of the Board of Directors, Management, and mid-management, of which the main ones are: - The Board of Directors, which outlines strategy once a year and the annual work plan based

on it, determines overall credit risk exposure policy, including among others: the overall risk appetite, risk limits, and exposure ceilings permitted in the various operating areas and segments, and sets standards for managing, measuring, monitoring, and reporting on credit risk exposures.

- The Credit Committee of the Board of Directors which used to meet generally at least once a quarter, was granted the authority of the Board of Directors, inter alia, for giving loans, deciding on credit facilities, determining collateral and so forth.

In the meeting of the Board of Directors held in August 2011, the new credit policy was adopted for 2011, including, inter alia, canceling the Credit Committee of the Board of Directors as part of the implementation of Proper Conduct of Banking Business Directive No. 301 (see also the chapter on Updates to Legislation).

- On a quarterly basis, there is a discussion by Management and the Board of Directors on the Bank’s overall exposure document, in the context of which reports are given on the Bank’s credit exposures, and the Bank’s compliance with the limits set by the Board of Directors.

- The Credit Risk Management Unit, which reports to the Manager of the Credit Department and consists of desk officers (analysts). The customers are allocated to the desk officers according to the business unit in which the customers are active, and according to their types of credit activities. Allocating customers in the aforesaid manner provides for professional proficiency.

- The Online Credit Supervision Unit – this is a unit incorporated in the Credit Department, specializing in carrying out controls and acting as a professional body in the area of credit supervision. The unit identifies and supervises credit exposures close to their creation, as far as possible, in customer activity in the dealing rooms of the Capital Market Division of the Bank. As part of its activity, the unit examines compliance with the limits set in areas of credit management in the various dealing rooms of the Capital Division of the Bank on an intra-day basis.

- The Loan Review Unit of the FIBI (the parent company) The Loan Review Unit of the parent company carries out, on behalf of the Bank, the provisions of the Bank of Israel in Proper Conduct of Banking Business Directive No. 319 in examining the credit risk of significant borrowers. The unit, headed by the Credit Risk Review Manager, reports to the Chief Risks Manager, who heads the Risk Management Division. The unit is responsible for reviewing credit risk of specific significant borrowers. The unit acts independently in accordance with Proper Conduct of Banking Business Directive No. 319 (“Loan Review”)

- The Credit Committee, which generally meets once a week, chaired by the General Manager.

- The Problem Loans Committee, chaired by the General Manager, convenes quarterly before the publication of the financial statements.



83

- The Internal Audit Function, which 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 various cross-sections, from management, supervisory and control functions. In addition, credit risk exposure is reported in comparison with approved facilities, to limits prescribed by the Board of Directors and the authorities for managing them in the framework of the quarterly “Exposures Document” as required in Directive No. 339 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 gross exposures to credit risk and gross average exposure during the period, classified by main types of credit exposure (NIS millions):


Type of exposure Gross credit

risks Gross average

credit exposure1

Gross credit risks

Gross average credit exposure1

Loans 4,791.53 4,787.83 4,597.52 4,701.72 Bonds 1,058.9 1,083.9 1,846.0 1,679.1 Derivatives (OTC) 212.6 315.7 383.3 406.8 Off-balance sheet exposures 1,656.1 1,708.3 2,381.5 2,417.5 Other assets 207.6 229.1 181.9 177.7 Total gross credit exposures 7,926.7 8,124.8 9,390.2 9,382.8

1 Gross average credit exposure is calculated based on average exposures for the last two quarters. 2 After specific and supplementary provision for doubtful debts. 3 Recorded debt balance before allowance for credit losses.



84

Total gross exposures to credit risk and gross average exposure during the period, classified by main types of credit exposure (NIS millions):

December 31, 2011

Impaired Loans

Past due loans

Balance of individual

allowances

Balance of collective

allowances

Corporations 20.0 0.2 - 14.1 Debts secured by commercial real estate - - - 0.3 Retail to individuals 0.1 - - 0.9 Total 20.1 0.2 - 15.3

Distribution of exposure by type of sector or by counterparty, classified by main types of credit exposure1 (NIS millions):

December 31, 2011 Type of exposure Sovereign Public

sector Banking

corporationsCorporations Secured by

commercial real estate

Retail to individuals

Mortgage Loans

Other Total

Loans 2,496.5 - 513.1 1,433.7 90.8 165.5 91.9 - 4,791.5

Bonds 899.5 19.8 37.9 101.7 - - - - 1,058.9

Derivatives (OTC) - - 33.4 176.2 - 3.0 - - 212.6

Off-balance sheet exposures - - 122.7 1,348.0 6.6 178.8 - - 1,656.1

Other assets - - - - - - - 207.6 207.6Total gross credit exposures 3,396.0 19.8 707.1 3,059.6 97.4 347.3 91.9 207.6 7,926.7

December 31, 2010 Type of exposure Sovreign Banking

corporationsCorporations Secured by

commercial real estate

Retail to individuals

Mortgage Loans

Other Total

Loans 2,044.0 793.6 1,581.4 57.6 83.4 37.5 - 4,597.5

Bonds 1,562.0 137.8 146.2 - - - - 1,846.0

Derivatives (OTC) - 62.1 320.9 - 0.3 - - 383.3

Off-balance sheet exposures - 151.8 2,209.8 6.1 13.8 - - 2,381.5

Other assets - - - - - - 181.9 181.9Total gross credit exposures 3,606.0 1,145.3 4,258.3 63.7 97.5 37.5 181.9 9,390.2

1 After accounting write offs and before allowance for credit losses.



85

Segmentation of the whole portfolio by contractual repayment period, classified by main types of risk Exposure1 (NIS millions):

December 31, 2011 Type of exposure

On demand

to one month

Over one month to

three months

Over three months to

one year

Over one year to three

years

Over three years to

five years

Over five years to ten

years

Total cash flows

Without repay-

ment date

Total

Loans 3,483.0 656.4 454.4 95.5 86.6 15.6 4,791.5 - 4,791.5

Bonds 24.3 - 67.6 96.9 35.5 834.6 1,058.9 - 1,058.9

Derivatives (OTC) 112.5 12.0 75.4 5.9 - 6.8 212.6 - 212.6

Off-balance sheet exposures - 1,566.0 - 90.1 - - 1,656.1 - 1,656.1

Other assets 123.0 24.1 - - - - 147.1 60.5 207.6

Total 3,742.8 2,258.5 597.4 288.4 122.1 857.0 7,866.2 60.5 7,926.7

December 31, 2010 Type of exposure

On demand

to one month

Over one month to

three months

Over three months to

one year

Over one year to three years

Over three years to

five years

Over five years to ten

years

Total cash flows

Without repay-

ment date

Total

Loans 2,954.3 916.7 559.1 85.9 53.9 6.7 4,576.6 20.9 4,597.5

Bonds 37.2 43.1 813.1 174.5 79.5 698.6 1,846.0 - 1,846.0

Derivatives (OTC) 247.9 40.6 7.4 80.8 4.0 2.6 383.3 - 383.3

Off-balance sheet exposures - 2,301.5 - 80.0 - - 2,381.5 - 2,381.5

Other assets 76.0 66.1 - - - - 142.1 39.8 181.9

Total 3,315.4 3,368.0 1,379.6 421.2 137.4 707.9 9,329.5 60.7 9,390.2

1 After accounting write offs and before allowance for credit losses.



86

Total balances (rated and unrated) before deduction of credit risk (NIS millions):

December 31, 2011

Type of exposure

Gross balance of exposure1

0% 20% 35% 50% 75% 100% 150%

Sovereign 3,396.0 3,310.5 85.5 - - - - -

Public sector 19.8 - - - 19.8 - - -

Banking corporations 707.1 - 613.0 - 92.7 - 1.4 -

Corporations 3,059.6 - - - - - 3,059.5 0.1

Secured by commercial real estate

97.4 - - - - - 97.4 -

Retail to individuals 347.3 - - - - 56.0 291.2 0.1

Mortgage loans 91.9 - - 91.9 - - - -

Other assets 207.6 79.8 - - - - 123.3 4.5

Total 7,926.7 3,390.3 698.5 91.9 112.5 56.0 3,572.8 4.7

December 31, 2010

Type of exposure


0% 20% 35% 50% 75% 100% 150%

Sovereign 3,606.0 3,417.2 188.8 - - - - -

Banking corporations 1,145.3 - 939.3 - 206.0 - - -

Corporations 4,258.3 - - - - - 4,231.6 26.7


63.7 - - - - - 63.7 -

Retail to individuals 97.5 - - - - - 97.5 -

Mortgage loans 37.5 - - 37.5 - - - -

Other assets 181.9 40.5 - - - - 137.3 4.1

Total 9,390.2 3,457.7 1,128.1 37.5 206.0 - 4,530.1 30.8

1 After accounting write offs and before allowance for credit losses. 2 After allowance for credit losses.



87

Total balances (rated and unrated) after deduction of credit risk (NIS millions):

December 31, 2011

Type of exposure


0% 20% 35% 50% 75% 100% 150%

Sovereign 3,396.0 3,310.5 85.5 - - - - -

Public sector 19.8 - - - 19.8 - - -

Banking corporations 724.4 - 598.7 - 124.3 - 1.4 -

Corporations 1,786.7 - - - - - 1,786.7 -


95.4 - - - - - 95.4 -

Retail to individuals 277.2 - - - - 54.8 222.3 0.1

Mortgage loans 89.9 - - 89.9 - - - -

Other assets 195.4 79.8 - - - - 111.1 4.5

Total 6,584.8 3,390.3 684.2 89.9 144.1 54.8 2,216.9 4.6

December 31, 2010

Type of exposure


0% 20% 35% 50% 75% 100% 150%

Sovereign 3,606.0 3,417.2 188.8 - - - - -

Banking corporations 1,160.2 - 954.2 - 206.0 - - -

Corporations 2,840.9 - - - - - 2,830.0 10.9


51.2 - - - - - 51.2 -

Retail to individuals 88.8 - - - - - 88.8 -

Mortgage loans 37.3 - - 37.3 - - - -

Other assets 155.0 40.5 - - - - 110.4 4.1

Total 7,939.4 3,457.7 1,143.0 37.3 206.0 - 3,080.4 15.0

1 After accounting write offs and before allowance for credit losses. 2 After allowance for credit losses.



88

Disclosure regarding exposures connected with counterparty credit risk (in NIS millions):

December 31, 2011

Collateral

Securities Type of exposure

Gross positive

fair value

Nominal amount

Amount of exposure1 Cash Government

TA-100 index

Exposure after

collateral

Interest derivatives - 93.2 1.3 - - - 1.3 Foreign currency derivatives 68.3 5,234.8 108.1 27.3 17.9 18.7 44.2

Share derivatives 51.6 3,703.4 103.2 32.0 10.4 37.7 23.1 Gold derivatives - 3.6 0.1 - - - 0.1 Commodity derivatives - 99.5 - - - - - Total 119.9 9,134.5 212.7 59.3 28.3 56.4 68.7

December 31, 2010

Collateral

Securities

Type of exposure

Gross positive

fair value

Nominal amount

Amount of exposure1 Cash Government

TA-100 index

Exposure after

collateral

Interest derivatives 0.5 468.5 2.7 - - - 2.7 Foreign currency derivatives 49.6 5,911.1 98.3 29.3 1.3 2.2 65.5

Share derivatives 84.0 5,725.5 282.2 167.7 31.6 50.0 32.9 Commodity derivatives - 203.0 0.1 0.1 - - - Total 134.1 12,308.1 383.3 197.1 32.9 52.2 101.1

1 The amount of exposure = AGROSS which is nominal amount x add-on (addition coefficient) + fair value as per standardized approach. Transactions traded on Stock Exchange are calculated in accordance with Stock Exchange collateral requirements.



89

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. In the framework of ongoing business activity, the Bank is exposed to the risk deriving from exposure to credit to foreign financial institutions. This risk is reflected in a range of activity with financial institutions such as transactions carried out in the dealing rooms of the Bank – depositing foreign currency balances and derivatives, and activity in the capital market. Foreign financial institutions include foreign banks and brokers. The exposure to foreign financial institutions is influenced both by the specific condition of each institution, and the risk of the country where it operates. The Bank’s activity with financial institutions, including the determining of authorities and criteria for compliance with frameworks for activity, are set out 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. For purposes of quantifying and assessing counterparties, the Bank relies on the parent company, and makes use of an internal model weighting the risk inherent in transactions according to risk characteristics – the type and characteristics of the risk, the term of the transaction and so on. The Bank takes steps to minimize counterparty risks by means of several acceptable agreements for minimizing exposure with third parties (Netting Agreements).



90

- 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 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, aftercalculation 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 about 22 banks, and CSA agreements with about 15 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.

- As of 10.2.11, the Bank began executing settlement through the CLS. As part of the minimizing of

settlement risks, the Bank settles most of its transactions by way of the CLS clearing system, for those currencies and transactions participating in 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.



91

c. Current credit exposure of the Bank to foreign financial institutions1 as at 31.12.11:

External credit rating4

No. of institutio

ns

Balance sheet

credit risk2

Off-balance

sheet credit risk3

Total credit risk

NIS millions NIS millions NIS millions

Credit exposure to foreign financial institutions AAA to AA- 12 164.8 24.3 189.1 A+ to A- 17 370.3 1.3 371.6 BBB+ to BB-* 2 1.4 - 1.4 Not rated** 2 23.1 - 23.1 Total credit exposure to foreign financial institutions 33 559.6 25.6 585.2

Balance of problematic debts5 - - - - Credit exposure of the Bank to foreign financial institutions1

as at 31.12.10:

External credit rating4

No. of institutio

ns

Balance sheet

credit risk2

Off-balance

sheet credit risk3

Total credit risk


Credit exposure to foreign financial institutions AAA to AA- 17 296.2 47.4 343.6 A+ to A- 14 480.1 - 480.1 BBB+ to BB-* 3 16.0 - 16.0 Not rated** 2 11.3 - 11.3 Total credit exposure to foreign financial institutions 36 803.6 47.4 851.0

Balance of problematic debts5 - - - - 1 Including banks and brokers. 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 4.1.12 for data at 31.12.2011 (for data at 31.12. 2010 the ratings are correct as at 11.1.2011). 5 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 of NIS 0.1 million is in respect of a deposit of a bank in Hungary rated BB (as at 31.12.2010 – NIS 0.1 million) and NIS 1.3 million is in respect of a deposit in a bank in South Africa rated BBB. As at 31.12.2010, credit risk included NIS 9.4 million in respect of a deposit in a European bank rated BBB, and NIS 6.5 million in respect of a bond of a European bank rated BBB. ** Exposure relating to unrated private European banks.



92

The institutions included in the disclosure are foreign banks and brokers. In the framework of the routine activities of the Bank with these institutions, the Bank allocates credit lines to a range of activities, including deposits, bonds, forward contracts, clearing and guarantees. Below is a list of countries where there is an exposure for the Bank and related overall credit risk:

Country Overall credit risk

31.12.11 31.12.10

NIS million NIS million U.S.1 216.8 182.1 Norway 110.9 72.0 Germany 93.8 36.5 Switzerland 41.4 216.3 U.K. 37.5 156.0 France 25.0 126.9 Australia 14.6 5.2 New Zealand 13.5 14.4 Belgium 12.7 8.3 Canada 9.1 20.9 Denmark 4.5 - Korea 3.8 - South Africa 1.3 - Sweden 0.2 1.1 Hungary 0.1 0.1 Ireland - 6.5 Spain - 0.3 Poland - 4.4 Total 585.2 851.0

1 On 5.8.11, the S&P rating agency lowered the credit rating of the US government from AAA- to AA+. 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. 32% 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 64% 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.



93

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 that 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 light of this, deposits in foreign banks are made for in the short term only. The duration of deposits in foreign banks is less than a month. 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 a settlement standard) is performed daily by the Risk and Credit Management Department (Middle Office). Balance sheet credit risk includes approx NIS 485.4 million of deposits with banks, the majority of which have been repaid and the funds re-deposited. Furthermore, this credit risk includes NIS 48.7 million of bonds of banks, which have a high rating and whose residual duration is 4.5 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 to the public 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 101.1 million. Notes: 1. Credit exposures do not include exposures to financial institutions that have the full and explicit

guarantee of governments, and do not include investments in asset-backed securities (see details in Note 4 – Securities).

2. For further details about the composition of credit exposures in respect of derivative instruments with banks and dealers/brokers, see Note 16.A.

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.



94

k. Environmental Risk Management

In the second half of 2009, the Supervisor of Banks issued a directive about exposure to environmental risks and how to manage them. The directive of the Supervisor describes various aspects of potential exposure to environmental risks, highlighting the need for early identification of the risks, their evaluation and management as specific risks. It is clarified that banking corporations are expected to maintain a risk management system that will include procedures and tools to identify risks when granting credit and throughout the credit life cycle.

The criteria and timetables for implementing the directive of the Supervisor are determined at Group level with the Bank having a representative in the Group Steering Committee. As part of Group preparations for implementation of the guidelines of the Supervisor on the subject, it is assisted by external consultants, and intends in the future to implement an overall Group methodology for environmental risk management, to include characterization of sectors and setting policy branches for extending credit to customers. Bank Management and the Board of Directors have approved the outline for implementing the directive.

l. Significant exposures to groups of borrowers

Below is a disclosure regarding the credit risk for significant exposures to groups of borrowers.

The disclosure is made with respect to every group of borrowers whose net indebtedness on a consolidated basis, after deducting allowable deductions under section 5 of Directive 313, exceeds 15% of the capital of the Bank.

Balance sheet credit risk1

Off-balance sheet credit risk

Total credit risk

Allowed deductions

Net indebtedness

NIS millions NIS millions NIS millions NIS millions NIS millions Group A 25.1 96.2 121.3 15.9 105.4 1 After net accounting write offs and after the allowance on an individual basis and including investment in securities and fair value in respect of derivative instruments. Credit to significant groups of borrowers is granted in accordance with the overall credit policy of the Bank. In addition to examination of loans according to regulatory limits, the Bank has set internal limits in its credit policy that take into account the group's credit rating and its exposure characteristics. Credit to groups of borrowers is granted for capital market and foreign currency activities and is for the most part secured by liquid collateral such as securities and deposits, that are revalued based on market value. The abovementioned loans are checked daily while maintaining online control in a number of control cycles, with collateral being checked on the basis of market value. The group of borrowers shown is a financial group active in the capital market and fully secured by financial assets.



95

6. Risk Management in Derivative Financial Instruments The Bank is active in a variety of derivative financial instruments, as part of market risk management (basis, currency, and interest exposures), and as a service to its customers. 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 basis or interest exposures, 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 total activity in derivative financial instruments (nominal value):

31.12.2011 31.12.10 NIS million NIS million Hedging transactions: Interest contracts 57.4 149.1 ALM and other transactions: Interest contracts 35.8 319.4 Foreign exchange contracts (including Spot) 6,751.0 7,205.7 Contracts for shares, share indices, commodities and others 7,495.3 11,852.9 Total derivative financial instruments 14,339.5 19,527.1

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 to carry out 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.



96

7. Exposures to Foreign Countries Total exposure to foreign countries is detailed in Addendum F to the Management Review. The exposure to foreign countries includes deposits, bonds, credit to the public, and the fair value of financial instruments. Compared with 31.12.2010, there was an increase in deposits in foreign banks and a decrease in investment in bonds in foreign banks deriving from sales and redemptions of these bonds. This decrease was partially offset by a rise in the fair value of derivative financial instruments 8. 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 a separate section).

- The definition of operational risk includes embezzlement and fraud, work practices and the work environment, and customer, product and business practices, damage to physical assets, business disruptions and system breakdowns, communications-related errors in carrying out, distributing and managing processes.

- Operational risks are inherent in all activities and working procedures in the Bank, in the range of products and systems, and, as a result, the management of operational risk is an integral part of the management of its business activity.

- The Bank views operational risk management as an integral part of the management of its business activity.

The Bank takes steps for the early identification of focal points of exposure to operational risk, the assessment of the exposure to risks, the minimizing of the risks by means of applying preventive controls, and carrying out stringent monitoring of its implementation.

- The Operational Risks Manager, Management of the Bank, and the parties responsible for the various areas of activity, in coordination and cooperation with external experts, make great efforts to improve existing tools for measurement, supervision and control in the Bank, with the aim of minimizing operational risks in the various areas.

- The Bank has made preparations for the constant improvement of the control environment and organizational frameworks for operation risk management, in accordance with the “Sound Practices” of the Basel Committee that were adopted by the Bank of Israel.

b. Policy - The Board of Directors of the Bank has determined a comprehensive overall policy for the

management of operational risk that determines the risk appetite and outlines the activity of the control environment. The organizational frameworks and managerial functions work toward managing and minimizing the exposure to operational risks. Furthermore, mechanisms are established in the policy framework for identifying and assessing risks, control, monitoring and follow-up, and reporting functions.

- The Board of Directors of the parent company has appointed a Group Operational Risks Manager who is responsible, by means of the Operational Risk Management Department, for formulating and implementing the policy for operational risk management approved by the Board of Directors, instructing to the various units in the Group, establishing standards for monitoring, reporting and control, and implementing and assimilating the policy in the Group.



97

c. Supervision and control of managing the exposure to operational risks The Bank maintains an appropriate deployment of control, management, supervision, and audit

mechanisms on the operational risk management process. Management of exposure to operational risks is examined and audited by the Board of Directors, Management, and middle management. The following parties take part in the management process:

- The Board of Directors of the Bank outlines once a year the overall exposure policy to operational risks, including, inter alia, the standards for managing, measuring, controlling, and reporting the exposure to operational risks.

- Once a quarter, a discussion takes place in the Board of Directors and Management of the overall exposure document of the Bank, in the framework of which a report is made of the Bank’s activity in managing operational risks.

- The Operational Risks Manager, responsible for maintaining the operational risk management policy, reports to the Chief Risks Manager of the Bank.

- Reporting to the Operational Risks Manager is an employee coordinating operational risks management activity in the Bank. In the divisions and subsidiary companies, a business processes officer and operational risks officers have been appointed to monitor exposure to operational risk on a routine basis, and give reports to the manager and area coordinator.

- The Bank maintains an Operational Risks Forum headed by the Chief Risk Manager, which is the forum designated to handle operational and legal risks.

- The Bank maintains a Risks Monitoring and Management Committee headed by the CEO, whose aims are the monitoring of risks and their management.

- The Internal Audit function of the Bank integrates the auditing the subject of operational 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 processes and procedures for managing risks in the Bank, and 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 processes.

d. Reporting Operational Risk Exposures

The Bank’s activity in managing exposure to operational risks is reported in the quarterly “Exposures Document”, as required under Proper Conduct of Banking Business Directive No. 339. In the context of the document are described operational exposures both by the categories set out by Basel II according to the organizational structure, and in accordance with the risk appetite determined by the Board of Directors, events of failure, the activities of the Bank for reducing risk exposure, such as operational risk surveys, monitoring risk indicators, training, and more.

e. Management of Operational Risk - Operational Risk Surveys

The main tool for identifying exposure to operational risks is surveys carried out by external specialists and consultants. A survey is a structured process of mapping and identification of operational risks in the processes taking place in the different units in the Bank. 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



98

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, technological improvements of the systems, etc.

- Key Risk Indicators

The Bank and the subsidiary companies have completed the process of indicators for identifying risks and threshold values for identification. Monitoring the indicators takes place on a routine basis, and is reported once a quarter in the framework of the Exposures Document. Key indicators provide the Bank with a tool for monitoring and pro-active management of operational risk.

- Collation and reporting of events of failure and loss

The Bank collects and documents internal events of failure, in which there is an event of monetary loss, or almost an event of monetary loss, according to reporting thresholds approved by the Board of Directors of the Bank and FIBI. This database is used for the verification of assessments by content specialists in evaluating operational risks in business processes and organizational units due to the risk-exposure rating, for long-term analysis and identification of trends, and for reporting. The collection 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 FIBI 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. 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 set business continuity policy and strategy, mapped critical processes, defined emergency procedures and working teams.

- The Bank has an emergency recovery site. The Bank takes action on an ongoing basis to prepare the emergency site, and conduct practice drills with the employees for purposes of moving to the site in emergency.

- A forum for business continuity and disaster recovery in the Bank, headed by the Chief Risks Manager, meets at least once in each quarter.

The forum is entrusted with promoting and monitoring the Bank’s deployment for business continuity in an emergency, in accordance with the policy and strategy of the Bank, and the instructions of regulatory bodies. Representatives from the Bank participate in the Group forum for business continuity and disaster recovery.



99

f. 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 CEO 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. In addition, the Bank appointed the manager of the Data Security Department in Mataf as the officer responsible for data security in the Bank, while adopting the policy principles of the parent company, FIBI, in the matter. 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.

g. 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 by 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 proficiency, breach of faith towards the 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.



100

9. 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. Consumer obligations applying to the Bank are organization-wide obligations for a wide range of activities, processes, and products that the Bank carries out every day.

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 Vice President, the Manager of the Headquarters Division, and Chief Risks Manager, who is not a business function.

Reporting to the Compliance Officer are a Compliance Coordinator and 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 Compliance Officer Committee that includes representatives from the various Bank units (Legal Department, Regulation and Processes Department, Human Resources and Administration Department, the Bank Secretary, a representative of Internal Audit, the Risk Management Department, a representative of the principal branches, a representative of the branches for affluent 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 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.



101

- At least once every five years, the Bank and the subsidiary companies conduct an infrastructures survey, the purpose of which is to make sure that the Bank is indeed appropriately prepared to implement its obligations deriving 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 Risks Management Department and the Credit 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 Headquarters Division and branches, given independently or based on the Group training system.

- The Bank’s Compliance Officer is responsible for following up the appropriate handling of customer complaints.

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. 10. Risks relating to the prohibition of money laundering and the finance of terrorism a. General

Risks relating to the prohibition of money laundering and the finance of terrorism (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 including the Amended Directive as published in January, 2011.

b. Policy

The Board of Directors of the Bank approves the policy document once a year.



102

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 the representative in the Bank for the prohibition of money laundering, and reporting to him are the Coordinator for Prohibition of Money Laundering, and Branch/Departmental Compliance and Prohibition of Money Laundering Officers (hereinafter: “the 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. The Bank fully assimilated the controls, tools, and procedures defined by the officer appointed by the Group.

- The 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 for branches for affluent individuals/Division Manager.

- Every half a year, the Regulation and Processes Department Manager holds a conference for the officers attended by subsidiary companies, the Credit Department officer, the Mnager of the International and Reconsiliations Department, and the Area Manager, in addition to seminars coordianted by the Training Department of the Group. From time to time as required, conferences for managers, and employees of new branches (prior to their opening), and lectures are held 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 distributes programmed teaching material for checking the assimilation of the content of the teaching material by 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 takes steps on a regular basis to locate and improve data by means of control reports distributed to the branches together with the appropriate instructions and aoded by the Actimize System for monitoring extraordinary activity in accounts.

- 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.



103

e. Reporting exposure Once a quarter, the officer appointed for the Prohibition of Money Laundering reports to Management of the Bank on activity during the past quarter. 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. In addition, the policy set by the Board of Directors provides definitions for immediate reports to the Board of Directors and the Bank of Israel.

11. Legal Risks a. General 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, based on Group policy on the matter. The policy 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 takes steps 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 Headquarters 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. Material events as mentioned above are reported to the CEO of the Bank.

e. 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.



104

Discussion of Risk Factors Below is a table summarizing risk factors and the degree of their effect (high, medium, low):

Risk Factor Risk Effect 1. Overall effect of credit risk Low 1.1 Risk in respect of quality of borrowers and collateral Low 1.2 Risk in respect of sectorial concentration Medium 1.3 Risk in respect of single borrower/group of borrowers’ concentration 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. Operational risk Medium 5. Legal risk Low 6. Reputational risk Low Other risks relevant to the banking corporation: 7. Legislation and Regulatory risk Medium 8. Competition and Strategy risk Medium

Below are explanations for the 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 low risk level.

1.1 Risk in respect of the quality of borrowers and their securities - low 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 facilitates rapid evaluation and response in the event of changes. At December 31, 2011, the balance of impaired debts amounted to NIS 30.4 million, which is 0.8% of balance sheet and off-balance sheet credit. This is a substantially lower rate than usual in the banking system. In 2009-2011, the Bank recorded income under the heading of Income in respect of Credit Losses.



105

1.2 Risk in respect of sectorial concentration - medium effect.

Risk caused by the exposure of a relatively high level of credit to a certain sector or area of activity, emanating from a lack of sectorial 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, 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 limits set by the Bank of Israel, regarding exposure to each sector. Credit to most of its customers in the financial sector is mostly secured by financial collateral, 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 on Restrictions and Supervision of the Bank’s Activities).

1.3 Risk in respect of the concentration of borrowers/group of borrowers - medium risk effect.

Risk caused by 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.

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.

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. Generally, the Bank keeps to a policy of matching, as far as possible, the dates of repayment or interest adjustment of assets and liabilities in each of the linkage sectors and taking positions in accordance with the risk appetite set by the Board of Directors. For further information - see the chapter dealing with interest-rate exposure in the framework of the Risk Management Policy. Because of the low level of interest in Israel and worldwide, the effect of this risk factor was determined as 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.



106

The Bank maintains a low exposure to changes 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 a 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 effect of this risk is small as the Bank has a small investment in shares.

3. 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 with the Bank of Israel and government bonds). For additional information-see the chapter on liquidity, included under Risk Management Policy.

4. Operational risk - medium risk effect.

For information on the Bank’s operational risk, see the chapter on operational risks included under Risk Management Policy.

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. Reputational risk - low risk effect.

As a small bank operating mainly in the capital market and private banking, there is great importance in the reputation of the Bank in the eyes of its customers, so that damage to its reputation 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.



107

The level of this risk is medium, as a small bank specializing in the capital market, the effect of legislation and regulation is likely to be material.

8. Competition and Strategy Risk - medium effect.

Competition risk derives from the exposure of the Bank to competition in Israel in all areas of banking business in which it engages. In addition, the Bank deals with additional competitors who provide alternative financial tools to those it offers, such as insurance companies and portfolio managers, which can lead to customers migrating to these entities, moving their activity, or the selective purchasing of services from different vendors. There is also a risk of erosion in profitability due to competitive pressure to reduce the level of commissions and interest margins. Strategy risk strategy derives from wrong business decisions, improper implementation of decisions or lack of response to sectorial, economic, or technological changes. The risk stems from, among other things, from entering into new areas, expanding existing services, mergers and acquisitions, and increasing investment in infrastructure, in order to exercise business strategy. This risk is a function of the correlation between the Bank's strategic objectives, business plans developed to achieve these objectives, resources allocated to meet these objectives, and the quality of their implementation. In view of the Bank's focus in capital market-based activity and the Bank's entering initiatives to expand into banking for affluent customers, the effect of this risk is estimated as medium.

In addition to the risks mentioned above, the Bank's financial results and performance is directly affected by the economic situation in Israel. Deterioration in the economic conditions in Israel, and/or deterioration of political and/or security conditions may have an impact on the income and capital of the Bank. The main activities of the Bank are in Israel. Therefore, economic recession, significant exit of foreign investment that were invested over the last few years, a significant economic slowdown and/or a decrease in the standard of living in Israel may have a significant impact on the results of the Bank. Economic recession may increase the amount of problematic debt and reduce capital market activity cycles.



108

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 of the need to estimate the influence of matters that by their nature are uncertain. Below are critical subjects as mentioned above, in respect of which accounting policy should be understood in order to understand the Bank’s reported results. In each of these critical subjects, Management used the most professional 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. The said critical subjects, in respect of which accounting policy should be understood in order to understand the Bank’s reported results, are the measurement and disclosure of impaired debts and the allowance for credit losses, the valuation of investment in securities, estimating the fair value of derivative financial instruments, the fair value of financial instruments, impairment of assets, and liabilities in respect of legal claims. Below is the accounting policy that has been adopted with regard to these subjects: 1. Measurement and disclosure of impaired debts and the allowance for credit losses As of January 1, 2011 the Bank implements the new directive of the Banking Supervision Department on the Measurement and Disclosure of Impaired Debts, Credit Risk, and the Allowance for Credit Losses. Accordingly, the Bank's accounting policy on the subject is presented below: Credit to the public and other debit balances The Directive applies to all debt balances, such as bank deposits, bonds, securities borrowed or purchased under agreements to resell, credit to the public, credit to the Government and so on. Credit to the public and other debt balances for which no specific were established in the Public Reporting Directives regarding the measurement of the allowance for credit losses (such as credit to the Government, bank deposits, etc.) are reported in the Bank's books at the recorded balance of debt. The recorded balance of debt is defined as outstanding debt, net of accounting write-offs, but before deduction of an allowance for credit losses for the same debt. The recorded balance does not include accrued interest that was not recognized, or that was recognized in the past and then canceled. It should be noted that before January 1, 2011, the Bank applied different rules, according to which the outstanding debt in the Bank's books included the interest component accrued before the debt was classified as a problem debt not accruing income. In light of this, loan balances reported in periods prior to the period of first-time implementation of the Directive are not comparable to loan balances reported after the commencement of its implementation. With regard to other debt balances, for which there are specific rules regarding the measurement and recognition of a provision for impairment (such as bonds), the Bank continues to implement the same standards of measurement. Allowance for credit losses The Bank established procedures, based on the existing procedures of the parent company, First International Bank, for credit classification and measurement of the allowance for credit losses, to maintain a provision at a level appropriate to cover expected credit losses with respect to its credit portfolio. In addition, the Bank established procedures required to maintain, as a separate liability account, the provision at a level appropriate to cover expected credit losses related to off-balance sheet credit instruments (such as derivatives, unutilized credit facilities and guarantees).



109

The allowance to cover expected credit losses with respect to the credit portfolio is estimated in one of two tracks: the "individual provision" and the "collective allowance". In addition, the Bank examines the overall adequacy of the allowance for credit losses. Individual allowance for credit losses - the Bank chose to select for individual examination debts whose contractual obligation is over NIS 1 million (the contractual liability is measured as a balance sheet debt with the addition of any unutilized current account facility and any exposure to futures transactions and guarantees of the customer). The individual allowance for credit losses is recognized for any debt that was classified as impaired. Debt is classified as impaired when, based on information and current events it is expected that the Bank cannot collect all amounts due to it under the contractual terms of the loan agreement. In any event, a debt is classified as an impaired debt when principal and interest in respect of it are in arrears of 90 days or more, unless the debt is well secured and it is under collection procedures. In addition, any debt whose terms were changed in a problem debt restructuring will be classified as impaired debt, unless prior to the restructuring and thereafter a minimal allowance was made in its respect for credit losses according to the extent of the arrears, in accordance with the Appendix to Proper Conduct of Banking Business Directive No. 314 on Problem Debts in Housing Loans of a Mortgage Bank. The individual allowance for credit losses is estimated based on expected future cash flows, discounted at the original effective interest rate of the loan. When the debt is contingent upon collateral or when the Bank determines a seizure of an asset is expected, the individual allowance is estimated based on the fair value of the asset pledged to secure the debt. Collective allowance for credit losses – this is calculated to reflect a provision for impairment in respect of unidentified individual credit losses inherent in large groups of small debts with similar risk characteristics, as well as for debts examined individually and found to be unimpaired. The allowance for credit losses in respect of debts valued on a collective basis, is calculated in accordance with rules prescribed by FAS 5 (ASC 450) – Accounting Treatment of Contingencies, based on a formula specified in a provisional directive determined by the Supervisor of Banks that is in effect until and including December 31, 2012. The formula is based on historical loss rates in different industries, divided between problematic credit and non-problematic credit, in 2008, 2009, 2010 and 2011, and the rates of net accounting write-offs actually recorded from January 1, 2011. In addition to calculating the range of historical rates of loss in different sectors of the economy as mentioned, so as to determine an appropriate rate for the allowance, the Bank takes into account additional data, including trends in the volume of credit in each sector and sectorial conditions, macroeconomic data, a general evaluation of the quality of credit to the sector of the economy, changes in volume and in the trend of balances in arrears and impaired balances, and the effects of changes in credit concentrations. The Bank bases itself on historical loss rates in various industries, as calculated for FIBI, the parent company. In accordance with the guidelines set out in the provisional directive, starting from January 1, 2011, the Bank does not maintain a general and supplementary provision, but continues to calculate the supplementary provision while checking that in any event the amount of the collective allowance at the end of each reporting period is not less than the amount of the supplementary provision that would have been calculated at that date, gross before tax. The allowance required with respect to off-balance sheet credit instruments is evaluated in accordance with rules prescribed by FAS 5 (ASC 450). The allowance estimated on a collective basis for off-balance sheet credit instruments is based on rates of allowance established for off-balance-sheet credit (as described above), taking into account the expected rate of realization of off-balance sheet credit risk. The rate of realization of credit is calculated by the Bank based on credit conversion coefficients, as set out in Proper Conduct of Banking Business Directive No. 203 – Measurement and Capital Adequacy – Credit Risk – The Standardized Approach.



110

Recognition of income A the time the debt is classified as impaired, the Bank defines the debt as a debt that does not accrue interest income and stops accruing interest income in respect of it, except as stated below regarding certain debts that were rescheduled. Also, at the time of classification of the loan as impaired, the Bank cancels all interest income accrued but not yet collected, and which was recognized as income in profit or loss. The debt continues to be classified as debt does not accrue interest, so long as its classification as an impaired debt has not been canceled. A debt which formally underwent a problem debt restructuring, and after the problem debt restructuring there is reasonable assurance that the debt will be repaid in accordance with its new terms, will be treated as an impaired debt accruing interest income. For debts examined and provided on a collective basis, which are in arrears of 90 days or more, the Bank does not stop the accumulation of interest income. These debts are subject to evaluation methods for an allowance for credit losses that ensure that the Bank's profit is not overstated. Problem debt restructuring A debt which formally underwent a problem debt restructuring is defined as a debt in respect of which, for economic or legal reasons related to financial difficulties of the debtor, the Bank granted a waiver by way of modification of the terms of debt to alleviate the burden of cash payments on the debtor in the near term (reduction or postponement of payments in cash required from the debtor) or by way of receiving other assets in repayment of debt (in part or in full). Restructured debts, including those that prior to restructuring were examined on a collective basis, shall be classified as impaired debt and evaluated on an individual basis for making an allowance for credit losses, or an accounting write-off. In light of the fact that that the debt for which the problem debt restructuring was carried out will not be repaid in accordance with its original contractual terms, the debt continues to be classified as impaired debt even after the debtor returns to a repayment schedule in accordance with the new conditions. Accounting write-off The Bank makes an accounting write-off of all or part of a debt evaluated on an individual basis that is considered as non-collectible and with a value so low that its remaining as an asset is not justified, or a debt for which the Bank is making long-term collection efforts (often defined as a period exceeding two years). For debts evaluated on a collective basis, write-off rules were established based on their period of arrears (in most cases over 150 days of continuous arrears) and other problem parameters. It is to be noted that write-offs do not involve legal waivers or reduce the debt balance reported for accounting purposes only, while creating a new cost basis of the debt in the books of the Bank. 2. Valuation of investment in securities According to the accounting rules applicable to banking corporations, securities in the financial statements appear as follows: Trading securities - appear 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 (quoted and unquoted) and quoted shares appear 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, except in the event of impairment of a nature other than temporary. In such cases, these losses are changed to the statement of profit and loss. Unquoted shares appear in accordance with their adjusted cost. The majority of the securities that the Bank holds are quoted 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 quoted the present value of future cash flows is used.



111

The value of bonds of foreign banks is based on quotations from an international supplier of prices outside 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. Calculations of the fair value of unquoted Israeli bonds are made by the Middle Office unit for nostro activity. The Middle Office unit is an entity independent of the business entity carrying out operations. In addition, evaluating and validating fair value is carried out by the Risk Monitoring Committee, and a party acting on its behalf, on a quarterly basis. In accordance with Bank of Israel directives, an arbitrator was appointed, whose role is to arbitrate if there is a dispute in respect of fair value calculations between the party determining fair value and the validating party. 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. Below is 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 (in NIS millions):

Decrease of 1% Increase of 1% Change in fair value 2.6 (2.2)

3. Estimating the fair value of derivative financial instruments The Bank operates in the area of derivative financial instruments, whose presentation in the financial statements 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, is 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 Management Department of the Bank, based on market prices, liquidity and marketability in the domestic market. The margin between 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 purchased 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 worldwide (the Bloomberg system). Calculations of the fair value of derivative financial instruments are made by the Middle Office unit, which belongs to the Risk Management Department. Further reasonableness tests and controls on the



112

calculation of fair value are carried out by the Accounting Department. Evaluating and validating fair value is carried out by the Risk Monitoring Committee, and a party acting on its behalf, on a quarterly basis. In accordance with Bank of Israel directives, an arbitrator was appointed, whose role is to arbitrate if there is a dispute in respect of fair value calculations between the party determining fair value and the validating party. 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, and otherwise (NIS millions):


Prices quoted in anactive market

(Level 1)

Other observable

data (Level 2)

Total

Prices quoted in an active market

(Level 1)

Other observable

data (Level 2)

Total

Financial assets 3,659.9 205.1 3,865.0 13,827.8 392.4 14,220.2

Financial liabilities 1,403.8 32.3 1,436.1 1,459.6 80.6 1,540.2

1 Restated 5. Impairment 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. The impairment of securities available for sale in the Nostro portfolio is examined in accordance with a procedure approved by 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 responsible for Credit, the Manager of the Risks Management Department, the Manager of the Finance Division, and the Chief Accountant (as observer) (with regard to changes in the duties of the Manager of the Headquarters Division in 2011, see the chapyer of Risk Managemant Policy – General). The function of the committee is to examine if impairment is of an other than temporary nature that has to be recorded in profit and loss. Securities 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;



113

- 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 an amount exceeding 40% (for debentures - adjusted cost) and whose fair value is less than the value at which it was purchase for three consecutive quarters. 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; - 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 up to restoration of the cost 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; 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 amount of reduction is charged to the statement of profit of loss. Increases in value in subsequent reporting periods are recognized in a separate item in shareholders’ equity under total other accumulated profit and is not charged to profit and loss (the new cost basis).

6. 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 evaluation 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 might be different from the provisions made.

Community Activities and Donations In 2011, the Bank began its activities with the Lilach Voluntary Association. The Lilach Voluntary Association works to make a difference in the lives of children at risk and their families, through clubhouses it operates around the Tel Aviv – Jaffa area, which provide a warm and loving home for the children and the families. The Association’s clubhouses are a complementary framework that allows children to receive the basic conditions they deserve - attention, help with homework, kindness, a hot meal - without taking them far away from the family environment. The Bank has adopted a clubhouse of the Association in the Neve Sharett neighborhood, and in addition to financial support, employees of the Bank take part in various clubhouse activities, and clubhouse children are invited to welfare activities in the Bank that are appropriate to them. Total donations for 2011 amounted to NIS 225 thousand.



114

Disclosure with regard to the Internal Auditor of the Bank Ms. Yael Ronen, CPA, serves as the Chief Internal Auditor of First International Bank since May 2011, and as Internal Auditor of all banking companies in the FIBI Group. The term of office of Ms. Yael Ronen, CPA, is in effect from 23.5.11. For the period until 18.3.2011, Mr. Nir Arbel, CPA, held the position (in which he served since May 2006), and in the period between 19.3.2011 and 22.5.2011, Mr. Kobi Ben Shoushan, Deputy Internal Auditor, served as acting internal auditor. Details of the Internal Auditor The Internal Auditor has a B.A. in Economics and Psychology, and graduate studies in Accountancy from Tel Aviv University. In her previous positions, she managed the SOX Department at Clal Insurance Co. Ltd., and was Manager of the Information Systems Risk Management Department at the KPMG accounting firm, with emphasis on audit and consultancy activities in the area of banking. The Internal Auditor is an employee of First International Bank and complies with the provisions set out in section 3(a) of the Internal Auditing Law. The Internal Auditor and her 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 of the Bank on 7.4.11 and the Board of Directors on 10.4.11. 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 (4-5 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 2011 was a result of a number of varying factors that 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. Material changes in 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 engaged in internal audit in UBank was about 4.3. 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.



115

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. Report of the Chief Internal Auditor The Internal Auditor reports to the Audit Committee on everything concerning working procedures and internal procedures. 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 reports, and semi-annual and annual summary reports). 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 24.2.11, the audit activity summary report for 2010 was discussed in the Audit Committee; on 27.9.11, the audit activity summary report for the first half of 2011 was discussed in the Audit Committee; and on 12.1.12, the audit work plan for 2012 was discussed. Evaluation of the Activity of the lnternal 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. In the opinion of the Board of Directors of the parent company, the auditor’s remuneration is appropriate for her position. And in the opinion of the Board of Directors, the auditor’s remuneration does not cause for any bias in the auditor’s professional judgment.



116

The Approval Process for the Financial Statements The officers engaged in preparing the Bank’s financial statements are the General Manager of the Bank, Mr. Ron Bedny, and the Chief Accountant, Ms. Orit Itzcovitch. The body responsible in the Bank for overall control is the Board of Directors of the Bank. The Board of Directors has appointed an Audit Committee, which holds preliminary detailed discussions on the financial statements. The Audit committee is chaired by an external director. In accordance with the decision of the Board of Directors, it is a requirement that at least two directors with accounting and financial expertise serve on the Board of Directors and on the Audit Committee. Currently, 4 out of 7 members of the Board of Directors and 2 out of 3 members of the Audit committee actually have accounting and financial expertise. The discussion takes place with the participation of the General Manager, the Chief Accountant, and the external auditor of the Bank. At the Audit Committee, as well as the Board of Directors when they are discussing and approving the financial statements, 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 Audit Committee and the members of the Board of Directors for any question or clarification before their approval. The Audit Committee gives its recommendations to the Board of Directors with regard to the approval of the financial statements a reasonable time before the discussion in the Board of Directors, and reports to it on any weakness or problem insofar as these come to light during the examination. In accordance with the provisions of SOX 302, the Disclosure Committee is convened quarterly, headed by the General Manager and the participation of the Chief Accountant and with the participation of the Chief Accountant, heads of divisions and departments reporting to the General Manager and / or the Board of Directors, the Chief Disclosure Coordinator , and the external auditor of the Bank. The Disclosure Committee discusses significant issues that potentially have an impact on the data of the financial statements, and deficiencies found in the control function over financial reporting, and the following up of corrections of those deficiencies. Before the financial statements are presented for plenary discussion, preliminary discussions are held regarding them by Bank Management, the Disclosure Committee, and with the participation of the General Manager, the Chief Accountant, and the external auditor of the bank, in which a discussion is held on material issues, insofar as these have arisen, in the preparation of the the financial statements and the accounting policies that are to be implemented. On a quarterly basis, the Audit Committee of the Board of Directors holds a discussion on impaired debts and the allowance for credit losses, for purposes of approving them and provisions for impairment in the Nostro portfolio before bringing the financial statements for approval by the Board of Directors. The discussion takes place with the participation of members of the Audit Committee and the General Manager, the Chief Accountant, and the external auditor of the Bank. In the framework of the approval process of the bank’s financial statements, the draft Financial Statements of the Bank, and the Directors’ Report, are handed for review to the members the Audit Committee and to the Board of Directors as required, before the date of 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. In the meeting of the Board of Directors at which the financial statements are discussed and approved, the General Manager of the Bank gives a detailed review of the major points of the financial statements as well as material issues in the financial reporting. 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.



117

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 to approve the Financial Statements of the Bank, and to authorize the Chairman of the Board of Directors, the General Manager and the Chief Accountant to sign the 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, which conducts in-depth discussions on the statements before they are brought for the Board of Directors’ approval. 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 allow them an in-depth understanding of financial statements of banking corporations: Mr. Jack Elaad has a Masters Degree in Business Management and a Bachelors degree in Economics. Mr. Elaad served as Chairman of the Board of Directors of the Bank and CEO of FIBI Bank (U.K.) Ltd and as a director of FIBI. Mr. Elaad serves as the Chairman of the Board of Directors of First International Bank, and is engaged in financial consultancy. In addition, he serves as Chairman of the Board of Directors and General Manager of Sadot Research & Development Fund Ltd Mr. Elaad served as Chairman of the Risk Management Committee. Mr. Jack Elaad ended his term of office as Chairman of the Board of Directors of UBank on December 18, 2011. On that date the Board of Directors appointed Mr Yoram Sirkis as Chairman of the Board of Directors commencing that date. 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., and Chairman of the Board of Directors of BSSH Israel Credit Insurance Company Ltd. Mr. Blumberg is a member of the Risk Management Committee and the Salary and Remuneration Committee.



118

Mr. Ben Zion Israel is a certified public 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 that discussed the financial statements of Tadir-Gan (Precision Products) 1993 Ltd. He is currently engaged in business and financial consultancy. Mr. Israel serves as Chairman of the Audit Committee. Ms. Keren Aslan has a MA in Economics and a BA in Economics and Management. Ms. Atzlan served as VP Finance, and subsequently as CEO, of Kaniel Packaging Industries Ltd., and serves currently as VP Finance of Tadiran Holdings (formerly Crystal Consumer Products Ltd.). As of 19.2.12, she serves as VP Finance and Economics of Israel Railways. Ms. Atzlan is a member of the Audit Committee and the Salary and Remuneration Committee. Mr. Yoram Sirkis is a certified public accountant, with a BA in Economics and Accounting and an MA in Business Administration. Mr. Sirkis served as Securities Department Manager at the First International Bank an presently serves as VP, Member of Management, and Head of the Customer Assets Management Division at FIBI. Mr. Sirkis serves as Chairman of the Board of Directors of the Bank since 18.12.2011 and as Chairman of the Risk Management Committee. Mr. Joseph Alshech has a BA in Economics. Mr. Alsheikh has served on various boards of directors, and currently is engaged in economic and financial consultancy through a company under his ownership – Yosi Alsheikh Economic Financial Consultants Ltd. Mr. Alsheikh serves as the Chairman of the Salary and Remuneration Committee. The Bank complies with the minimum number of directors with accounting and financial expertise. Activity of the Board of Directors and Changes in Membership of the Board of Directors and its Committees During 2011, the Board of Directors of the Bank 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 plenum of the Board of Directors and its committees, the Audit Committee, Credit Committee and Risk Management Committee, held detailed discussions, each in its own sphere. During the year, there were 11 meetings of the Board of Directors and 18 meetings of the various committees of the Board of Directors. On 2.10.2011, the Board of Directors approved changes in the composition and types of committees of the Board of Directors, which came into effect from that date. Among the changes were the cancelation of the Credit Committee and the establishment of the Salary and Remuneration Committee.



119

Members of the Board of Directors of the Bank 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 2011: Yoram Sirkis, Chairman Term of office as director: 14.8.07 - present. Appointed Chairman of the Board of Directors on 18.12.11. Membership of Committees: Chairman of the Risk Management Committee. Internal or External Director*: Internal Education: BA Economics and Accounting - Hebrew University Jerusalem and CPA; MBA Business Administration - Hebrew University Jerusalem. Employment during last five years: 2007 - present: VP, Member of Management, and Head of Customers’ Assets Division in First International Bank of Israel Ltd. 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 Maof Clearing House Ltd. Jack Elaad, former Chairman Term of office: 22.12.04 – 18.12.11. Membership of Committees: Chairman of the Risk Management Committee. Internal or External Director*: Internal Education: BA Economics - Hebrew University Jerusalem, MA Business Administration (Finance) – Hebrew University Jerusalem. Employment during last five years: 2004 – 18.12.11: Director and Chairman of the Board of Directors of UBank, 2006 - present: Chairman of the Board of Directors of First International Bank of Israel Ltd., Financial Consultant. Memberships in additional boards of directors as at the date of publication of the reports: Jack Elaad Consultants Ltd., Spearcast Ltd. and the First International Bank of Israel Ltd. and Chairman of the Board of Directors of FIBI Switzerland. David Blumberg Term of office: 14.10.07 - present. Membership of Committees: Risk Management Committee and Salary and Remuneration 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; 1998 - 2006: Chairman of the Board of Directors of Bank Yerushalayim. Memberships in additional boards of directors as at the date of publication of the reports: Chairman of the Board of Directors of Bar Mutav Ltd., and BSSH Israel Credit Insurance Company Ltd., IMI Mortgage Insurance Co. Ltd., the National Library. Director: Africa-Israel Properties Ltd. Avi Cramer Term of office: 6.5.08 - present. Membership of Committees: Audit Committee and Credit Committee. Internal or External Director*: External Education: BA Economics - Tel Aviv University. Employment during last five years: 2005-2007: VP Sales and Member of Management - IBM Israel Ltd.; 2008 - 2009: General Manager - B Safe Information Systems (1983) Ltd. 2009-present: business and information systems consultant. Memberships in additional boards of directors as at the date of publication of the reports: None.



120

Ben Zion Israel Term of office: Commencement of service 23.2.09 - present. Membership of Committees: Chairman - Audit Committee. Internal or External Director*: External Education: BA Economics and Accounting - Tel Aviv University, CPA. Employment during last five years: Currently business and financial consultant. From 2009-2010: CEO - Baker Tilly Consultants (Israel) Ltd. 2004-2008: acting CEO and VP - 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. Ziva Barak Term of office: 4.3.10 - present. Membership of Committees: Risk management Committee. Internal or External Director*: Internal. Education: BA Economics and Political Science - Hebrew University Jerusalem, MA Business Administration - Hebrew University Jerusalem. Employment during last five years: 2007-present: Head of Construction and Real Estate Sector in Business Division of FIBI; Memberships in additional boards of directors as at the date of publication of the reports: None. Keren Aslan Term of office: 5.10.10 - present. Membership of Committees: Audit Committee and Salary and Remuneration Committee. Internal or External Director*: External. Education: BA Economics and Management – Tel Aviv University, MA Economics – Tel Aviv University. Employment during last five years: 19.2.2012 – present: VP Finance and Economics – Israel Railways, 2010-5.2011: VP Finance – Tadiran Holdings (formerly Crystal Consumer Products Ltd.), 2005-2009: CEO - Kaniel Packaging Industries Ltd. Memberships in additional boards of directors as at the date of publication of the reports: Keren A. Financial Management Services Ltd. Joseph Alshech Term of office: 1.7.11 - present. Membership of Committees: Chairman of the Salary and Remuneration Committee. Internal or External Director*: Internal. Education: BA Economics – New School University, New York. Employment during last five years: 1996-2011: Served on various boards of directors, including FIBI Holdings Ltd., Al-Bad Massuot Yitzchak Ltd., Blue Square Assets and Investments Ltd., Maabarot Products Ltd., Harel Finance Ltd., and Dan Public Transportation Co. Ltd., through a company under his ownership – Yosi Alsheikh Economic Financial Consultants Ltd. Memberships in additional boards of directors as at the date of publication of the reports: Lachish Industries Ltd., Whitewater Ltd., Mega Retail Ltd., 013 Netvision Ltd., and Housing and Construction Ltd.



121

Yosef Yarom Term of office: 1.8.10 – 17.3.11. Membership of Committees: Risk Management Committee. Internal or External Director*: Internal. Education: BA Education Studies and Judaism Sciences – Institute of Jewish Studies, Argentina, and the Rav Gold Institute in Jerusalem. MA Law and Social Sciences – National University, Cordova – Argentina. Employment during last five years: 2006-2008: Chairman – Bank Massad of the Bank Hapoalim Group in partnership with the Union of Teachers. Memberships in additional boards of directors as at the date of publication of the reports: Director of Bank Massad and the ORT Hermelin Academic College for Engineering and Technology, Netanya. * External Director as defined in Proper Conduct of Banking Business Directive No. 301. Members of the Management of the Bank The members of the Management of the Bank at the date of publication of this report and during 2011 are: Ron Bedny, General Manager Term of office: 1.4.10 - present. Education: BA Economics and Business Administration – Hebrew University Jerusalem; MBA Finance – Tel Aviv University. Employment during recent years: 2006-2.2010: Global Treasurer, Israel Discount Bank Ltd. Avi Basson, VP and Head of Capital Market Division Term of office: 7.6.05 - present. Education: BA Economics - Tel Aviv University, MBA Finance and Accounting - Tel Aviv University. Employment during last five years: Since 2005: VP and Head of Capital Market Division. Yaacov Garten, VP, Head of Headquarters Division, and Chief Risk Manager. Term of office: 3.1.07 - present. Education: B.Sc. Chemical Engineering - Technion, MBA Business Administration -Tel Aviv University Employment during last five years: Since 2007: VP and the Head of Headquarters Division, U-Bank Ltd. Shimon Vaknin, Head of Finance Division Term of office: 1.3.06 - 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. Orit Itzcovitch, Manageress of the Chief Accountant’s Division and Chief Accountant. Term of office: 1.12.06 - 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’s Division and Chief Accountant, UBank Ltd.



122

Yehuda - Udi Dahan, Manager of Personal Banking Division Term of office: 21.11.11 - present. Education: BA in Computer and Economic Studies - Tel Aviv University, M.Sc. in Economics and International Management – St. Gallen University, Switzerland, MBA in Business Administration – Nanvang University, Singapore, Ph.D. Business Administration – St. Gallen University, Switzerland. Employment during last five years: 2010-2011: General Manager Contango Finance Co. Ltd. (a company under his ownership). 2009-2010: Manager of UBS Wealth Management, Israel. 2006-2009: Investment Consultant Team Manager at UBS, Switzerland. Michal Goren Miller, Manageress of Personal Banking Division Term of office: 24.3.08 – 31.12.11. 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: Since 2008: Manageress of Personal Banking Division; 2007-2008: General Manager and Director of UBank Trust Co. Ltd.; 2004-2007: Head of Business Centers in the Legal Counsel Department of Bank Hapoalim Ltd.; 1995-2007: Legal Counsel (Counsel to Special Credits Department) in Corporate Division of Bank Hapoalim Ltd. Changes in Members of Bank Management On 19.6.11, Ms. Michal Goren Miller, Manageress of the Personal Banking Division in the Bank, gave notice of her intention to resign from her position at the end of 2011. Her resignation came into effect on 31.12.2011. On 20.11.11, the Board of Directors of the Bank approved the appointment of Dr. Yehuda – Udi Dahan to the position of Manager of the Personal Banking Division, with effect from 21.11.11.



123

Evaluation of Controls and Procedures regarding Disclosure in the Financial Statements In accordance with the Directives on Reporting to the Public of the Supervisor of Banks, 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 December 31, 2008. 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 statements are certifications by the General Manager of the Bank and the Chief Accountant of the Bank, separately, 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. Following the initial implementation on January 1, 2011 of the directives of the Supervisor of Banks on the Measurement and Disclosure of Impaired Debts, Credit Risk, and the Allowance for Credit Losses, there was during 2011 a significant change in the process of identifying problem loans and the allowance for credit losses, and consequently there was a change in the internal control of the Bank over financial reporting. The Bank mapped the control environment related to these processes, implemented key compensating controls related to data integrity and the reasonableness of the results, and reviewed the effectiveness of the relevant controls. However, new automated systems developed for purposes of implementation of the Impaired Debts Directive, as well as new characterizations of existing systems, began operating for the first time in 2011, and in those cases in which deficiencies were discovered, action was taken to rectify them.



124

Details of Payments and Benefits to the Recipients of the Highest Salaries in the Bank Below are details of payments and benefits paid, or in respect of which a provision was recorded in the reporting year1, to the recipients of the highest salaries among the officers of the Bank, in reported amounts, in NIS thousands: Disclosure of remuneration to interested parties and senior office holders

For the year ended December 31, 2011 Details of recipient of remuneration

Remuneration for services

Position % Position

% Holdings in Bank’s Equity Salary Bonus

Value of Benefit2

Severance, provident, and training funds, vacation and social security

Supplement to reserves for related expenses as result of changes in salary in reporting year

Total salaries and related expenses

Other remun-. ation

Jack Elaad6

Chairman of the Board of Directors 3 - - - - - - - 687

Ron Bedny General Manager 100% - 1,151 231 75 377 2 1,836 -

Avi Basson VP - Head of Capital Market Division 100% - 1,011 152 75 297 3 1,538 -

Yaacov Garten

VP - Head of Headquarters Division 100% - 752 105 80 246 33 1,216 -

Shimon Vaknin

Head of Finance Division 100% - 747 109 63 252 14 1,185 -

Michal Goren7

Manager of Personal Banking Division 100% - 663 89 64 195 23 1,034 -

See notes on next page.



125

For the year ended December 31, 2010

Details of recipient of remuneration

Remuneration for services

Position % Position

% Holdings in Bank’s Equity Salary Bonus

Value of Benefit2

Severance, provident, and training funds, vacation and social security

Supplement to reserves for related expenses as result of changes in salary in reporting year

Total salaries and related expenses

Other remun-. ation

Jack Elaad Chairman of the Board of Directors 3

- - - - - - - 689 Ron Bedny5

General Manager 100% - 838 200 55 1,253 - 2,346 -

Avi Basson

VP - Head of Capital Market Division 100% - 975 200 66 248 2 1,491 -

Shimon Vaknin

Head of Finance Division 100% - 734 95 65 239 8 1,141 -

Yaacov Garten

VP - Head of Headquarters Division 100% - 683 95 68 197 4 1,047 -

Orit Itzcovitch

Head of Chief Accountant’s Division and Chief Accountant 100% - 654 80 66 172 13 985 -

Ilan Raviv4 General Manager 100% - 312 - 35 42 1 390 -

1. Excluding salary tax and information on loans granted on terms similar to all Bank’s employees. 2. Including the value of benefits for company car, cellular telephone, newspaper, and health insurance. 3. The scope of employment by the Group, as Chairman of the First International Bank and as Chairman of UBank, is 90%

of a full-time position, of which at least two days per week at UBank. 4. Ended his term of office on March 3, 2010. 5. Began his term of office on April 1, 2010. 6. Ended his term of office on December 18, 2011. 7. Ended her term of office on December 31, 2011.

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 considering 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.



126

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 UBank. 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 employer-employee relationship will not apply between the parties. In addition, the Board of Directors discusses once a year the granting of additional remuneration (annual bonus) to the Chairman, at their absolute discretion, both with regard to granting the remuneration and its amount, if it is decided to make the grant. The period of limitation of competition is for six months from the date employment at the Bank is terminated. Mr. Jack Elaad ended his term of office as Chairman of the Board of Directors of UBank on December 18, 2011. Mr. Ron Bedny has been employed as General Manager of the Bank since April 1, 2010 under a personal agreement for a period of two years until April 1, 2012. Near the end of the term of office, the Board of Directors of the Bank intends to dult extend the term of office of the General Manager 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. Bedny 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. Bedny for the period not claimed. The period of limitation of competition is for three months from the date employment at the Bank is terminated. Mr. Bedny is 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. 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. In the meetings of the Board of Directors in December 2010 and December 2011, a deviation from the bonus formula was approved exceptionally, and a bonus was approved for an amount exceeding the bonus under the formula. Mr.Bedny is also entitled to an adaptation grant upon termination of his employment by the Bank of three monthly salaries. Mr. Bedny’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. 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.



127

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 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. Ms. Michal 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, Ms. Goren is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Ms. Goren’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.



128

On 19.6.11, Ms. Michal Goren Miller, Manager of the Personal Banking Division in the Bank, gave notice of her intention to resign from her position at the end of 2011. Her resignation came into effect on 31.12.2011. Ms. Orit Itzcovitch commenced her term of office as a Member of Management as of December 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 her employment at the Bank, Ms. Itzcovitch 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 severance pay in the provident fund for which the Bank has provided amounts in her favor. In addition, Ms. Itzcovitch is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Ms. Itzcovitch’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. Yehuda – Udi Dahan commenced his term of office as a Member of Management on November 20, 2011 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. Dahan 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. Dahan is entitled to an adaptation grant of three monthly salaries on termination of employment by the Bank. Mr. Dahan’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.



129

Remuneration of the Auditors

Consolidated Bank

2011 2010 2011 2010

NIS thousands NIS thousands NIS thousands NIS thousands

Auditors’ Remuneration:1,2,3

Audit activities4 1,776 1,783 1,600 1,607 Additional services: Services related to auditing5 - - - - Tax services7 159 165 159 165 Other services6 41 117 10 117 Total for additional services 200 282 169 282 Total 1,976 2,065 1,769 1,889 1 The Directors’ Report to the Annual General Meeting on auditors’ remuneration for audit work and additional services, pursuant

to sections 165 and 167 of the Companies Law - 1999. 2 Auditors’ remuneration includes payments by the Bank and its consolidated companies and also includes payments pursuant to

the Value Added Tax Law. 3 Includes remuneration paid and accrued. 4 Auditing annual financial statements, audit of SOX, tax reports and reviewing interim statements. 5 Including special audit work. 6 Including fees for consultancy. 7 Including remuneration for QI audit. The auditors of the Bank since its establishment are Somekh Chaikin. The Board of Directors expresses its gratitude to the General Manager of the Bank, Mr.Ron Bedny, for his significant contribution to the Bank. The Board of Directors expresses its gratitude to the former Chairman of the Board of Directors of the Bank, Mr. Jack Elaad, for his significant contribution to the Bank over the many years he has served in his position. 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. ____________________________ ____________________________

Yoram Sirkis Ron Bedny Chairman of the Board of Directors General Manager February 26, 2012


U-BANK LTD. AND CONSOLIDATED COMPANIES

130


131

Following are tables of detailed financial information by the following subjects:

A Consolidated Balance Sheet for the year end 2007 - 2011

B Consolidated Statement of Profit and Loss for the years 2007 - 2011

C Rates of Income and Expense on a Consolidated Basis

D Exposure to Changes in Interest Rates 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 Condensed Consolidated Quarterly Balance Sheet - Multi Quarter Data

H Condensed Consolidated Statement of Profit and Loss - Multi Quarter Data



132


133

Annual Report 2011 Management Review of the Financial Condition of the Bank and its Operating Results



134

Addendum A: Consolidated Balance Sheet for the year end 2007 - 2011

Reported amounts

December 31

2011 2010 2009 2008 2007

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Assets

Cash and deposits with banks 2,023.5 2,154.0 2,784.0 2,701.8 1,744.5

Securities 2,433.9 2,750.8 2,447.9 2,930.7 2,765.5

Securities borrowed 999.5 698.7 996.2 698.6 434.3

Credit to the public 1,786.9 1,774.91,2 2,056.51,2 1,976.41,2 2,462.01,2 Allowance for credit losses (13.6) (23.5) 1,2 (34.7) 1,2 (44.8) 1,2 (57.9) 1,2

Credit to the public, net 1,773.3 1,751.4 2,021.8 1,931.6 2,404.1 Investments in companies included on equity basis

- - -4 0.8 -

Buildings and equipment 19.0 18.7 18.3 17.7 14.2

Intangible assets 8.6 10.72 3.92 2.62 1.32

Assets in respect of derivative instruments 114.2 126.82 124.82 109.12 141.92

Other assets 134.0 117.92 727.22 105.22 103.52

Total assets 7,506.0 7,629.0 9,124.1 8,498.1 7,609.3

Liabilities and Equity

Deposits of the public 5,715.1 6,008.1 7,084.0 6,820.2 6,469.3

Deposits from banks 34.9 65.6 72.9 252.0 19.1

Deposits of the Government 19.1 15.8 4.9 6.1 264.1

Subordinated note 82.1 80.0 - - -

Liabilities in respect of derivative instruments 92.8 169.12 126.92 146.12 154.42

Other liabilities 1,130.13 869.32 1,293.72 822.12 287.92

Total liabilities 7,074.1 7,207.9 8,582.4 8,046.5 7,194.8

Equity 431.9 421.1 541.7 451.6 414.5

Total liabilities and equity 7,506.0 7,629.0 9,124.1 8,498.1 7,609.3

1 On 1.1.2011, the Bank adopted for the first time the directive of the Supervisor of Banks on Measurement and Disclosure of Impaired

Debts, Credit Risk, and the Allowance for Credit Losses. Comparative figures for prior years have not been restated, and so the figures for 31.12.2011 are not comparable with the figures for 2010. For further explanations on the effect of the first-time adoption of the directive, see Note 1 below.

2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period. See also Note 4 below.

3 Of which an allowance for credit losses in respect of off-balance sheet credit instruments in the amount of NIS 1.7 million. 4 Amount less than NIS 0.1 million.

MANAGEMENT REVIEW 2011 /


135

Addendum B: Consolidated Statement of Profit and Loss for the years 2007 - 2011 Reported amounts December 31

2011 2010 2009 2008 2007

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Profit from financing operations before income in respect of credit losses 110.4 108.0 160.4 145.1 123.0

Income (expense) in respect of credit losses (5.0) (7.2) (3.9) (4.4) 1.3

Profit from financing operations after income in respect of credit losses 115.4 115.2 164.3 149.5 121.7Operating and other income: Operating commissions 130.1 132.3 120.8 121.8 142.2Profits (losses) on investment in shares, net 0.1 0.8 (2.7) 0.9 2.7Other income 1.8 3.1 5.9 1.7 2.9

Total operating and other income 132.0 136.2 124.0 124.4 147.8

Operating and other expenses: Salaries and related expenses 75.7 70.5 75.8 79.3 73.0Maintenance and depreciation of buildings and equipment 23.5 20.32 21.02 19.22 16.12

Amortization of intangible assets 2.8 1.92 0.92 0.22 0.12

Other expenses 82.6 79.1 80.8 71.4 61.6

Total operating and other expenses 184.6 171.8 178.5 170.1 150.8

Profit from ordinary operations before taxes 62.8 79.6 109.8 103.8 118.7Provision for taxes on profit from ordinary operations 23.3 29.3 43.4 39.4 41.5Profit from ordinary operations after taxes 39.5 50.3 66.4 64.4 77.2Bank’s share in profits (losses) from ordinary operations of companies included on equity basis, after tax effect (0.1) (1.3) (0.8) 0.9 -1

Net profit from ordinary operations 39.4 49.0 65.6 65.3 77.2Profit from extraordinary operations after Tax 1.5 -1 - - 1.5

Net profit 40.9 49.0 65.6 65.3 78.7 Earnings per share NIS NIS NIS NIS NIS Net earnings per ordinary share: Net profit from ordinary operations attributed to shareholders of the Bank 12.6 15.7 21.0 20.9 24.7Net profit from extraordinary operations after taxes attributed to shareholders of the Bank 0.5 -1 - - 0.5

Net profit attributed to shareholders of the Bank 13.1 15.7 21.0 20.9 25.2

1 Amount less than NIS 0.1 million. 2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period.



136

Addendum C: Rates of Income and Expense on a Consolidated Basis

Reported amounts

2011 20106

Rate of income (expense)


Average Balance1

Financing income (expense)

excluding effect of derivatives

including effect of derivatives

Average Balance1




NIS millions

NIS millions % % NIS

millions NIS

millions % %

Unlinked NIS:

Assets9,10 5,031.9 149.8 2.98 5,359.0 99.2 1.85

Effect of ALM derivatives7 1,283.1 42.2 1,134.0 22.8

Total assets 6,315.0 192.0 3.04 6,493.0 122.0 1.88

Liabilities9 3,575.0 (59.7) (1.67) 4,080.0 (31.3) (0.77)

Effect of ALM derivatives7 2,250.3 (69.5) 1,899.2 (34.2)

Total liabilities 5,825.3 (129.2) (2.22) 5,979.2 (65.5) (1.10)

Interest margin 1.31 0.82 1.08 0.78

CPI-Linked NIS:

Assets9,10 441.4 7.5 1.70 377.8 1.2 0.32

Effect of ALM derivatives7 - - - -

Total assets 441.4 7.5 1.70 377.8 1.2 0.32

Liabilities9 422.6 (8.3) (1.96) 371.4 (1.1) (0.30)

Effect of ALM derivatives7 68.5 (4.0) 63.1 (3.2)

Total liabilities 491.1 (12.3) (2.50) 434.5 (4.3) (0.99)

Interest margin (0.26) (0.80) 0.02 (0.67) See notes to table on page 139.



137

Reported amounts

2011 20106



Average Balance1




Average Balance1




NIS millions

NIS millions % % NIS

millions NIS

millions % %

Foreign Currency2 (including Israel currency linked to foreign currency):

Assets9,10 1,064.1 94.4 8.87 1,533.0 (76.9) (5.02)

Effect of derivatives7:

Hedging derivatives 36.8 (3.6) 170.8 (24.7)

ALM derivatives 3,949.8 379.0 4,258.0 (168.2)

Total assets 5,050.7 469.8 9.30 5,961.8 (269.8) (4.53)

Liabilities9 2,136.3 (124.8) (5.84) 2,271.9 133.1 5.86


Hedging derivatives 38.0 1.4 188.9 21.7

ALM derivatives8 2,934.9 (319.2) 3,435.1 133.2

Total liabilities 5,109.2 (442.6) (8.66) 5,895.9 288.0 4.88

Interest margin 3.03 0.645 0.84 0.355

Total Monetary assets that produced financing income 9,10

6,537.4 251.7 3.85 7,269.8 23.5 0.32



ALM derivatives 5,232.9 421.2 5,392.0 (145.4)

Total assets 11,807.1 669.3 5.67 12,832.6 (146.6) (1.14) Monetary liabilities that produced financing expenses9

6,133.9 (192.8) (3.14) 6,723.3 100.7 1.50



ALM derivatives 5,253.7 (392.7) 5,397.4 95.8

Total liabilities 11,425.6 (584.1) (5.11) 12,309.6 218.2 1.77

Interest margin3 0.71 0.56 1.82 0.63 See notes to table on page 139.



138

Addendum C: Rates of Income and Expense on a Consolidated Basis (cont’d) Reported amounts

2011 20106

Average Balance1


Average Balance1


NIS millions

NIS millions

NIS millions

NIS millions

In respect of options (2.7) 0.8

In respect of other derivatives (not including options, hedging derivatives, ALM derivatives and separated embedded derivatives) - -

Commissions from financing business and other financing income4 27.9 35.6

Profit from financing activities before income in respect of credit losses 110.4 108.0

Income in respect of credit losses (5.0) (7.2) Profit from financing activities after income in respect of credit losses 115.4 115.2

Total:

Monetary assets that produced financing income9,10 6,537.4 7,269.8

Assets derived from derivative instruments8 148.3 149.7

Other monetary assets9 177.6 118.2

Allowance for credit losses (14.0) (10.2)

Total monetary assets 6,849.3 7,527.5

Total:

Monetary liabilities that produced financing expenses9 6,133.9 6,723.3

Liabilities derived from derivative instruments8 170.3 173.2

Other monetary liabilities9 165.3 156.7

Total monetary liabilities 6,469.5 7,053.2

Total surplus of monetary assets over monetary liabilities 379.8 474.3

Non-monetary items 38.3 32.2

Total capital means 418.1 506.5

See notes to table on page 139.



139

Reported amounts

2011 20106



Average Balance1

Financing income (expense



Average Balance1

Financing income (expense



US$ millions

US$ millions % % US$

millions US$

millions % %

Foreign Currency2 (including Israel currency linked to foreign currency):

Assets9,10 297.1 5.1 1.72 410.8 4.6 1.12



ALM derivatives 1,103.6 5.7 1,140.0 0.7

Total assets 1,411.0 9.8 0.69 1,596.6 (1.3) (0.08)

Liabilities9 596.5 (0.5) (0.08) 608.8 (0.5) (0.08)



ALM derivatives 820.0 2.1 919.7 1.9

Total liabilities 1,427.1 2.0 0.14 1,579.1 7.2 0.46

Interest margin 1.64 0.83 1.04 0.38

1 On the basis of monthly opening balances (excluding unlinked Israeli currency sector, which is on the basis of daily figures), before deducting

the average balance of the allowance for credit losses. 2 Local activity - including Israeli currency linked to foreign currency. 3 The interest margin in all linkage sectors together cannot be compared between periods since it includes the weighted position in the CPI-

linked sector. 4 Including profits and losses from the sale of bonds and adjustments to fair value of bonds held for trading. 5 The volatility in the foreign currency margin is a result of activity in shekel/foreign currency options, which are covered by

transactions in the underlying asset. 6 Restated. 7 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. 8 Average balances of derivative instruments (does not include average of off-balance sheet derivative instruments). 9 Excluding derivative instruments. 10 From the average balance of bonds available for sale is deducted the average balance of unrealized profits from adjustments to fair value of

bonds available for sale, that are included in shareholders’ equity under accumulated other comprehensive income in the item for “adjustments arising from the reporting of securities available for sale at fair value” for the year ending December 31, 2011, in the sum of NIS 0.7 million in the foreign currency and foreign currency-linked segments, and a negative amount of NIS (8.3) million and NIS (2.1) million in the unlinked and CPI-linked segments, respectively (for the year ending on December 31, 2010, in the sum of NIS 0 million, NIS 0.7 million, and NIS 1.4 million in the unlinked shekel, the CPI-linked, and the foreign currency and foreign currency-linked segments, respectively.

Notes: a. Complete data on rates of income and expense 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 the off-balance sheet effect of derivative instruments).



140

Addendum D: Analysis of Exposure to Changes in Interest Rates on a Consolidated Basis

Reported amounts

December 31, 2011

On demand up to one month

From one to three months

From three months to one year

From one to three years

NIS millions

NIS millions

NIS millions

NIS millions

Unlinked NIS Financial assets, amounts receivable in respect of derivative instruments and off-balance sheet financial instruments

Financial assets1,3 3,859.8 483.1 294.5 56.0 Derivative financial instruments (excluding options) 464.8 203.8 22.6 -

Options (in terms of underlying asset) 0.6 15.5 1.0 10.5

Total fair value 4,325.2 702.4 318.1 66.5 Financial liabilities, amounts payable in respect of derivative instruments and off-balance sheet financial instruments

Financial liabilities1 3,054.9 20.4 65.5 56.9 Derivative financial instruments (excluding options) 1,811.7 124.0 60.3 -

Options (in terms of underlying asset) - 14.9 1.0 9.7

Total fair value 4,866.6 159.3 126.8 66.6 Exposure to changes in interest rates in the segment (541.4) 543.1 191.3 (0.1)

Cumulative exposure in the segment (541.4) 1.7 193.0 192.9

CPI-linked NIS Financial assets, amounts receivable in respect of derivative instruments and off-balance sheet financial instruments

Financial assets1 125.8 1.1 112.3 484.9 Derivative financial instruments (excluding options) - - - -

Options (in terms of underlying asset) - - - -

Total fair value 125.8 1.1 112.3 484.9 Financial liabilities, amounts payable in respect of derivative instruments and off-balance sheet financial instruments

Financial liabilities1 125.9 1.0 38.3 161.3 Derivative financial instruments (excluding options) 0.5 0.6 21.1 49.1

Options (in terms of underlying asset) - - - -

Total fair value 126.4 1.6 59.4 210.4 Exposure to changes in interest rates in the segment (0.6) (0.5) 52.9 274.5

Cumulative exposure in the segment (0.6) (1.1) 51.8 326.3 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 16B 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 16B 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 16B to the Financial Statements.

d. The effective 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.



141

December 31, 2010 From three to five years

From five to ten years

From ten to twenty years

Over twenty years

No repay-ment date

Total fair value

Internal rate of return

Effective duration

Fair value Internal rate of return

Effective duration

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

%

Years

NIS millions

%

Years

42.8 151.9 51.7 - 11.3 4,951.1 4.39 0.46 5,168.7 4.02 0.60

- - - - - 691.2 0.07 1,707.2 0.10

0.6 - - - - 28.2 0.69 43.7 0.93

43.4 151.9 51.7 - 11.3 5,670.5 0.412 6,919.6 0.482

42.9 44.9 2.9 - - 3,288.4 3.24 0.20 4,021.3 3.46 0.23

- - - - - 1,996.0 0.05 2,484.9 0.23

- - - - - 25.6 0.66 40.3 0.84

42.9 44.9 2.9 - - 5,310.0 0 .152 6,546.5 0.242

0.5 107.0 48.8 - 11.3 360.5

193.4 300.4 349.2 349.2 360.5

76.8 228.4 184.8 - - 1,214.1 2.09 4.33 715.6 1.94 2.93

- - - - - - - - -

- - - - - - - - -

76.8 228.4 184.8 - - 1,214.1 4.332 715.6 2.932

395.5 342.1 11.7 27.5 1,103.3 1.93 4.40 689.3 1.92 3.27

2.4 20.9 - - - 94.6 2.46 67.2 2.50

- - - - - - - - - - -

397.9 363.0 11.7 27.5 - 1,197.9 4.252 756.5 3.212

(321.1) (134.6) 173.1 (27.5) - 16.2

5.2 (129.4) 43.7 16.2 16.2 1 Excluding book values of derivative financial instruments and fair value of off-balance sheet financial instruments. 2 Weighted average according to fair value of effective duration. 3 Including shares shown in the “No repayment date” column.



142

Addendum D: Analysis of Exposure to Changes in Interest Rates on a Consolidated Basis (cont’d)

Reported amounts

December 31, 2011


From one to three months

From three months to one year

From one to three years

NIS millions

NIS millions

NIS millions

NIS millions

Foreign currency4 Financial assets, amounts receivable in respect of derivative instruments and off-balance sheet financial instruments and compound financial assets

Financial assets1,3 794.2 152.1 37.9 7.1 Derivative financial instruments (excluding options) 2,870.2 465.7 105.4 4.8


Total fair value 3,672.6 633.3 144.4 23.0 Financial liabilities, amounts payable in respect of derivative instruments and off-balance sheet financial instruments

Financial liabilities1 2,325.9 120.6 93.9 - Derivative financial instruments (excluding options) 1,439.8 450.5 62.6 19.1


Total fair value 3,774.4 587.1 157.6 31.0 Exposure to changes in interest rates in the segment (101.8) 46.2 (13.2) (8.0) Cumulative exposure in the segment (101.8) (55.6) (68.8) (76.8)

Overall exposure to interest rate changes Financial assets, amounts receivable in respect of derivative instruments and off-balance sheet financial instruments and compound financial assets

Financial assets1,3 4,796.7 657.3 444.7 548.0 Derivative financial instruments (excluding options) 3,335.0 669.5 128.0 4.8


Total fair value 8,179.7 1,358.7 575.3 585.2 Financial liabilities, amounts payable in respect of derivative instruments and off-balance sheet financial instruments

Financial liabilities1 5,522.4 163.0 197.7 218.2 Derivative financial instruments (excluding options) 3,252.0 575.1 144.0 68.2


Total fair value 8,823.4 769.9 344.3 318.8 Exposure to changes in interest rates in the segment (643.7) 588.8 231.0 266.4

Cumulative exposure in the segment (643.7) (54.9) 176.1 442.5 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 16B 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 16B 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 16B to the financial statements.

d. The effective 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.



143

December 31, 2010 From three to five years

From five to ten years

From ten to twenty years

Over twenty years

No repayment date1

Total fair value

Internal rate of return

Effective duration

Fair value Internal rate of return

Effective duration

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

%

Years

NIS millions

%

Years

26.6 67.5 0.5 0.8 31.9 1,118.6 3.87 0.64 1,504.3 3.20 0.83

3.2 22.7 - - - 3,472.0 0.10 4,022.9 0.18

- - - - - 35.9 0.43 48.7 0.62

29.8 90.2 0.5 0.8 31.9 4,626.5 0.232 5,575.9 0.362

- - - - - 2,540.4 1.02 0.03 2,261.4 0.55 0.04

7.3 70.5 - - - 2,049.8 0.32 3,216.8 0.45 0.6 - - - - 38.3 0.47 52.0 0.70 7.9 70.5 - - - 4,628.5 0.162 5,530.2 0.292

21.9 19.7 0.5 0.8 31.9 (2.0)

(54.9) (35.2) (34.7) (33.9) (2.0)

146.2 447.8 237.0 0.8 55.1 7,333.6 2.87 1.13 7,560.6 3.18 0.87

3.2 22.7 - - - 4,163.2 0.09 5,730.1 0.16

0.6 - - - - 115.5 0.03 92.4 0.05

150.0 470.5 237.0 0.8 55.1 11,612.3 0.742 13,383.1 0.562

438.4 387.0 14.6 27.5 - 6,968.8 2.08 0.80 7,119.9 2.33 0.47

9.7 91.4 - - - 4,140.4 0.24 5,768.9 0.38

0.6 - - - - 116.4 0.03 92.3 0.04

448.7 478.4 14.6 27.5 - 11,225.6 0.592 12,981.1 0.432

(298.7) (7.9) 222.4 (26.7) 55.1 386.7

143.8 135.9 358.3 331.6 386.7

1 Excluding book values of derivative financial instruments and fair value of off-balance sheet financial instruments. 2 Weighted average according to fair value of effective duration. 3 Including shares shown in the “No repayment date” column. 4 Including Israeli currency linked to foreign currency.



144 Addendum E: Total Credit Risk to the Public by Economic Sector on a Consolidated Basis Reported amounts December 31, 2011

Credit Risk to the Public Credit Losses5

Included in Credit Risk to the Public:

Balance sheet credit risk1,2

Off balance sheet credit risk1,3

Total credit Risk1

Problem credit risk1,4

Impaired credit to the public1

Income in respect of credit losses

Collections and net accounting write offs

Balance of allowance for credit losses

NIS millions NIS millions NIS

millions NIS

millions NIS

millions NIS

millions NIS millions NIS millions

In respect of borrowers’ activity in Israel

Agriculture 50.9 6.9 57.8 - - - - -

Industry 186.9 98.6 285.5 0.2 0.1 (0.4) 0.4 1.3

Construction and Real Estate 362.9 69.2 432.1 3.0 - (0.2) 0.2 3.7

Electricity and Water 19.8 - 19.8 - - - - -

Commerce 144.5 70.8 215.3 - - (2.1) 2.1 0.8 Hotels, food and accommodation services 1.5 4.0 5.5 - - - - -

Transport and Storage 23.1 5.0 28.1 5.5 5.5 - - -

Communication and computer services 76.5 31.5 108.0 - - - - 0.8

Financial services 572.0 1,218.0 1,790.0 0.4 - (0.3) 0.3 5.5

Other business services 224.6 115.7 340.3 20.2 20.0 (0.4) 0.4 2.3

Community and public services 40.0 44.6 84.6 - - - - 0.2 Individuals - Housing Loans 100.5 - 100.5 - - - - - Individuals - Other 48.8 104.5 153.3 1.1 - (0.2) 0.2 0.5

Total 1,852.0 1,768.8 3,620.8 30.4 25.6 (3.6) 3.6 15.1

In respect of borrowers’ activity abroad

Industry 3.9 - 3.9 - - (1.4) 1.4 -

Construction and Real Estate 22.2 1.2 23.4 - - - - 0.2

Communication and computer services 7.1 - 7.1 - - - - -

Financial services 81.8 26.9 108.7 - - - - -

Other business services 18.0 1.2 19.2 - - - - -

Transport and Storage 0.2 3.4 3.6 - - - - -

Total 133.2 32.7 165.9 - - (1.4) 1.4 0.2

1 Balance sheet and off-balance sheet credit risk, problematic credit risk and impaired credit to the public are shown before the effect of the

allowance for credit losses, and before the effect of collateral deductible for purposes of single borrower and group of borrowers indebtedness. 2 Includes: credit to the public of NIS 1,786.9 million, investments in bonds of the public of NIS 158.3 million, and other assets in respect of

derivative instruments with the public of NIS 40.0 million. 3 Off-balance sheet financial instruments credit risk, as calculated for the purpose of the restriction on credit to single borrowers. 4 Balance sheet and off-balance sheet credit risk in respect of the public which is impaired, substandard or special mention. 5 Including in respect of off-balance sheet credit instruments (shown in the balance sheet under “Other liabilities”).



145

Reported amounts December 31, 20103

Balance sheet credit risk1

Off-balance sheet credit risk2

Total credit risk to the public

Annual income in respect of specific provision for doubtful debts

Balance of problematic debts

NIS millions NIS millions NIS millions NIS millions NIS millions

In respect of borrowers’ activity in Israel

Agriculture 30.4 0.3 30.7 - -

Industry 165.8 55.6 221.4 (1.5) 19.5

Construction and Real Estate 367.4 63.1 430.5 (3.3) 0.5

Electricity and Water 8.9 - 8.9 - - - Commerce 79.4 80.3 159.7 - 1.1

Hotels, food and accommodation services 2.1 1.5 3.6 - -

Transport and Storage 24.5 3.8 28.3 - 9.0

Communication and computer services 53.5 56.8 110.3 - -

Financial services 906.4 2,397.7 3,304.1 (0.5) 1.3

Other business services 209.6 92.9 302.5 (0.1) 0.1

Community and public services 37.6 36.7 74.3 - - Individuals - Housing Loans 37.5 - 37.5 - - Individuals – Other 65.7 88.2 153.9 - 0.1

Total 1,988.8 2,876.9 4,865.7 (5.4) 31.6 In respect of borrowers’ activity abroad Industry 23.0 - 23.0 (1.2) -

Construction and Real Estate 36.3 1.6 37.9 - 4.6

Transport and Storage - 4.0 4.0 - -

Financial services 51.3 65.6 116.9 - -

Other business services 0.6 14.5 15.1 - -

Total 111.2 85.7 196.9 (1.2) 4.6

1 Includes credit to the public of NIS 1,761.3 million, investments in bonds of the public of NIS 328.3 million, and other assets in respect of derivative instruments with the public of NIS 10.4 million.

2 Off-balance sheet financial instruments credit risk, as calculated for the purpose of the restriction of debt of a single borrower. 3 Restated. Notes: a. Credit risk is shown before deductions permitted in accordance with Bank of Israel directives. b. The balance of problematic debt is shown after deduction of credit covered by collateral eligible for deduction for the purpose of the restriction of debt of a single

borrower and a group of borrowers, including off-balance sheet credit risk factors. c. Credit risk and the balance of problematic debts are shown after deducting specific provisions for doubtful debts.



146

Addendum F: Exposure to Foreign Countries on a Consolidated Basis

Reported amounts

a. Information on total exposure to foreign countries, and individual exposure to countries, where the

amount of exposure to each country is more than 1% of consolidated assets or more than 20% of equity, whichever the lower1:

December 31, 2011

Cross-border balance sheet exposure Off-balance sheet

exposure2 Cross-border

balance sheet exposure

Govern-ments3

Banks Others Total balance sheet exposure

Balance of problematic commercial debts4

Impaired debts4

Total off- balance sheet exposure

Of which: problematic off-balance sheet credit risk

For repayment up to one year

For repayment over one year

NIS millions

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

Country

US - 186.9 30.6 217.5 - - 87.7 - 209.2 8.3 Norway - 110.9 - 110.9 - - - - 110.9 - Germany - 93.8 2.9 96.7 - - 6.4 - 94.0 2.7 Italy - - 3.0 3.0 - - 1.6 - 3.0 - Others 9.2 139.9 32.5 181.6 - - 53.3 - 151.2 30.4 Total exposure to foreign countries

9.2 531.5 69.0 609.7 - - 149.0 - 568.3 41.4

Total exposure to LDC countries - 1.3 1.55 2.8 - - 1.2 - 2.8 -

1 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 sheet and off-balance sheet credit risk, problematic credit risk and impaired credit to the public are shown before the

effect of the allowance for credit losses, and before the effect of collateral deductible for purposes of single borrower and group of borrowers indebtedness.

5 Credit backed up by non-marketable collateral not in the country of origin, but in Israel.



147

Reported amounts

a. Information on total exposure to foreign countries, and individual exposure to countries, where the

amount of exposure to each country is more than 1% of consolidated assets or more than 20% of equity, whichever the lower1:

December 31, 2010

Cross-border balance sheet exposure Off-balance sheet

exposure2 Cross-border

balance sheet exposure

Govern-ments3

Banks Others Total balance sheet exposure

Balance of problematic debts4

Total off- balance sheet exposure

Of which: problematic off-balance sheet credit risk

For repayment up to

one year

For repayment over one year

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

NIS million

Country

Switzerland - 183.1 2.5 185.6 - 209.2 - 185.6 -

US - 167.8 4.1 171.9 - 514.9 - 154.1 17.8

UK - 156.0 0.3 156.3 - 352.5 - 146.7 9.6

France - 126.9 9.1 136.0 3.1 1.4 - 125.1 10.9

Others* - 169.8 54.2 224.0 29.3 575.1 - 155.4 68.6Total exposure to foreign countries - 803.6 70.2 873.8 32.4 1,653.1 - 766.9 106.9

Total exposure to LDC countries - - 2.9 2.9 - 1.5 - 2.9 -*Of which:

Ireland - 6.5 29.35 35.8 29.35 - - - 35.8

b. Information on countries, where the amount of exposure to each country is between 0.75% and 1% of

total assets or between 15% and 20% of equity, whichever the lower: December 31, 2010

Balance sheet exposure

Off-balance sheet exposure

Total exposure

NIS million NIS million NIS million

Norway 72.0 - 72.0

1 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 component.

5 Credit backed up by non-marketable collateral not in the country of origin, but in Israel.



148

Addendum G: Condensed Consolidated Balance Sheet as at the end of each Quarter in 2011

Reported amounts

2011

Quarter 4 Quarter 3 Quarter 2 Quarter 1

NIS millions NIS millions NIS millions NIS millions

Assets

Cash and deposits with banks 2,023.5 2,187.7 2,993.4 3,160.8

Securities 2,433.9 2,120.8 1,980.3 2,192.8

Securities borrowed 999.5 818.7 685.0 863.6Credit to the public 1,786.9 1,797.2 1,978.0 1,962.7Allowance for credit losses (13.6) (14.5) (14.5) (15.2)Credit to the public, net 1,773.3 1,782.7 1,963.5 1,947.5Buildings and equipment 19.0 19.0 19.1 18.3

Intangible assets 8.6 9.2 9.4 10.1

Assets in respect of derivative instruments 114.2 234.7 105.0 178.8

Other assets 134.0 164.1 178.3 166.4

Total assets 7,506.0 7,336.9 7,934.0 8,538.3

Liabilities and equity

Deposits of the public 5,715.1 5,592.9 6,254.7 6,354.3

Deposits from banks 34.9 26.5 57.6 168.4

Deposits of the Government 19.1 13.2 18.9 15.7

Subordinated note 82.1 84.5 83.2 81.5

Liabilities in respect of derivative instruments 92.8 242.6 153.6 224.3

Other liabilities 1,130.1 952.6 946.1 1,283.9

Total liabilities 7,074.1 6,912.3 7,514.1 8,128.1

Equity 431.9 424.6 419.9 410.2

Total liabilities and equity 7,506.0 7,336.9 7,934.0 8,538.3



149

Addendum G: Condensed Consolidated Balance Sheet as at the end of each Quarter in 2010

Reported amounts

2010



Assets

Cash and deposits with banks 2,154.0 2,531.9 3,248.0 2,922.7

Securities 2,750.8 2,615.2 2,071.2 2,724.0

Securities borrowed 698.7 436.8 749.3 918.7

Credit to the public 1,774.91,2 1,875.11,2 1,822.21,2 2,041.61,2 Allowance for credit losses (23.5)1,2 (26.4) 1,2 (27.0) 1,2 (31.4) 1,2

Credit to the public, net 1,751.41,2 1,848.71,2 1,795.21,2 2,010.21,2 Investments in companies included on equity basis

- - - 0.1

Buildings and equipment 18.7 18.7 19.1 19.0

Intangible assets 10.72 11.22 3.72 4.02

Assets in respect of derivative instruments 126.82 162.52 281.62 64.62

Other assets 117.92 106.82 225.92 73.02

Total assets 7,629.0 7,731.8 8,394.0 8,736.3

Liabilities and equity

Deposits of the public 6,008.1 6,319.7 6,511.5 7,008.5

Deposits from banks 65.6 84.5 41.4 30.6

Deposits of the Government 15.8 12.2 12.8 3.5

Subordinated note 80.0 - - -

Liabilities in respect of derivative instruments 169.12 210.52 301.62 92.72

Other liabilities 869.32 595.72 1,029.72 1,112.02

Total liabilities 7,207.9 7,222.6 7,897.0 8,247.3

Equity 421.1 509.2 497.0 489.0

Total liabilities and equity 7,629.0 7,731.8 8,394.0 8,736.3

1 On 1.1.2011, the Bank adopted for the first time the directive of the Supervisor of Banks on Measurement and Disclosure of

Impaired Debts, Credit Risk, and the Allowance for Credit Losses. Comparative figures for prior years have not been restated, and so the figures for 31.12.2011 are not comparable with the figures for 2010. For further explanations on the effect of the first-time adoption of the directive, see Note 1D(4) below.

2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period. See also Note 4 below.



150

Addendum H: Condensed Quarterly Consolidated Statement of Profit and Loss in 2011 Reported amounts

Year ending December 31, 2011


NIS millions

NIS millions

NIS millions

NIS millions

Profit from financing operations before income in respect of credit losses 29.0 17.6 26.5 37.3

Income in respect of credit losses (0.6) (1.6) (1.1) (1.7)Profit from financing operations after income in respect of credit losses 29.6 19.2 27.6 39.0Operating and other income:

Operating commissions 28.5 32.1 32.3 37.2

Profits (losses) on investment in shares, net (2.3) 0.4 2.1 (0.1)

Other income 0.5 0.4 0.4 0.5

Total operating and other income 26.7 32.9 34.8 37.6

Operating and other expenses:

Salaries and related expenses 18.7 16.4 17.8 22.8

Maintenance and depreciation of buildings and equipment 6.2 6.1 5.7 5.5

Amortization of intangible assets 0.7 0.7 0.7 0.7

Other expenses 21.1 19.8 20.7 21.0

Total operating and other expenses 46.7 43.0 44.9 50.0 Profit from ordinary operations before taxes 9.6 9.1 17.5 26.6

Provision for taxes on profit from ordinary operations 2.9 3.4 7.2 9.8

Profit from ordinary operations after taxes 6.7 5.7 10.3 16.8Bank’s share in profits (losses) from ordinary operations of companies included on equity basis, after tax effect 0.1 - - (0.2)Net profit from ordinary operations 6.8 5.7 10.3 16.6

Profit from extraordinary operations after tax - - 1.5 -

Net profit 6.8 5.7 11.8 16.6 Earnings per share NIS NIS NIS NIS

Net earnings per ordinary share: Net profit from ordinary operations attributable to shareholders of the Bank 2.2 1.8 3.3 5.3

Net profit from extraordinary operations after taxes attributable to shareholders of the Bank - - 0.5 -

Net profit attributable to shareholders of the Bank 2.2 1.8 3.8 5.3



151

Addendum H: Condensed Quarterly Consolidated Statement of Profit and Loss in 2010 Reported amounts Year ending December 31, 2010


NIS millions

NIS millions

NIS millions

NIS millions

Profit from financing operations before income in respect of credit losses 21.3 28.3 25.7 32.7

Income in respect of credit losses (2.2) (0.6) (1.1) (3.3)

Profit from financing operations after income in respect of credit losses 23.5 28.9 26.8 36.0Operating and other income:

Operating commissions 36.4 32.1 33.0 30.8

Profits (losses) on investment in shares, net 0.6 0.2 0.3 (0.3)

Other income 2.0 0.7 0.2 0.2

Total operating and other income 39.0 33.0 33.5 30.7

Operating and other expenses:

Salaries and related expenses 19.9 15.7 17.1 17.8

Maintenance and depreciation of buildings and equipment 5.42 5.32 5.02 4.62

Amortization of intangible assets 0.72 0.72 0.22 0.32

Other expenses 19.3 19.9 20.9 19.0

Total operating and other expenses 45.3 41.6 43.2 41.7 Profit from ordinary operations before taxes 17.2 20.3 17.1 25.0

Provision for taxes on profit from ordinary operations 5.7 7.5 6.2 9.9

Profit from ordinary operations after taxes 11.5 12.8 10.9 15.1Bank’s share in profits (losses) from ordinary operations of companies included on equity basis, after tax effect (0.5) (0.5) (0.4) 0.1Net profit from ordinary operations 11.0 12.3 10.5 15.2

Profit from extraordinary operations after tax -1 - - -

Net profit 11.0 12.3 10.5 15.2

Earnings per share NIS NIS NIS NIS Net earnings per ordinary share: Net profit from ordinary operations attributable to shareholders of the Bank 3.5 3.9 3.4 4.9

Net profit from extraordinary operations after taxes attributable to shareholders of the Bank -1 - - -

Net profit attributable to shareholders of the Bank 3.5 3.9 3.4 4.9 1 Amount less than NIS 0.1 million. 2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period.



152


153

Annual Report 2011 Certifications of the General Manager and the Chief Accountant



154

Certification I, Ron Bedny, declare that: 1. I have reviewed the Annual Report of U-Bank Ltd. (hereinafter: “the Bank”) for 2011 (hereinafter: “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 required in order that the representations included 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 included in the report properly reflect, from all material aspects, the financial position, operating results, changes in shareholders’ equity, and cash flows of the Bank for the dates and periods shown in the report.

4. I and other persons in the Bank making this declaration are responsible for the determination and performance of controls and procedures with regard to disclosure1 and the internal control of the Bank over financial reporting1; and also a. We have established such controls and procedures or have ensured the establishment 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 established such internal control over financial reporting or have ensured the establishment of such internal control over financial reporting, that are designed to provide a reasonable level of security regarding the reliability of financial reporting, and that the financial statements for outside purposes have been prepared in accordance with general accepted accounting principles and the directives and instructions of the Supervisor of Banks.

c. We have assessed the effectiveness of the controls and procedures with regard to the Bank’s disclosure and we have presented our conclusions in the report with regard to the effectiveness of controls and procedures with regard to the disclosure, at the end of the period covered by the report, based upon our evaluation; and also

d. We have given disclosure in the report of any change in the Bank’s internal control over financial reporting that occurred in the fourth quarter that materially affected, or is reasonably anticipated to materially affect, the Bank’s internal control over financial reporting; and also

5. I and other persons in the Bank making this declaration have given disclosure to the Bank’s auditors, its Board of Directors and the Audit Committee of the Board of Directors, based on our most current evaluation with regard to the internal control over financial reporting: a. All significant deficiencies and material weaknesses in determining or operating internal control over

financial reporting 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 over financial reporting.

The above does not detract from my responsibility, or that of any other person, under the law. 1 As defined in the Public Reporting Directives regarding “Report of the Board of Directors”.

____________________________ Ron Bedny

General Manager

February 26, 2012

CERTIFICATIONS OF THE GENERAL MANAGER AND THE CHIEF ACCOUNTANT 2011 /


155

Certification I, Orit Itzcovitch, declare that: 1. I have reviewed the Annual Report of U-Bank Ltd. (hereinafter: “the Bank”) for 2011 (hereinafter: “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 required in order that the representations included 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 included in the report properly reflect, from all material aspects, the financial position, operating results, changes in shareholders’ equity, and cash flows of the Bank for the dates and periods shown in the report.

4. I and other persons in the Bank making this declaration are responsible for the determination and performance of controls and procedures with regard to disclosure1 and the internal control of the Bank over financial reporting1; and also a. We have established such controls and procedures or have ensured the establishment 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 established such internal control over financial reporting or have ensured the establishment of such internal control over financial reporting, that are designed to provide a reasonable level of security regarding the reliability of financial reporting, and that the financial statements for outside purposes have been prepared in accordance with general accepted accounting principles and the directives and instructions of the Supervisor of Banks.

c. We have assessed the effectiveness of the controls and procedures with regard to the Bank’s disclosure and we have presented our conclusions in the report with regard to the effectiveness of controls and procedures with regard to the disclosure, at the end of the period covered by the report, based upon our evaluation; and also

d. We have given disclosure in the report of any change in the Bank’s internal control over financial reporting that occurred in the fourth quarter that materially affected, or is reasonably anticipated to materially affect, the Bank’s internal control over financial reporting; and also

5. I and other persons in the Bank making this declaration have given disclosure to the Bank’s auditors, its Board of Directors and the Audit Committee of the Board of Directors , based on our most current evaluation with regard to the internal control over financial reporting: a. All significant deficiencies and material weaknesses in determining or operating internal control over

financial reporting 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 over financial reporting.

The above does not detract from my responsibility, or that of any other person, under the law. 1 As defined in the Public Reporting Directives regarding “Report of the Board of Directors”.

____________________________ Orit Itzcovitch

Chief Accountant

February 26, 2012



156


157

Annual Report 2011 Report of the Board of Directors and Management on Internal Control over Financial Reporting and Report of the Auditors to the Shareholders of U-Bank Ltd. on Internal Control over Financial Reporting



158

REPORT OF THE BOARD OF DIRECTORS AND MANAGEMENT ON THEIR RESPONSIBILITY FOR THE ANNUAL REPORT 2011 /


159

Report of the Board of Directors and Management on Internal Control over Financial Reporting The Board of Directors and Management of U-Bank Ltd. (hereinafter: "the Bank"), are responsible for establishing and maintaining appropriate internal control over financial reporting (as defined in the Public Reporting Directives under "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 regarding the proper preparation and presentation of financial statements published in accordance with generally accepted accounting principles and the directives and instructions of the Supervisor of Banks. Irrespective of the level of quality level in their design, all internal control systems have inherent limitations. Therefore, even if it is determined that these systems are effective, they can only provide a reasonable level of confidence with reference to the preparation and presentation of financial statements. 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 given by 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 31.12.11, 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 31.12.11, the Bank's internal control over financial reporting is effective. The effectiveness of the Bank's internal control over financial reporting as at 31.12.11 was audited by the Bank's Auditors (Somekh Chaikin), as stated in their Report on page 161, which includes an opinion regarding the effectiveness of the Bank's internal control over financial reporting as at 31.12.11. _______________ _______________ _______________ Yoram Sirkis Ron Bedny Orit Itzcovitch Chairman of the Board of Directors General Manager Chief Accountant

February 26, 2012



160

Somekh Chaikin Telephon 972684 8000

KPMG Millennium Tower Fax 972 3 684 8444

17 Ha'arba'a Street, PO Box 609 Internet www.kpmg.co.il

Tel Aviv 61006 Israel

Auditors’ Report to the Shareholders of U-Bank Ltd. According to Public Reporting Directives of the Supervisor of Banks regarding Internal Control over Financial Reporting We have audited the internal control over financial reporting of U-Bank Ltd. (hereinafter: "the Bank") as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). The Bank’s Board of Directors and the Management are responsible for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Report of the Board of Directors and Management on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Bank's internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (PCAOB) in the United States regarding the audit of internal control over financial reporting, as adopted by the Institute of Certified Public Accountants in Israel. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. Internal control over financial reporting in a bank is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles in Israel (Israeli GAAP) and in accordance with directives and guidelines of the Supervisor of Banks. Internal control over financial reporting in a bank includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and transfers of the assets of the Bank (including their removal from its possession); (2) provide reasonable assurance that transactions are recorded as necessary to facilitate preparation of financial statements in accordance with generally accepted accounting principles in Israel (Israeli GAAP), and in accordance with directives and guidelines of the Supervisor of Banks, and that receipt and payment of funds of the Bank are being made only in accordance with authorizations given by the Management and Board of Directors of the Bank; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or transfer (including their removal from its possession) of the Bank’s assets that could have a material effect on the financial statements. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, future projections of any evaluation of present are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, the Bank maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). We have also audited, in accordance with generally accepted auditing standards in Israel, and certain auditing standards applied in the audit of banking institutions as required in the directives and guidelines of the Supervisor of Banks, the consolidated financial statements of the Bank as of December 31, 2011 and 2010, and for each of the three years in the period ended December 31, 2011, and our report dated February 26, 2012 expressed an unqualified opinion on those financial statements ( - ) Somekh Chaikin Certified Public Accountants (Isr.) February 26, 2012

Somekh Chaikin, an Israeli partnership and a member

firm of the KPMG network of independent member

firms affiliated with KPMG International Cooperative (“KPMG

International”), a Swiss entity.



162

Auditors’ Report to the Shareholders 165

Financial Statements as at December 31, 2011 and for the year ending on that date

Consolidated Balance Sheet 166

Consolidated Statement of Profit and Loss 167

Statement of Changes in Equity 168

Consolidated Statement of Cash Flows 170

Balance Sheet of the Bank 171

Statement of Profit and Loss of the Bank 172

Statement of Cash Flows of the Bank 173

Notes to the Financial Statements 174


163

Annual Report 2011 Financial Statements as at December 31,2011



164

Somekh Chaikin Telephon 972684 8000

KPMG Millennium Tower Fax 972 3 684 8444

17 Ha'arba'a Street, PO Box 609 Internet www.kpmg.co.il

Tel Aviv 61006 Israel

Auditors’ Report to the Shareholders of U-Bank Ltd. We have audited the accompanying balance sheets of U-Bank Ltd. (hereinafter: "the Bank") as of December 31, 2011 and 2010, and the consolidated balance sheets as of those dates and the related consolidated statements of profit and loss, statements of changes in equity and statements of cash flows – of the Bank and the consolidated group - for each of the three years in the period ending December 31, 2011. These financial statements are the responsibility of the Bank’s Board of Directors and of its Management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards in Israel, including standards prescribed by the Auditors Regulations (Manner of Auditor's Performance),1973 and certain auditing standards applied in the audit of banking institutions as required in directives and guidelines of the Supervisor of Banks. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by the Board of Directors and Management of the Bank, and evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of the Bank and the consolidated group as of December 31, 2011 and 2010, and the results of operations, changes in equity and cash flows of the Bank and the consolidated group for each of the three years in the period ending December 31, 2011, in accordance with generally accepted accounting principles in Israel (Israeli GAAP). Furthermore, in our opinion, these financial statements are prepared in accordance with the directives and guidelines of the Supervisor of Banks. We have also audited, in accordance with the standards of the PCAOB (Public Company Accounting Oversight Board) in the United States regarding the audit of internal control over financial reporting, as adopted by the Institute of Certified Public Accountants in Israel, the Bank’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) and our report dated February 26, 2012 expressed an unqualified opinion on the effectiveness of the Bank’s internal control over financial reporting. ( - ) Somekh Chaikin Certified Public Accountants (Isr.) February 26, 2012

Somekh Chaikin, an Israeli partnership and a member

firm of the KPMG network of independent member

firms affiliated with KPMG International Cooperative (“KPMG

International”), a Swiss entity.



166

Consolidated Balance Sheet as at December 31 Reported amounts

2011 2010

Note NIS millions NIS

millions

Assets

Cash and deposits with banks 2 2,023.5 2,154.0

Securities 3 2,433.9 2,750.8 (Of which 180.4, 398.2 respectively pledged to lenders) (Of which 2,427.7, 2,744.8 respectively shown at fair value)

Securities borrowed 1D(5) 999.5 698.7 Credit to the public 4 1,786.9 1,774.91,2

Allowance for credit losses 4 (13.6) (23.5)1,2

Credit to the public, net 4 1,773.3 1.751.4

Buildings and equipment 6 19.0 18.7

Intangible assets 6A 8.6 10.72

Assets in respect of derivative instruments 16A 114.2 126.82

Other assets 7 134.0 117.92 (Of which 36.3, 66.1 respectively shown at fair value)

Total assets 7,506.0 7,629.0


Deposits of the public 8 5,715.1 6,008.1

Deposits from banks 9 34.9 65.6

Deposits of the Government 19.1 15.8

Subordinated note 10 82.1 80.0

Liabilities in respect of derivative instruments 16A 92.8 169.12

Other liabilities 11 1,130.13 869.32 (Of which 1,056.0, 788.8 respectively shown at fair value)

Total liabilities 7,074.1 7,207.9

Equity 13A 431.9 421.1

Total liabilities and equity 7,506.0 7,629.0

_______________ _______________ _______________ Yoram Sirkis Ron Bedny Orit Itzcovitch Chairman of the Board of Directors General Manager Chief Accountant

1 On 1.1.2011, the Bank adopted for the first time the directive of the Supervisor of Banks on Measurement and Disclosure of Impaired Debts, Credit Risk, and the Allowance for Credit Losses. Comparative figures for prior years have not been restated, and so the figures for 31.12.2011 are not comparable with the figures for 2010. For further explanations on the effect of the first-time adoption of the directive, see Note 1D(4) below.

2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period. See also Note 4 below. 3 Of which an allowance for credit losses in respect of off-balance sheet credit instruments of NIS 1.7 million. The accompanying notes are an integral part of the financial statements.

Date of approval of the financial statements: February 26, 2012

FINANCIAL STATEMENTS 2011 /


167

Consolidated Statement of Profit and Loss for the year ending December 31 Reported amounts

2011 2010 2009

Note NIS millions

NIS millions

NIS millions

Profit from financing operations before income in respect of credit losses 18 110.4 108.0 160.4

Income in respect of credit losses 4 (5.0) (7.2)3 (3.9) 3 Profit from financing operations after income in respect of credit losses 115.4 115.2 164.3 Operating and other income: Operating commissions 19 130.1 132.3 120.8 Profits (losses) on investment in shares, net 20 0.1 0.8 (2.7) Other income 21 1.8 3.1 5.9 Total operating and other income 132.0 136.2 124.0 Operating and other expenses: Salaries and related expenses 22 75.7 70.5 75.8 Maintenance and depreciation of buildings and equipment 6 23.5 20.32 21.02

Amortization of intangible assets 6A 2.8 1.92 0.92 Other expenses 23 82.6 79.1 80.8 Total operating and other expenses 184.6 171.8 178.5 Profit from ordinary operations before taxes 62.8 79.6 109.8 Provision for taxes on profit from ordinary operations 24 23.3 29.3 43.4 Profit from ordinary operations after taxes 39.5 50.3 66.4 Bank’s share in losses from ordinary operations of companies included on equity basis, after tax effect 5 (0.1) (1.3) (0.8) Net profit from ordinary operations 39.4 49.0 65.6 Profit from extraordinary operations after tax 25 1.5 -1 - Net profit 40.9 49.0 65.6

Earnings per share 26 NIS NIS NIS

Basic earnings per ordinary share: Net profit from ordinary operations attributable to shareholders of the Bank 12.6 15.7 21.0

Net profit from extraordinary operations after taxes attributable to shareholders of the Bank 0.5 -1 -

Net profit attributable to shareholders of the Bank 13.1 15.7 21.0

Number of shares of NIS 1 par value each (In thousands of shares) 3,123.9 3,123.9 3,123.9 1 Amount less than NIS 0.1 million. 2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period. See Note 1B(5) below. 3 On 1.1.2011, the Bank adopted for the first time the directive of the Supervisor of Banks on Measurement and Disclosure of Impaired Debts, Credit Risk, and the

Allowance for Credit Losses. Comparative figures for prior years have not been restated, and so the figures for 2011 are not comparable with the corresponding figures for the periods ended on December 31, 2010 and 2009. For further explanations on the effect of the first-time adoption of the directive, see Note 1D(4) below.

The accompanying notes are an integral part of the financial statements.



168

Statement of Changes in Equity

Reported amounts

Paid-up share capital

Premium

NIS millions

NIS millions

Balance as at January 1, 2009 60.2 334.6 Changes during 2009: Net profit for the year - - Dividend - - Adjustments in respect of presentation of securities available for sale at fair value - - Adjustments in respect of presentation of securities available for sale that were reclassified in the profit and loss statement - - Related tax effect - -

Balance as at December 31, 2009 60.2 334.6

Changes during 2010: Net profit for the year - - Dividend - - Adjustments in respect of presentation of securities available for sale at fair value - - Adjustments in respect of presentation of securities available for sale that were reclassified in the profit and loss statement - - Related tax effect - -


Changes during 2011: Cumulative effect, net, of first-time implementation on 1.1.2011 of directive on Measurement of Impaired Debts and the Allowance for Credit Losses2 - - Net profit for the year - - Adjustments in respect of presentation of securities available for sale at fair value - - Adjustments in respect of presentation of securities available for sale that were reclassified in the profit and loss statement - - Related tax effect - -


The accompanying notes are an integral part of the Financial Statements. 1 See Note 3 below. 2 See Note 1D(4) below.



169

Capital reserves

Accumulated other comprehensive income

From benefits from controlling shareholders

Total paid-up share capital and capital reserves

Adjustments for fair value of securities available for sale1

Retained earnings

Dividend declared after balance sheet date

Total equity

NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions

2.8 397.6 (28.8) 82.8 - 451.6

- - - 65.6 - 65.6 - - - (75.0) 75.0 - - - 60.6 - - 60.6

- - (22.0) - - (22.0)

- - (14.1) - - (14.1)

2.8 397.6 (4.3) 73.4 75.0 541.7

- - - 49.0 - 49.0

- - - (100.0) (75.0) (175.0)

- - 23.6 - - 23.6

- - (15.5) - - (15.5)

- - (2.7) - - (2.7)

2.8 397.6 1.1 22.4 - 421.1

- - - (20.5) - (20.5)

- - - 40.9 - 40.9

- - (10.4) - - (10.4)

- - (4.1) - - (4.1)

- - 4.9 - - 4.9

2.8 397.6 (8.5) 42.8 - 431.9



170

Consolidated Statement of Cash Flows for the year ending December 31 Reported amounts 2011 2010 2009 NIS millions NIS millions NIS millions Cash flows from operating activity Net profit for the year 40.9 49.0 65.6 Adjustments needed to show cash from operating activity: Share in operating loss of companies included on equity basis, after deduction or addition of dividend received 0.1 1.3 0.8

Capital gain from the sale of company included on equity basis (1.5) -1 - Depreciation of buildings and equipment 2.2 2.1 2.0 Deductions 2.8 1.9 0.9 Income in respect of credit losses (5.0) (7.2) (3.9) Loss (gain) on sale and revaluation of securities available for sale (41.2) 15.4 (36.0) Realized and unrealized gain from adjustments to fair value of trading securities (7.7) (23.3) (29.7) Revaluation of subordinated note 2.1 - - Provision for impairment of securities available for sale 3.2 0.8 17.5 Deferred taxes, net (1.3) (0.6) (2.7) Changes in surplus of provision over reserve 1.8 (2.2) (5.2) Increase (decrease) in derivative financial instruments (63.7) 40.21 (34.9)1 (Increase) decrease in other assets 2.6 588.21 (456.4)1 Increase (decrease) in other liabilities (35.0) (157.9)1 181.41 Net cash flow from operating activity (99.7) 507.71 (300.6)1 Cash flow from activity in assets Trading securities, net (0.2) (286.5) 440.9 Purchase of securities available for sale (1,964.3) (3,812.1) (3,458.6) Proceeds of realization of securities available for sale 2,445.0 2,842.2 3,520.8 Proceeds of redemption of securities available for sale 289.5 737.6 222.2 Proceeds of sale of company included on equity basis 0.1 - - Securities borrowed, net (300.8) 297.5 (297.6) Deposits with banks, net 90.4 (66.1)1 7.4 Credit to the public, net (75.5) 301.6 (86.3) Acquisition of buildings and equipment (2.5) (2.5) (2.6) Acquisition of intangible assets (0.7) (2.8)1 (2.2)1 Net cash flow from activity in assets 481.0 8.91 344.01 Cash flows from activity in liabilities and equity Issue of subordinated note - 80.0 - Deposits of the public, net (261.7) (1,109.5) 226.5 Deposits from banks, net (30.7) (7.3) (179.1) Deposits from the government, net 14.9 (0.9) (1.2) Dividend paid to shareholders - (175.0) - Net cash from activity in liabilities and equity (277.5) (1,212.7) 46.2 Increase (decrease) in cash 103.8 (696.1)1 89.6 Cash on hand at beginning of year 2,063.6 2,759.7 2,670.1 Cash on hand at end of year 2,167.4 2,063.61 2,759.7 Material non-cash activity - On 31.12.11, the Bank borrowed securities for the trading portfolio in the sum of NIS 39.7 million (31.12.10 - NIS 71.0 million). The Bank lent securities from the trading portfolio in the sum of NIS 0 million (31.12.10 - NIS 12.2 million), and borrowed securities from the Treasury for its customers in the amount of NIS 0 million (31.12.10 - NIS 11.7 million). 1 Reclassified. The accompanying notes are an integral part of the financial statements.



171

Balance Sheet of the Bank as at December 31 Reported amounts

2011 2010

Note NIS millions NIS

millions

Assets

Cash and deposits with banks 2 2,022.6 2,153.6

Securities 2,316.0 2,654.4 (Of which 180.4, 398.2 respectively pledged to lenders) (Of which 2,309.8, 2,684.4 respectively shown at fair value)

Securities borrowed 1D(5) 999.5 698.7 Credit to the public 1,786.9 1,775.71,2

Allowance for credit losses (13.6) (23.5)1,2

Credit to the public, net 1,773.3 1,752.2 Investment in companies included on equity basis 5 305.6 286.7

Buildings and equipment 6 15.4 14.9

Intangible assets 6A 8.6 10.72

Assets in respect of derivative instruments 16A 114.2 126.82

Other assets 7 125.8 106.62

(Of which 36.3, 66.1 respectively shown at fair value)

Total assets 7,681.0 7,804.6


Deposits of the public 8 5,893.8 6,193.3

Deposits from banks 9 34.9 65.6

Deposits of the Government 19.1 15.8

Subordinated note 10 82.1 80.0

Liabilities in respect of derivative instruments 16A 92.8 169.12

Other liabilities 11 1,126.43 859.72

(Of which 1,056.0, 788.8 respectively shown at fair value)

Total liabilities 7,249.1 7,383.5

Equity 13A 431.9 421.1

Total liabilities and equity 7,681.0 7,804.6

_______________ _______________ _______________ Yoram Sirkis Ron Bedny Orit Itzcovitch Chairman of the Board of Directors General Manager Chief Accountant 1 On 1.1.2011, the Bank adopted for the first time the directive of the Supervisor of Banks on Measurement and Disclosure of Impaired Debts, Credit Risk, and the

Allowance for Credit Losses. Comparative figures for prior years have not been restated, and so the figures for 31.12.2011 are not comparable with the figures for 2010. For further explanations on the effect of the first-time adoption of the directive, see Note 1D(4) below.

2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period. See also Note 4 below. 3 Of which an allowance for credit losses in respect of off-balance sheet credit instruments of NIS 1.7 million. The accompanying notes are an integral part of the financial statements.

Date of approval of the financial statements: February 26, 2012



172

Statement of Profit and Loss of the Bank for the year ending December 31

Reported amounts

2011 2010 2009

Note NIS millions

NIS millions

NIS millions

Profit from financing operations before income in respect of credit losses 110.6 104.5 153.0

Income in respect of credit losses 5 (5.0) (7.2)3 (3.9)3

Profit from financing operations after income in respect of credit losses 115.6 111.7 156.9

Operating and other income: Operating commissions 19 81.6 82.3 82.3 Profits (losses) on investment in shares, net 20 (0.5) 1.3 (0.2)Other income 21 3.3 4.3 8.0

Total operating and other income 84.4 87.9 90.1 Operating and other expenses: Salaries and related expenses 22 67.9 63.1 68.5

Maintenance and depreciation of buildings and equipment 6 21.8 19.02 19.02

Amortization of intangible assets 6A 2.8 1.92 0.92 Other expenses 23 71.3 69.0 71.9

Total operating and other expenses 163.8 153.0 160.3 Profit from ordinary operations before taxes 36.2 46.6 86.7 Provision for taxes on profit from ordinary Operations 24 14.2 18.4 34.9

Profit from ordinary operations after taxes 22.0 28.2 51.8 Bank’s share in profits from ordinary operations of companies included on equity basis, after tax effect 5 17.4 20.8 13.8

Net profit from ordinary operations 39.4 49.0 65.6 Profit from extraordinary operations after Tax 25 1.5 -1 -

Net profit 40.9 49.0 65.6

Earnings per share 26 NIS NIS NIS

Basic earnings per ordinary share: Net profit from ordinary operations attributable to shareholders of the Bank 12.6 15.7 21.0

Net profit from extraordinary operations after taxes attributable to shareholders of the Bank

0.5 -1 -

Net profit attributable to shareholders of the Bank 13.1 15.7 21.0

Number of shares of NIS 1 par value each (In thousands of shares) 3,123.9 3,123.9 3,123.9 1 Amount less than NIS 0.1 million. 2 Amounts have been reclassified to comply with the headings of the items and the method of presentation in the current period. See Note 1B(5) below. 3 On 1.1.2011, the Bank adopted for the first time the directive of the Supervisor of Banks on Measurement and Disclosure of Impaired Debts, Credit Risk, and the

Allowance for Credit Losses. Comparative figures for prior years have not been restated, and so the figures for 2011 are not comparable with the corresponding figures for the periods ended on December 31, 2010 and 2009. For further explanations on the effect of the first-time adoption of the directive, see Note 1D(4) below.

The accompanying notes are an integral part of the financial statements.



173

Statement of Cash Flows of the Bank for the year ending December 31 Reported amounts 2011 2010 2009

NIS millions

NIS millions

NIS millions

Cash flows from operating activity Net profit for the year 40.9 49.0 65.6 Adjustments needed to show cash from operating activity: Share in profit of investee companies (18.9) (20.8) (12.2) Depreciation of buildings and equipment 1.5 1.2 1.3 Deductions 2.8 1.9 0.9 Income in respect of credit losses (5.0) (7.2) (3.9)

Loss (gain) on sale and revaluation of securities available for sale (41.2) 15.1 (36.0)

Realized and unrealized gain from adjustments to fair value of trading securities (6.9) (24.7) (29.0) Revaluation of subordinated note 2.1 - - Provision for impairment of securities available for sale 3.2 - 14.9 Deferred taxes, net (0.8) 0.61 (2.5) Changes in surplus of provision over reserve 1.8 (2.3) (4.9) Increase (decrease) in derivative financial instruments (63.7) 40.21 (34.9)1 (Increase) decrease in other assets (1.0) 576.81 (449.2)1 Increase (decrease) in other liabilities (30.5) (156.4)1 177.81 Net cash flow from operating activity (115.7) 473.41 (312.1)1

Cash flows from activity in assets Trading securities, net 21.3 (299.0) 538.2 Purchase of securities available for sale (1,964.3) (3,811.5) (3,457.7) Proceeds from realization of securities available for sale 2,445.0 2,842.1 3,520.8 Proceeds from redemption of securities available for sale 288.7 736.1 220.7 Securities borrowed, net (300.8) 297.5 (297.6) Deposits with banks, net 90.4 (66.1)1 7.4 Credit to the public, net (74.7) 298.8 (85.0) Acquisition of buildings and equipment (2.0) (1.8) (2.1) Acquisition of intangible assets (0.7) (2.8)1 (2.2)1 Net cash flow from activity in assets 502.9 (6.7)1 442.5

Cash flows from activity in liabilities and equity Issue of subordinated note - 80.0 - Deposits of the public, net (268.2) (1,059.4) 139.9 Deposits from banks, net (30.7) (7.3) (179.1) Deposits from the government, net 15.0 (0.9) (1.2) Dividend paid to shareholders - (175.0) - Net cash flow from activity in liabilities and equity (283.9) (1,162.6) (40.4)

Increase (decrease) in cash 103.3 (695.9)1 90.0 Cash on hand at beginning of year 2,063.2 2,759.1 2,669.1 Cash on hand at end of year 2,166.5 2,063.21 2,759.1 Material non-cash activity - On 31.12.11, the Bank borrowed securities for the trading portfolio in the sum of NIS 39.7 million (31.12..10 - NIS 71.0 million). The Bank lent securities from the trading portfolio in the sum of NIS 0 million (31.12.10 - NIS 12.2 million), and borrowed securities from the Treasury for its customers in the amount of NIS 0 million (31.12.10 - NIS 11.7 million). 1 Reclassified. The accompanying notes are an integral part of the financial statements.



174

Notes to the Financial Statements Note 1: Significant Accounting Policies A. General 1. U-Bank Ltd. (hereinafter: “the Bank”) is incorporated in Israel. The financial statements as at

December 31, 2011 include those of the Bank and of its subsidiaries. The financial statements have been prepared in accordance with generally accepted accounting principles in Israel (Israeli GAAP) and the directives and guidelines of the Supervisor of Banks.

The financial statements were authorized for issue by the Board of Directors of the Bank on 26.2.12. 2. Since in some of the financial statement items there is no significant difference between the data

for the Bank and the consolidated data, the notes to the financial statements in respect of these items relate to the consolidated data only.

Definitions in these financial statements - 1. International Financial Reporting Standards (hereinafter: “IFRS") are standards and interpretations

that were adopted by the International Accounting Standards Board (IASB) and which include international financial reporting standards (IFRS) and international accounting standards (IAS), along with the interpretations of these standards of the International Financial Reporting Standards Interpretations Committee (IFRIC) or interpretations of the Standing Interpretations Committee (SIC), respectively.

2. Generally accepted accounting principles by US banks are accounting principles that US banks traded in the US are required to implement. These principles are determined by the banking supervisory authorities in the US, the US Securities and Exchange Commission, the US Financial Accounting Standards Board, and other US bodies, and are implemented in accordance with a hierarchy determined in US Accounting Standard FAS 168 (ASC 105-10) - "Accounting Standards Codification of the U.S. Financial Accounting Standards Board and the Hierarchy of Generally Accepted Accounting Principles", which replaces US Accounting Standard FAS 162. In addition, in accordance with the decision of the Banking Supervision Department, notwithstanding the hierarchy set out in FAS 168, it was clarified that any position published by banking supervisory authorities in the US, or by a team of banking supervisory authorities in the U.S., regarding the manner of implementation of accounting principles generally accepted in the US is deemed an accounting principle generally accepted by US banks.

3. Consolidated companies: companies the financial statements of which are fully consolidated, directly or indirectly, in the financial statements of the Bank.

4. Companies included on equity basis: companies, other than consolidated companies, in which the Bank’s investment is included, directly or indirectly, in the financial statements on equity basis.

5. Investee companies: consolidated companies or companies in which the Bank’s investment is included, directly or indirectly, in the financial statements on equity basis.

6. Functional currency: the currency of the main economic environment in which the Bank operates; generally, this is the currency of the environment where the corporation produces and spends most of its cash funds.

7. Reporting currency: the currency in accordance with which the financial statements are reported. The reporting currency of a banking corporation in Israel is the shekel.

8. Related parties: as defined in Opinion No. 29 of the Institute of Certified Public Accountants in Israel, except for interested parties.

9. Interested parties: as defined in paragraph 1 of the definition “Interested Party, in a Corporation” in section 1 of the Securities Law, 1968.



175

10. Index - the Consumer Price Index in Israel, published by the Central Bureau of Statistics. 11. Adjusted amount: an historical nominal amount that was adjusted to the December 2003 CPI,

in accordance with the provisions of Opinions 23 and 36 of the Institute of Certified Public Accountants in Israel.

12. Adjusted financial reporting: financial reporting in values adjusted to changes in the general purchasing power of Israeli currency in accordance with the provisions of the opinions of the Institute of Certified Public Accountants in Israel.

13. Reported amount: an amount adjusted to the transition date (December 31, 2003) with the addition of amounts in nominal values that were added after the transition date, less amounts that were eliminated after the transition date.

14. Cost: the reported amount of cost. 15. Nominal financial reporting - financial reporting based on reported amounts.

B. Basis for preparation of the financial statements

1. Reporting principles

The financial statements of the Bank have been prepared in accordance with the Public Reporting Directives and instructions of the Supervisor of Banks. In preparing the financial statements, the Bank applies, inter alia, certain International Financial Reporting Standard (IFRS) and accounting principles generally accepted by US banks, as detailed below:

- On matters related to the core business of banking – the accounting treatment is in accordance with the Public Reporting Directives and instructions of the Supervisor of Banks and accounting principles generally accepted by US banks, which were adopted in the framework of the Public Reporting Directives of the Supervisor of Banks.

- On matters not related to the core business of banking - the accounting treatment is in accordance with accounting principles generally accepted in Israel, and in accordance with certain International Financial Reporting Standard (IFRS). International standards are applied according to the principles detailed below:

(1) In cases in which a material matter arises which is not specifically addressed by international standards or implementation instructions of the Supervisor, the Bank deals with the matter in accordance with accounting principles generally accepted by US banks that apply specifically to these matters;

(2) In cases in which there is no specific reference in the standards or interpretations to material issues or there are a number of alternatives for dealing with a material issue, the Bank acts in accordance with specific implementation instructions determined by the Supervisor;

(3) Where an International Financial Reporting Standard that was adopted contains a reference to another IFRS adopted in the Public Reporting Directives, the Bank acts in accordance with the provisions of the IFRS;

(4) Where an International Financial Reporting Standard contains a reference to another IFRS not adopted in the Public Reporting Directives, the Bank acts in accordance with the Reporting Directives and with Israeli GAAP;

(5) Where an International Financial Reporting Standard contains a reference to a definition of a term defined in the Public Reporting Directives, the reference to the definition in the Directives shall replace the original reference.

2. Functional Currency and Reporting Currency The shekel (NIS) is the currency that represents the principal economic environment in which the Bank operates. The financial statements are shown in NIS and rounded to the nearest 0.1 million, unless stated otherwise.



176

3. Basis for Measurement

The statements have been prepared on the historic costal basis except for the assets and liabilities listed below; - Derivative financial instruments and other financial instruments, which are measured at fair

value through profit and loss (such as investments in securities in the trading portfolio or instruments for which the fair value option was chosen);

- Financial instruments classified as available for sale; - A liability in respect of a share-based payment to be settled in cash; - Non-current assets held for sale and a group of assets held for sale; - Deferred tax assets and liabilities; - Provisions; - Assets and liabilities for employee benefits; - Investments in associate companies treated on equity basis. The values of non-monetary assets and equity items that were measured on the historical cost basis were adjusted to changes in the Consumer Price Index until December 31, 2003, since until that date, the Israeli economy was considered hyper-inflationary. As of January 1, 2004, the Bank prepares its financial statements in reported amounts.

4. Use of estimates When preparing the financial statements in accordance with generally accepted accounting principles in Israel (Israeli GAAP) and the directives and guidelines of the Supervisor of Banks, Management of the Bank is required to use its judgment in estimates and assumptions that affect the application of policy and the amounts of assets libilities, income and expenses. It should be clarified that actual results may differ from such estimates. The preparation of accounting estimates used in the preparation of the Bank’s financial statements requires Management to make assumptions regarding circumstances and events that involve considerable uncertainty. Management of the Bank prepares the estimates on the basis of past experience, various facts, external circumstances, and reasonable assumptions according to the pertinent circumstances of each estimate. Estimates and underlying assumptions are reviewed on an ongoing basis. Revisions to accounting estimates are recognized in the period in which the estimates are revised and in any future periods affected

5. Change in classification Following the first-time implementation of certain accounting standards and directives of the Supervisor of Banks (see sections C and D, below), certain sections in the context of the financial statements and comparative figures were reclassified to comply with the headings of the items and reporting requirements during the current period. Specifically, the following have been reclassified: Items included in the balance sheet: - Intangible assets in the amount of NIS 10.7 million, included in the consolidated balance sheet

and the balance sheet of the Bank at December 31, 2010 under the heading of other assets, have been reported in the consolidated balance sheet and the balance sheet of the Bank at December 31, 2011 on a separate line.



177

- Assets in respect of derivative instruments in the amount of NIS 126.8 million, included in the consolidated balance sheet and the balance sheet of the Bank at December 31, 2010 under the heading of other assets, have been reported in the consolidated balance sheet and the balance sheet of the Bank at December 31, 2011 on a separate line.

- Liabilities in respect of derivative instruments in the amount of NIS 169.1 million, included in the

consolidated balance sheet and the balance sheet of the Bank at December 31, 2010 under the heading of other liabilities, have been reported in the consolidated balance sheet and the balance sheet of the Bank at December 31, 2011 on a separate line.

- Data for credit to the public, net, at December 31, 2010, have been reclassified to comply with reporting as a gross amount as of January1, 2011.

Items included in the statement of profit and loss: - Expenses in respect of amortization of intangible assets in the amount NIS 1.9 million and NIS

0.9 million in the consolidated financial statements of the Bank and in the financial statements of the Bank have been reclassified from expenses for maintenance and depreciation of buildings and equipment and reported on a separate line in the financial statements of the Bank for each the years ending December 31, 2010 and 2009.

C. First-time Implementation of Accounting Standards, Updates to Accounting Standards and

Directives of the Banking Supervision Department During 2011, the Bank began implementing the accounting standards and directives set out below: 1. Directives of the Banking Supervision Department on the subject of Measurement and Disclosure

of Impaired Debts, Credit Risk and Allowance for Credit Losses, and an amendment to directives on the Treatment of Problem Debts.

2. Certain International Financial Reporting Standards (IFRS) set out below:

• IAS 8 Accounting Policies, Changes in Accounting Estimates and Errors • IAS 10 Events after the Reporting Period • IAS 16 Property, Plant and Equipment • IAS 17 Leases • IAS 21 The Effects of Changes in Foreign Exchange Rates • IAS 27 (2008) Consolidated and Separate Financial Statements • IAS 28 Investments in Associates • IAS 29 Financial Reporting in Hyperinflationary Economies • IAS 33 Earnings per Share • IAS 34 Interim Financial Reporting • IAS 36 Impairment of Assets • IAS 38 Intangible Assets

3. US Financial Accounting Standard FAS 157 (ASC 820-10) - "Fair Value Measurements"

(hereinafter: “FAS 157”), and US Financial Accounting Standard FAS 159 (ASC 825-10) - "Fair Value Option for Financial Assets and Financial Liabilities" (hereinafter: “FAS 159”) , and Accounting Standards Update ASU 2010-06 - "Improving Disclosures about Fair Value Measurements";

In 2011 the Bank implemented the directives for disclosure applicable in the standard. The directives for measurement are to be applied as of January 1, 2012.



178

4. Directives of the Banking Supervision Department on strengthening the internal control over financial reporting of employee rights; and

5. Accounting Standards Update ASU 2011-02 – "A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring".

The accounting policy of the Bank, as set out in section D, below, combines the new accounting policy with respect implementing the above accounting standards, accounting standards updates, and the directives of the Banking Supervision Department, and reports the manner and effect of their first-time implementation, if applicable.

D. Accounting Policy Implemented in the Preparation of the Financial Statements

1. Foreign Currency and linkage -Transactions in Foreign Currency Transactions in foreign currency are translated to the functional currency of the Bank at the exchange rate at the dates of the transactions. Monetary assets and liabilities denominated in foreign currency at the reporting date are translated to the functional currency at the exchange rate at that date. The foreign currency differences for monetary items are the difference between amortized cost in the functional currency at the beginning of the year, adjusted for effective interest and payments during the year, and the amortized cost in foreign currency translated at the exchange rate at the end of the year. Non-monetary assets and liabilities denominated in foreign currencies and measured at fair value are translated to the functional currency at the exchange rate at the date that the fair value was determined. Foreign currency differences arising on translation to the functional currency are recognized in profit and loss, except for differences arising from translation to the functional currency of non-monetary capital financial instruments classified as available for sale, which are recognized in other comprehensive income. Non-monetary items denominated in foreign currency measure by historic cost are translated using the exchange rate at the date of the transaction.

Index-linked Assets and Liabilities not measured according to fair value Assets and liabilities linked to the CPI are included according to the terms of linkage determined for each balance.

Below are details of the representative exchange rates and Consumer Price Index and the rates of change therein: 2011 2010 2009 Consumer Price Index: December 110.3 108.0 105.2 November 110.3 107.6 105.2 Rate of exchange of US$ 3.821 3.549 3.775 Rate of exchange of Euro 4.938 4.738 5.442 Rate of exchange of Japanese Yen 0.0493 0.0436 0.0409

2011 2010 2009 Consumer Price Index: December 2.2% 2.7% 3.9% November 2.5% 2.3% 3.8% Revaluation (Depreciation) of the shekel in relation to: Rate of exchange of US$ 7.7% (6.0%) 0.7% Rate of exchange of Euro 4.2% (12.9%) (2.7%) Rate of exchange of Japanese Yen 13.1% 6.6% (2.7%)



179

2. Basis of consolidation

Subsidiary companies

Subsidiary companies are entities controlled by the Bank. The financial statements of subsidiary companies are included in the consolidated financial statements from the date control is obtained until the date control ceases. Control is the ability to determine the financial and operating policy of the entity in order to derive benefit from its activities. The accounting policy of subsidiary companies was amended as necessary in order to adapt it to the accounting policy adopted by the Bank.

Companies included on equity basis

Companies included on equity basis are entities in which the Bank has material influence over the financial and operating policy, but control of them has not been achieved. There is an assumption that holding between 20% and 50% in an investee grants material influence. When examining the existence of material influence, potential voting rights which can be realized or converted immediately into shares in the investee company. Investments in companies included on equity basis are dealt with according to the equity-base method and recognized initially at cost. Investment cost includes transaction cost. When the Bank obtains material influence for the first time over an investment dealt with an asset available for sale up until the date material influence was achieved, the equity-base method is implemented retrospectively, consistent with the rules set out on the subject in generally accepted accounting principles in US banks. The consolidated financial statements include the Bank’s share in the income and expenses, profit and loss, and other comprehensive income of entities held dealt with according to the equity-base method, after the adjustments necessary to adapt the accounting policy to that of the Bank, from the date there is material influence or joint control until the date material influence or joint control no longer exists. It should be made clear that the Bank does not make adjustments to the accounting policy for matters at the core of the banking business (matters for which International Financial Reporting Standards have not yet been adopted in the Public Reporting Directives) which has been implemented by a non-banking company included on equity basis. When the Bank’s share in the losses exceeds the value of the Bank’s rights in the company included on equity basis, the book value of those rights is amortized to zero and the Bank does not recognize further losses, unless the Bank has an obligation to support the investee company or if the Bank paid amounts for it. Regarding impairment in investments in companies included on equity basis - see section D (9) below.

Intra-company transactions

Mutual balances in the Bank and unrealized income and expenses deriving from intra-company transactions, have been eliminated in the process of preparation of the consolidated financial statements. Unrealized profits deriving from transactions with companies included on equity basis have been eliminated against the investment in accordance with the Bank's rights in these investments. Unrealized losses have been eliminated in the same manner by which unrealized profits have been eliminated, insofar as there was no evidence of impairment.



180

3. Basis of recognition of income and expenses

(a) Financing income and expenses are included on an accrual basis, except for items set out as follows: - Interest accruing on problematic debts that were classified as non-accrual debts is

recognized on a cash basis when there is no doubt with regard to collection of the remaining recorded debt balance of an impaired debt. In these situations, an amount collected on account of the interest that is recognized as interest income, is limited to the amount that would be accumulated in the reporting period on the remaining recorded balance of the debt according to the contractual interest rate. Interest income on a cash basis is classified in the statement of profit and loss as a profit from financing activity (before allowance for credit losses) under the relevant item in "Finance income in respect of assets". When there is doubt as to collection of the remaining recorded balance of debt, all payments collected serve to reduce the loan principal. In addition, interest on past-due amounts in respect of housing loans is recognized in the profit and loss statement on an actual collection basis.

- Income from commissions on early repayment of loans, after deducting a relative portion relating to the financial equity, are included in the profit and loss statement in equal annual amounts during the period of the remainder of the period until repayment of the loan or for three years from the date of early repayment, whichever period is shorter.

- Allocation fees for credit facilities, together with commissions on financing business (such as commissions in respect of acceptances, guarantees and documentary credits), are recognized in the statement of profit and loss relative to the periods of the transactions.

(b) Operating commissions for granting services (such as: from activity in securities and derivative

instruments, credit cards, account management, dealing with credit, conversion differences and foreign trade activity) are recognized in profit and loss, when the Bank’s entitlement to receive them occurs.

(c) Securities - see Section D (5) below. (d) Derivative financial instruments - see Section D (6) below. (e) In consecutive periods following impairment of a nature other than temporary, interest income

from investments in debt instruments shall be recognized as follows: - Beneficial interests acquired or beneficial interests that have continue to be held by the

Bank in the securitization of financial assets, which are accounted for using the prospective interest method – the excess of the amount of expected cash flows to be collected over the fair value of the debt instrument will be recognized as interest income over the remaining life of the debt instrument. In rare instances in which the Bank has no reasonable estimate with regard to amounts and timing of expected cash flows to be collected from the debt instruments, the Bank recognizes income using the cost recovery method or recognizes income on a cash basis.

- Other debt instruments – Income in the reporting period is accrued on the basis of the excess of expected cash flows of the debt instrument. (The base amount of the debt instrument at the date of impairment in value which is of a nature other than temporary constitutes its fair value).

(f) Other income and expense are recognized on an accrual basis.



181

4. Impaired Debts, Credit Risk, and the Allowance for Credit Losses

In accordance with the new directive of the Supervisor of Banks on the subject of “Measurement and Disclosure of Impaired Debts, Credit Risk and Provision for Credit Losses”, the Bank, as of January 1, 2011, implements US accounting standards (ASC 310) and staff positions of banking supervisory institutions and of the SEC in the US, as adopted in the Public Reporting Directives. In addition, as of that date, the Bank implements the instruction of the Banking Supervision Department on the treatment of problem debts. Credit to the public and other debit balances The Directive has been implemented with regard to all debt balances such as deposits in banks, bonds, securities borrowed or purchased under repurchase agreements, credit to the public, credit to the government, etc. Credit to the public and other debt balances for which no specific rules were made in the Public Reporting Directives regarding the measurement of the allowance for credit losses (such as credit to the government, deposits in banks, etc.) are reported in the books of the Bank according to the recorded debt balance. The recorded debt balance is defined as a debt balance after deducting accounting write-offs, but before deducting the allowance for credit losses in respect of that debt. The recorded debt balance does not include accumulated interest that was not recognized, or was recognized in the past but cancelled subsequently. It should be explained that prior to January 1, 2011, the Bank applied different rules according to which the debt balance in the Bank's books included the interest component accumulated before the debt was classified as a non-income bearing problem debt. Accordingly, loan balances reported in periods before the initial implementation period of the directive are not comparable with loan balances reported after the commencement of implementation. With regard to other debt balances, for which there are specific rules for measurement and recognition of impairment (such as bonds), the Bank continues to apply the same rules for measurement. Allowance for Credit Losses The Bank has set out procedures for classifying credit and for measuring the allowance for credit losses, so as to maintain an allowance at an appropriate level to cover the expected credit losses relating to its credit portfolio. In addition, the Bank has set out procedures required to maintain an allowance at an appropriate level to cover expected credit losses connected with off-balance sheet instruments in a separate liability account (such as commitments to give credit, unutilized credit facilities, and guarantees). The allowance to cover expected credit losses in relation to the credit portfolio is assessed by one of two methods: “individual allowance” and “group allowance”. The Bank also examines the overall appropriateness of the allowance for credit losses. Individual allowance for credit losses – the Bank has elected to examine on an individual basis those debts whose contractual balance exceeds NIS 1 million. The individual allowance for credit losses is recognized for all debt classified as impaired. Debt is classified as impaired when, based on current information and events, it is probable that the Bank will be unable to collect the full amounts owed to it according to the contractual terms of the debt agreement. In any event, debt is classified as impaired when principal or interest is in arrears of 90 days or more, except if the debt is collateralized well and is also under collection proceedings. In addition, any debt where terms have been changed in a problem debt restructuring is classified as impaired debt, unless a minimal provision for credit losses was made for it before and after the problem debt restructuring, based on



182

the extent of arrears method, in accordance with the Appendix to Proper Conduct of Banking Business Directive No. 314 concerning problem debts in housing loans in a mortgage bank. The individual allowance for credit losses is assessed based on expected future cash flows, discounted at the original effective interest rate of the debt. When the debt is contingent upon collateral, or when the Bank determines that seizure of an asset is expected, the individual allowance is assessed based on the fair value of the collateral pledged to secure that debt. The allowance for credit losses assessed on a group basis - is calculated to reflect provisions for impairment in respect of individually unidentified credit losses inherent in large groupings of small homogeneous debts, and for debts examined individually and found to be unimpaired. The allowance for credit losses on debts estimated on a group basis is calculated according to the rules prescribed in FAS 5 (ASC 450) – Accounting Treatment of Contingencies, based on a formula detailed in a temporary directive set out by the Supervisor of Banks, in effect until December 31, 2012. The formula is based on historical loss rates in various sectors of the economy, divided between problem debt and non-problem debt during the years 2008, 2009, 2010, and 2011, as well as on the actual rate of net accounting write-offs as of 1 January 2011. In addition to calculating the range of historical rates in the various sectors of the economy as mentioned above, for purposes of determining the appropriate rate of the allowance, the Bank takes into account other data, including trends in the volume of credit in each sector and the conditions of the sector, macroeconomic data, a general assessment of the quality of credit to the economic sector, changes in volume and the trend of balances in arrears and impaired balances, and the effect of the changes on credit concentrations. The Bank bases itself on historical loss rates in the various economic sectors as calculated by the parent company, the First International Bank. In accordance with the instructions set out in the temporary directive, as of January 1, 2011 the Bank does not maintain a general and supplementary provision, but continues to calculate the supplementary provision, and checks that in any event the amount of the group allowance at the end of each reporting period is not less than the general and supplementary provision that would have been calculated for that period, before tax. The allowance required with reference to off-balance sheet credit instruments is is calculated according to the rules prescribed in FAS 5 (ASC 450). The allowance assessed on a group basis for off-balance sheet credit instruments is based on the rates of allowance determined for balance sheet credit (as explained above), taking into account the percentage of off-balance sheet credit risk expected to be realized by the Bank. The percentage of credit realized is calculated by the Bank based on credit conversion coefficients as set out in Proper Conduct of Banking Business Directive No. 203 – Measurement and Adequacy of Capital – Credit Risk – The Standardized Approach, with certain adjustments in cases where the Bank has prior experience indicating percentages for the realization of credit. The minimum provision in respect of housing loans is calculated according to a formula determined by the Supervisor of Banks, taking into account the extent of arrears, whereby the rates of the provision increase as the arrears grow. At the date of implementation of the new directive, an amendment came into effect to the Appendix to Proper Conduct of Banking Business Directive No. 314 - Problem Debts in Housing Loans in a Mortgage Bank, which expands the implementation of calculating the provision by the extent of arrears formula to all housing loans, except for loans not repayable in periodic installments financing activity of a business nature. The Bank classifies all of its problem debts and problem off-balance-sheet credit items under the categories: special mention, substandard, or impaired.



183

Recognition of income

At the time the debt is classified as impaired, the Bank defines the debt as a debt not accruing interest income, and ceases accruing interest income on it, except that stated below regarding certain impaired debts after restructuring. In addition, at the time the debt is classified as impaired, the Bank cancels all the interest income accrued but not yet collected, which was recognized as income in profit and loss. The debt remains classified as a debt not accruing interest income, as long as the impaired debt classification is not canceled. A debt that underwent a formal problem debt restructuring, and after the restructuring there is reasonable certainty that the debt will be repaid and will perform in accordance with its new terms, will be treated as an impaired debt accruing interest income. For details regarding recognition of income on a cash basis for debts classified as impaired, see Note 1D (3). Regarding debts assessed and provided for on a collective basis, which are in arrears of 90 days or more, the Bank continues to accrue interest income. These debts are subject to methods of evaluation for the allowance for credit losses that ensure that the profit of the Bank is not overstated. Problem Debt Restructuring A debt which formally underwent a problem debt restructuring is defined as a debt in respect of which, for economic or legal reasons related to the debtor's financial difficulties, the Bank granted a waiver by way of modification of the terms of debt, in order to alleviate the burden for the debtor of short-term cash payments (reduction or postponement of payments in cash demanded from the debtor) or by way of receipt of other assets as payment of the debt (in whole or in part). For purposes of determining whether a debt agreement executed by the Bank comprises a problem debt restructuring, the Bank performs a qualitative examination of the totality of the terms of the arrangement and the circumstances under which it was made, in order to determine whether (1) the debtor is in financial difficulties and (2) the Bank granted a waiver under the arrangement to the debtor. In order to determine whether the debtor is in financial difficulties, the Bank examines whether there are signs that point to the fact that the borrower is in difficulties at the time of the arrangement or the existence of a reasonable possibility that the borrower will get into financial difficulties if not for the arrangement.The Bank examines, inter alia, the existence of one or more of the following circumstances: at the time of the debt arrangement the borrower is in default, including when any other debt of the borrower is in default; with regard to debts which at the time of the arrangement are not in arrears, the Bank estimates if according to the current repayment ability it is likely that in the foreseeable future the borrower will get into a default situation, and will not meet the original contractual terms of the debt; the debtor was declared bankrupt, is under receivership, or there are significant doubts as to the borrower's continued existence as a going concern; and that without a change in the terms of the debt, the debtor will not be able to raise debt from other sources at market rates of interest for debtors not in default. The Bank will conclude that the debtor was granted a waiver under the arrangement, even if under the arrangement an increase was made in the contractual interest rate, if one or more of the following situations exists: as a result of restructuring, the Bank is not expected to collect all amounts outstanding (including accrued interest according to the contractual terms); the current fair value of the collateral, in respect of debts conditional on collateral, does not cover the contractual balance of the debt and indicates the inability to collect all amounts due; the debtor has no possibility of raising funds at the rate prevailing in the market for a debt with terms and characteristics such as those of the debt granted under the arrangement.



184

In addition, the Bank will not classify debt as a restructured problem debt if, under the arrangement, the debtor was granted a stay of payments that is not material, given the frequency of the payments in the contractual repayment period and the expected duration of the original debt. In this regard, if several arrangements were made involving changes in the terms of the debt, the Bank takes into account the cumulative effect of the previous arrangements for the purpose of determining whether the stay of payments is not material. Restructured debts, including those that prior to the restructuring were examined on a group basis, will be classified as impaired debt and will be evaluated on an individual basis for purposes of making an allowance for credit losses, or an accounting write-off. Given that the debt, for which the problem debt restructuring was carried out, will not be paid in accordance with its original contractual terms, the debt continues to be classified as impaired debt, even after the debtor returns to the repayment schedule in accordance with the new terms.

Accounting write-off The Bank makes an accounting write-off for any debt or part thereof examined on an individual basis that is considered uncollectible and of such a low value that its remaining as an asset is not justified, or a debt which the Bank has been making efforts to collect over an extended period (generally defined as a period exceeding two years). Regarding debts examined on a group basis, rules for writing off have been set out based on their extent of arrears (in most cases above 150 days consecutive arrears), and other problem parameters. It should be explained that accounting write-offs do not involve a legal waiver, and they reduce the reported balance of debt for accounting purposes only, while creating a new cost base for the debt in the Bank's books.

Policy for the provision for doubtful debts before implementation of the directives on impaired debts, credit risk, and allowance for credit losses, the amendment to directives on the treatment of problem debts, and Accounting Standards Update ASU 2011-02 – "A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring"

The provision for doubtful debts is determined on a specific basis. In addition, a general provision and a supplementary provision are included, in accordance with the directives of the Supervisor of Banks. The specific provision for doubtful debts is made based on Management’s cautious estimate of the losses inherent in the credit portfolio, including debts in off-balance-sheet items. In the previously mentioned estimate, Management takes into account, among other considerations, the extent of the risks related to the financial stability of borrowers, based on its information regarding their financial condition, their business operations, their meeting of obligations, and an evaluation of collateral received from them. Interest income in respect of a debt declared as doubtful is not recorded as of the beginning of the quarter in which the debt is declared doubtful. Upon collection of the interest, the interest income is recorded in the item “other financing income”. The specific provision in respect of housing loans given by the Bank was calculated in accordance with the directives of the Supervisor of Banks, taking into account the extent of arrears, whereby the rates of the provision increase as the arrears grow. The supplementary provision for doubtful debts is based on the quality of the customer debt portfolio, in accordance with risk attributes defined in the directives of the Supervisor of Banks. Different provision rates have been determined for each such risk attribute. The supplementary provision for doubtful debts is calculated according to the rates determined for the different attributes. The general provision is in values adjusted for the end of 2004, in an amount constituting 1% of the total indebtedness under the responsibility of the Bank and investee banking companies on December 31, 1991. The cumulative percentage of the supplementary and general provision for



185

doubtful debts from the amount of risk of total credit to the public at December 31, 2011, is 0.4% (December 31, 2010 - 0.2%, December 31, 2009 - 0.2%). Writing off bad debts is carried out when the Bank has determined that the debt is uncollectible, following legal proceedings undertaken or as a result of agreements or arrangements made, most of them in cases in which no legal proceedings were undertaken, and the debts are not collectible, or due to other reasons for which the debts are uncollectible.

Initial implementation of the directives of the Banking Supervision Department on the measurement and disclosure of impaired debts, credit risk, and allowance for credit losses, the amendment to directives on the treatment of problem debts, and Accounting Standards Update ASU 2011-02 – "A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring"

In accordance with instructions from the Banking Supervision Department, the directive was not applied retrospectively to financial statements for prior periods. At the date of initial implementation, the Bank, inter alia:

- made an accounting write-off for any debt that at that date met the conditions for being written off in the accounts;

- classified as special mention, substandard or impaired, any debt that met the conditions for such classification; it should be explained that for this purpose, notwithstanding the definition according to which a problem debt that has undergone restructuring is an impaired debt, the Bank did not classify as an impaired debt a debt that was restructured before January 1, 2007, as long as the debt was not impaired based on the conditions set out in the restructuring agreement.

- canceled all interest income that had accumulated but not been paid for any debt that at that date met the relevant conditions;

- adjusted the balance of the allowance for credit losses in respect of credit to the public and in respect of off-balance credit instruments at January 1, 2011, to the requirements of the directive; and

- adjusted the balance of current taxes and deferred taxes to be received or paid at January 1, 2011.

The effect of the first-time implementation in the amount of NIS 20.5 million (net of tax) was charged as a reduction in retained earnings at January 1, 2011. Moreover, in December 2010, a circular was published by the Supervisor of Banks on the treatment of problem debts. In accordance with the circular, the definition was changed for housing loans in respect of which the Bank is required to make a provision by the extent or arrears method. The Bank implemented the amendment prospectively as of the financial statements for periods beginning January 1, 2011. Implementing the amendment had no effect on the financial statements of the Bank. In addition, in April 2011, the FASB published Accounting Standards Update ASU 2011-02 – "A Creditor's Determination of Whether a Restructuring is a Troubled Debt Restructuring". The rules set out in the ASU for identifying arrangements defined as problem debt restructuring were adopted by the Banking Supervision Department and came into effect as of July 1, 2011. The rules apply for purposes of determining if a restructuring is a troubled debt restructuring with regard to every debt arrangement effected after January 1, 2011. The changes in the method of measurement of the allowance for credit losses were implemented prospectively, so that the update to the allowance required to be calculated on an individual basis was recorded in the third quarter of 2011. The initial implementation of the ASU had no material effect on the results of the Bank.



186

5. Securities

a. Securities in which the Bank invests are classified in two portfolios as follows:

1. Securities held for trading Securities that are acquired and held with the aim of selling them in the near future, except for shares for which no fair value is available. Securities held for trading are shown in the balance sheet at fair value at the reporting date. Profits and losses on adjustment to fair value are charged to the profit and loss statement.

2. Securities available for sale Securities not classified as held to maturity Bonds (Bonds which the Bank intends and is able to hold until redemption date) or as securities held for trading. Shares for which a fair value is available and Bonds are stated in the balance sheet at their fair value at the date of the report. Shares for which fair value is not available are measured in the balance sheet according to cost. Unrealized profits or losses on adjustment to fair value are not charged to the profit and loss statement, and are reported net, less an appropriate reserve for tax, in a separate item in the shareholders’ equity in the framework of accumulated other comprehensive income.

b. Dividend income, accumulated interest, linkage and exchange rate differences, amortization of premium or discount (in accordance with the effective interest method), as well as losses from

impairment not of a temporary nature, are charge to the profit and loss statement. c. The Bank’s investments in venture capital funds is treated according to cost less losses

from impairment not of a temporary nature. Profit from investments in venture capital is charged to the profit and loss statement at the time the investment is realized.

d. The cost of securities realized is calculated on a “first in, first out” (FIFO) basis. e. Concerning the calculation of fair value - see section D (7) below. f. Concerning the treatment of impairment not of a temporary nature - see section D (9) below. g. Securities Exchange Transactions

Exchange transactions of government bonds with other government bonds for redemption in under a year, are shown as government bonds purchased at tender price and sale of bonds at market price.

h. Lending Securities 1. The lending of securities by one customer to another or to the Bank, in which the Bank acts as

an intermediary, is shown by the Bank as “deposits with banks”, “credit to the public” and “deposits of the public” as long as the securities have not been returned. Transactions carried out as “ordinary” credit transactions in which the Bank lends securities against a collateral portfolio, and the borrower does not provide the banking corporation with a security margin relating specifically to the securities lending transaction, are shown as credit to the public as per market value and are added to the liability of the borrower.

2. Borrowing of Securities from the Treasury: The Bank borrows securities from the Treasury for purposes of covering short sales of securities (of the Bank’s nostro or of the Bank’s customers). Securities borrowing by the Bank is shown in the item “Securities Borrowed”. The short sale of securities by the Nostro is shown in the item “Other Liabilities” and the short sale of securities by customers is shown in the item “Credit to the Public”.

6. Derivative financial instruments including hedge accounting

a. As part of the Bank’s activity for its customers, and in the framework of its Asset and Liability Management policy aimed at the controlled management of its exposure to financial risks, the Bank executes transactions in derivative financial instruments with customers, banks, the Maof Clearing House, and the Bank of Israel. These instruments include among others: forward transactions, futures contracts, financial swaps, options etc., whose main purpose is to provide protection against index basis exposure, currency exposure, and interest exposure.



187

b. The Bank is exposed to credit risks, liquidity risks, and market risks. As part of the overall strategy of the Bank for managing its level of exposure to the various risks, the Bank makes use of derivative financial instruments which include among others, forward transactions, futures contracts, financial swaps, options etc. The Bank holds earmarked and eligible derivatives as fair value hedges, and derivatives not earmarked for an eligible hedging relationship.

c. The Bank may enter into a contract which is not a derivative instrument on its own, but contains an embedded derivative. With regard to each contract, the banking corporation evaluates if the economic characteristics of the embedded derivative have a clear and close relationship to those of the host contract and determines if a separate instrument with the same terms as the embedded instrument would satisfy the definition of an embedded derivative. When it is determined that the embedded derivative has economic characteristics that do not have a clear and close relationship to those of the host contract, and that a separate instrument with the same terms would be eligible as a derivative instrument, the embedded derivative is separated from the host contract and dealt with separately. An embedded derivative that was separated is included in the balance sheet together with the host contract. When the host contract is measured at fair value, and changes in its fair value are reported on a current basis in the statement of profit and loss; or when the Bank is not able to identify and reliably measure an embedded derivative for purposes of separating it from the host contract, the contract is recorded as a whole in the balance sheet at fair value.

d. The Bank holds derivative financial instruments for purposes of hedging foreign currency risks and interest rate risks, and also carries out activity in derivatives. The Bank formally documents all the hedging relationships between hedging instruments and hedged items, including the purpose and strategy of managing risks by means of creating the various hedging transactions. Documentation includes the specific identification of the asset, the liability, the firm commitment, and the forecast transaction designated as the hedged item, and the manner in which the hedging instrument is expected to hedge the risks relating to the hedged item. The Bank evaluates the effectiveness of hedging relationships both at the beginning of the hedge and also on an ongoing basis in accordance with its risk management policy.

e. Fair value hedging - the Bank designates certain derivatives as fair value hedges. Changes in the fair value of derivatives hedging exposure to changes in the fair value of an asset, liability or firm commitment, are recognized on a current basis in the profit and loss statement; as are changes in fair value of the hedged item which can be attributed to the hedged risk.

For purposes of evaluating the effectiveness of hedges, the Bank extracted the time value of the options and the differences between the spot price and forward price of forward contracts.

For data on the subject of the non-effectiveness relating to fair value hedges, the profit (loss) component in respect of derivative instruments that was extracted for purposes of evaluating the effectiveness of the hedges, and the profits (losses), net, in respect of a firm commitment that is no longer eligible as a fair value hedge, see Note 18 – “Profit from financing activities before income in respect of credit losses – in section F – “Non-effective component in hedging relationships”.

The Bank ceases hedge accounting prospectively when: (a) It is determined that the hedge is no longer effective in offsetting changes in the fair value of the

hedged item; (b) The derivative expires, is sold, canceled, or realized; (c) The derivative ceases to be designated as a hedging instrument, as it is almost certain that the

forecast transaction will not be carried out; (d) A hedged firm commitment no longer fulfills the definition of a firm commitment; (e) Management cancels the designation of the derivative as a hedging instrument. When hedge accounting is discontinued since it is determined that the derivative is no longer eligible as an effective fair value hedge, the derivative continues to be recorded in the balance sheet at fair value, but the hedged asset or liability will no longer be adjusted for changes in fair value. When hedge accounting is discontinued since the hedged item no longer meets the definition of a firm



188

commitment, the derivative continues to be recorded in the balance sheet at fair value, and any asset or liability recorded in accordance with recognition of the firm commitment will be cancelled from the balance sheet and recognized as profit or loss in the statement of profit and loss for the current period.

f. Economic hedging - Hedge accounting is not applied with regard to derivative instruments serving as part of the Bank’s asset and liability management function (ALM). Changes in the fair value of these derivatives are recognized in the statement of profit and loss when incurred.

g. Derivatives not used for hedging - Changes in the fair value of derivatives not used for hedging are charged immediately to profit and loss.

h. Embedded derivatives - An embedded derivative that was separated appears in the balance sheet together with the host contract, and changes in fair value of separated embedded derivatives are charged immediately to profit and loss. In certain cases (such as in cases when the Bank is not able to separate the embedded derivative from the host contract), pursuant to US Accounting Standard FAS 155 (ASC 815-15) - “Accounting Treatment of Certain Hybrid Financial Instruments”, the Bank elects not to separate the embedded derivative and to measure the hybrid instrument as a whole for fair value while reporting on changes in the fair value in the statement of profit and loss when they occur. The above election is made at the date of purchase of the hybrid instrument or on the occurrence of certain events when the instrument is subject to a re-measurement event, such as a result of business combinations or material changes in debt instruments. Such fair value election is irrevocable.

i. The Bank is active in the area of derivative financial instruments, which are reported in the Financial Statements based on fair value, as opposed to the value on accrual basis. The fair value calculations of derivative financial instruments, in respect of their foreign currency element, are based on prevailing data in international money markets, and in respect of the Israeli currency element, on the rates of unlinked and index-linked interest for which the Risk Management Department of the Bank has made an estimate, taking into account market prices, liquidity and negotiability prevailing in the domestic market. The margin between 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 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 that the Bank purchased or wrote. With regard to compound derivative financial instruments that have no active market, fair value calculations are generally made by the leading financial information systems in the field, which are used by dealing rooms and banks worldwide (the Bloomberg system and the Super Derivatives system). Interest rates in Israeli currency and foreign currency for varying time-periods, as mentioned above, are also the basis for the calculation of fair value for balance sheet items, as noted in detail in Note 16B to the Financial Statements. These interest rates are also used for calculating the fair value of assets and liabilities hedged against derivative financial instruments, if they meet hedging criteria as required by accounting principles and the directives of the Supervisor of Banks in the matter.

7. Determination of fair value of financial instruments

FAS 157 (ASC 820-10) defines fair value and establishes a consistent working framework for the measurement of fair value by defining fair value assessment techniques with regard to assets and liabilities, and by establishing a fair value hierarchy and detailed instructions for implementation. Fair value is defined as the amount/price that would be received from the sale of an asset or that would be paid to transfer a liability in a transaction between a willing seller and a willing buyer at the measurement date. The Standard stipulates, inter alia, the need for fair value valuation, to make



189

optimum use of observable inputs, and to minimize the use of unobservable inputs. Observable inputs provide information available to the market received from independent sources, whereas unobservable inputs reflect assumptions by the banking corporation. FAS 157 stipulates a hierarchy of measurement techniques based on the determination if the inputs used for purposes of determining fair value are observable or unobservable. These types of input create a fair value hierarchy detailed as follows: - Level 1 inputs: quoted prices (not adjusted) in active markets for identical assets or liabilities. - Level 2 inputs: prices quoted for similar assets or liabilities in active markets; prices quoted for

identical assets or liabilities in inactive markets; prices derived from evaluation methods in which all the significant inputs are observable in the market, or are supported by observable market data

- Level 3 inputs: unobservable inputs for the asset or the liability deriving from evaluation model for which one or more of the significant inputs are not observable.

This hierarchy requires the use of observable market data, where such exist. When this is possible, the Bank considers relevant observable data in its evaluation, the scope and frequency of the transactions, the size of the bid-ask margin, and the size of adjustment required when comparing similar transactions, are all factors taken into account when determining the level of market liquidity and the degree of relevance of observable prices in those markets. The implementation of the rules set out in FAS 157 require the discontinuation of the use of the blockage factor in calculating fair value, and amends the instructions of EITF 02-3 (ASC 815-10) - "Issues Involved in Accounting for Derivative Contracts Held for Trading Purposes and Contracts Involved in Energy Trading and Risk Management Activities" which prohibit the recognition of day-one profits and require that the fair value measurement of derivative instruments not traded on an active market be determined according to the transaction price.

Securities The fair value of securities held for trading and securities available for sale is determined based on market prices quoted in the principal market. When there are several markets in which the security is traded, the evaluation is carried out according to the market price quoted in the most efficient market. In these cases, the fair value of the Bank’s investments in securities is the multiple of the number of units and the same quoted market price. The quoted price used for determining fair value is not adjusted for the size of the holding by the Bank, or the size of the position relative to the trading volume (the holding size factor). If a quoted market price is not available, the fair value estimate is based on the best available information, while making maximum use of observable inputs, and taking into account the risks inherent in the financial instrument (market, credit, or commodity risk and so on).

Derivative financial instruments Derivative financial instruments that have an active market were valued at market value determined as the principal market, and in the absence of a principal market, according to the market price quoted in the most efficient market. Derivative financial instruments that are not traded were valued on the basis of models that take into account the risks inherent in the derivative instrument (market risk, credit risk and so on). For further details, see below regarding the methodology of evaluation of credit risk and non-performance risk. Regarding the measurement of the fair value of derivative financial instruments in 2011, see Note 1(6)i.

Additional non-derivative financial instruments For most of the financial instruments in this category (such as: credit to the public, credit to the government, deposits of the public and deposits with banks, subordinated notes, and non-quoted loans) a “market value” cannot be quoted because they do not have an active trading market in which they are quoted. Therefore the fair value is estimated by means of accepted pricing models, such as the present value of future cash flows, discounted at an interest rate that reflects the level of



190

risk inherent in the financial instrument. For this purpose, future cash flows for impaired debts and other debts were calculated after deducting the effects of accounting write-offs and allowances for credit losses in respect of the debts. In addition, in certain cases, for purposes of fair value measurement of unquoted financial obligations, the Bank applies the instructions set out in ASU 2009-05 – “Measurement of Obligations According to Fair Value”. In particular, the Bank assesses their fair value by using prices quoted for the obligations (or of similar obligations) which traded as assets. Assessment of Credit Risk and Nonperformance Risk The Standard requires the banking corporation to reflect credit risk and nonperformance risk in measuring the fair value of debt, including derivative instruments, issued by the Bank and measured at fair value. Nonperformance risk includes the credit risk of the banking corporation, but is not limited to this risk alone. The Bank assesses credit risk in derivative instruments in the following manner: - When sufficient liquid collateral exists in respect of the exposure, specifically securing the

derivative instrument at a high degree of legal certainty, the Bank assumes that the credit risk inherent in the instrument is zero, and does not record adjustments to fair value in respect of the quality of credit of the counterparty.

- When exposure in respect of the counterparty on a consolidated basis is material, the banking corporation performs a fair value assessment based on indications from transactions in an active market of the quality of credit of the counterparty, insofar as such indications are available with reasonable effort. The Bank derives these indications, among other things, from prices of debt instruments of the counterparty traded in an active market, and from prices of credit derivatives the basis for which is the quality of credit of the counterparty. If no such indications exist, the Bank calculates the adjustments based on internal ratings (such as estimates of anticipated rates of default and rates of credit losses in times of default).

- When the exposure in respect of the counterparty on a consolidated basis is immaterial, the Bank calculates the aforesaid adjustment on a group basis, and using a credit quality index for groups of similar counterparties, for example based on internal ratings.

Furthermore, the Bank performs reasonableness checks on the results received in the internal assessment in relation to changes in margins in the market, and makes the adjustments required, as applicable. For further details regarding the main methods and assumptions used to estimate the fair value of financial instruments, see Note 16B below concerning balances and fair value estimates of financial instruments. In accordance with transitional provisions for 2011, specific instructions were set out regarding the data serving in calculating the fair value of derivative instruments. In addition, it was determined that in the 2011 annual and quarterly financial statements, a banking corporation is not required to use complex models including different scenarios of potential exposure in order to measure the credit risk component included in the fair value of derivative instruments. In accordance with these provisions, and in coordination with the Supervisor of Banks at Group level, including the Bank, in the fair value measurement of derivative instruments, the Bank will continue measurement in the format used in the Bank until December 31, 2010, which also takes into consideration, inter alia, the credit risk component. The Bank implemented the principles set out in FAS 157 in full as of January 1, 2012. Disclosure requirements FAS 157 expands the disclosure requirements for measurements of fair value. In addition, ASU 2010-06 requires the inclusion of additional disclosures, such as disclosure of amounts of significant transitions from Level 2 fair value measurements to Level 1 measurements and vice versa, and the inclusion of explanations for such transitions. Disclosure is also required for gross amounts of



191

changes in Level 3 fair value measurements resulting from transactions of acquisition, sale, issuance, and repayment at maturity. The new disclosures are required on a quarterly basis. The aforesaid disclosure requirements are included in these financial statements. However, there is no requirement to apply the aforesaid disclosure requirements to financial statements for periods presented before the initial implementation of the standard. Accordingly, these financial statements do not include comparative figures for the new disclosures. Initial Implementation of FAS 157 – “Fair Value Measurements”, and ASU 2010-06 – “Improving Disclosures about Fair Value Measurements” FAS 157 (ASC 820-10) was adopted for the first time in a limited format of retrospective implementation. In light of this, the Standard was implemented prospectively, except for financial instruments that were measured prior to its first time implementation, in the manner detailed below: - Positions in financial instruments traded in an active market that were measured for fair value

by using a holding-size factor; - Financial instruments, including hybrid financial instruments, that are measured for fair value at

the date of initial recognition under Part A1 of the Public Reporting Directives, by using the transaction price in accordance with the instructions in the footnote of EITF 02-3 (ASC 815-10)

The Bank implemented in full the new rules for fair value measurement as of January 1, 2012. In the Bank’s opinion, implementation of these rules is expected to increase the financing expenses of the Bank in the first quarter of 2012 by about NIS 2.0 million.

8. The Fair Value Option for Financial Assets and Financial Liabilities FAS 159 (ASC 825-10) allows a banking corporation to elect, on defined dates, to measure financial instruments and certain other items (the eligible items) at fair value, which under the Public Reporting Directives are not required to be measured at fair value. Unrealized profits and losses in respect of changes in the fair value of the items for which the fair value option is selected shall be reported in the statement of profit and loss for each consecutive reporting period. In addition, prepaid costs and fees related to the items for which the fair value alternative is selected are recognized in profit and loss on the date of their creation. The election to apply the fair value alternative, as noted above, shall be made instrument by instrument, and is irrevocable. In addition, the Standard establishes presentation and disclosure requirements aimed at facilitating comparisons between banking corporations that choose different bases for measurement of similar types of assets and liabilities. Notwithstanding the above, it was clarified by the Banking Supervision Department that a banking corporation should not elect the fair value option unless it has developed prior know-how, systems, procedures, and controls at a high level, which will enable it to measure the item to a high degree of reliability. Thus, the Bank may not elect the fair value alternative with regard to any asset requiring classification as level 2 or level 3 of the fair value hierarchy, or with regard to any liability, unless it receives prior approval to do so from the Banking Supervision Department. Initial Implementation of FAS 159 - Fair Value Option for Financial Assets and Financial Liabilities The Bank does not apply FAS 159, and accordingly there is no effect on the financial statements.

9. Impairment of Financial Instruments

Securities For every reporting period, the Bank examines whether the impairment of the fair value of securities classified in the available for sale portfolio is of a nature other than temporary.



192

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 until the publication date of the report to the public for this period; - A security that near the publication date of the report to the public for this period the Bank

intended to sell within a short period of time. - 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 rate exceeding 40% for debentures - amortized cost), and its fair value was less than the value at which it was acquired for three consecutive quarters. 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 rate of loss in relation to the cost of the security (regarding debentures - to the amortized 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; When impairment of a nature other than temporary occurs, the cost of the security is reduced to the fair value and serves as the new cost basis. The amount of the reduction is charged to the statement of profit and loss. Increases in value in subsequent reporting periods are included in a separate item in shareholders’ equity under accumulated other comprehensive income and are not charged to profit and loss (the new cost basis).

10. Offsetting assets and liabilities a. The Bank offsets assets and liabilities deriving from the same counterparty and states their balance

net in the balance sheet if the following cumulative conditions exist: - For these liabilities, there exists a legally enforceable right to offset liabilities from assets; - There is the intent to repay the liabilities and to realize the assets on a net basis or at the

same time. b. The Bank offsets assets and liabilities with two different counterparties and states a net amount

in the balance sheet if the above cumulative two conditions exist, and on condition that there is an agreement between the three parties clearly determining the Bank’s right of offset of those liabilities.

c. The Bank offsets deposits whose repayment to the depositor is conditional upon the amount of the credit collected and the credit granted from these deposits, in respect of which the Bank has no risk of loss from the credit.

d. The Bank offsets derivative instruments carried out with the same counterparty subject to a master netting arrangement.



193

11. Transfers and Servicing of Financial Assets and Extinguishments of Liabilities

The Bank applies the principles of measurement and disclosure set out in US Accounting Standard FAS 140 (ASC 860-10) - “Transfers and Servicing of Financial Assets and Extinguishments of Liabilities”, as amended by FAS 166 - “Transfers and Servicing of Financial Assets” (ASC 860-10) for the purpose of dealing with transfers of financial assets and extinguishment of liabilities. In accordance with these principles, the transfer of a financial asset will be accounted for as a sale, if and only if, all of the following conditions are fulfilled: (1) The transferred financial asset has been isolated from the transferor, both in a state of

bankruptcy or other receivership; (2) Any recipient (or, if the recipient is an entity whose sole purpose is to engage in securitization

or asset-backed financing activities and that entity is constrained from pledging or exchanging the financial assets it receives, each third-party holder of its beneficial interests) can pledge or exchange the assets (or beneficial interests) it received, and no condition exists that also constrains the recipient (or a third-party of its beneficial interests) from taking advantage of its right to pledge or exchange and provides the transferor with more than a trivial benefit;

(3) The transferor or consolidated companies included in its financial statements or its agents do not maintain effective control over the financial assets or beneficial interests relating to the transferred financial assets.

In addition, in order for the transfer of some of the financial asset to be considered a sale, the part transferred must comply with the definition of participating interests. Participating interests must comply with the following criteria: the interest must represent a proportionate interest in relation to an entire financial asset; all cash flows received from the assets are divided proportionately among the participating interest holders in an amount equal to their share of ownership; the rights are not subordinated rights in relation to other rights; there is no right of recourse to the transferor or to other holders in participating interests (other than in the event of a breach of representations or warranties, ongoing contractual obligations to service the entire financial asset and administer the transfer contract, and contractual obligations to share in any set-off benefits received by any holder of participating interests); and neither the transferor, nor the participating interest holder has the right to pledge or exchange the entire financial asset, unless all participating interest holders agree to pledge or exchange the entire financial asset. If the transaction meets the conditions for treating a transaction as a sale, the transferred financial assets are deducted from the Bank's balance sheet. If the sale conditions are not fulfilled, the transfer is considered a secured debt. A sale of part of a financial asset which is not a participating interest is treated as a secured debt, i.e., the transferred assets continue to be recorded in the Bank's balance sheet and the proceeds from the sale will be recognized as a liability of the Bank.

12. Fixed Assets (Buildings and Equipment)

Recognition and measurement Items of fixed assets are measured at cost less accumulated depreciation and losses from

impairment. Cost includes expenses that are directly attributable to the acquisition of the asset. Cost of assets established independently includes the cost of materials and direct salary expenses, and additional cost directly attributable to bringing the asset to the location and condition required so that it can operate in the manner intended by Management. Profit or loss on the disposal of items of fixed assets is determined by comparing the proceeds of disposal of the asset with its book value, and are included net under “Profit from extraordinary activities after taxes” in the profit and loss statement.

Subsequent costs The cost of replacement of part of an item of fixed assets is recognized as part of the book value of that item if it is expected that the future economic advantages inherent in the part replaced will come



194

to the Bank, and if its cost can be measured accurately. The book value of the part replaced is deducted. Ongoing maintenance costs of fixed asset items are charged to the profit and loss statement when incurred.

Depreciation

Depreciation is the systematic allocation of the amortizable amount of an asset over its useful lifetime. The amortizable amount is the cost of the asset, or another amount replacing the cost, less the asset’s residual value. Depreciation is charged to the profit and loss statement according to the straight-line method over the estimated useful lifetime of every part of the fixed asset items, since this method reflects best the predicted pattern for the consumption of future economic benefits inherent in the asset. Estimates of the method of depreciation, useful lifetime, and residual value are reviewed at least at the end of every financial year and adjusted when necessary.

Software costs appear in the balance sheet under “Intangible assets”. Regarding the accounting treatment of software costs - see section 14 below. Initial Implementation of IAS 16 – Property, Plant and Equipment There was no material effect on the financial statements of the Bank from the initial implementation of the standard.

13. Leases The Bank has leases classified as operating leases, with the leased assets not recognized in the

balance sheet of the Bank. Payments in the framework of an operational lease are charged to profit and loss on a straight line basis over the term of the lease. Determination if an arrangement includes a lease At the commencement of an arrangement or when it is reviewed, the Bank determines if the arrangement is a lease or if it includes a lease. An arrangement is a lease or includes a lease if the following two conditions exist: - The existence of the lease is contingent on the use of the specific asset or assets; and - The arrangement includes the right of use of the asset. Payments and other consideration required under the arrangement are separated at the commencement of the arrangement or when it is reviewed into payments for the lease and other components on the basis of their relative fair value. Initial Implementation of IAS 17 – Leases There was no material effect on the financial statements of the Bank from the initial implementation of the standard.

14. Intangible assets Goodwill

For information on the measurement of goodwill on first-time recognition, see section D (2) above. In subsequent periods, goodwill is measured at cost less accumulated losses from impairment.

Subsequent measurement Goodwill is measured by cost less accumulated depreciation and losses from impairment. Goodwill in respect of investments treated according to the equity base method, in included at the book value of the investment. Loss from impairment in respect of investments as mentioned above is not attributed to any asset, including goodwill, which represents part of the book value of the investment.



195

Software costs Software purchased by the Bank is measured at cost less accumulated depreciation and losses from impairment.

Subsequent costs These are recognized as an intangible asset only if they increase the future economic benefits

inherent in the asset for which they were expended. Other costs are charged to profit and loss statement when incurred.

Depreciation Depreciation is charged to the profit and loss statement according to the straight line method over the estimated of useful lifetime of the intangible asset including software, commencing on the date the software is ready for use. Initial Implementation of IAS 38 – Intangible Assets The Bank implemented the standard for the first time as of January 1, 2011. There was no material effect from the implementation of the standard.

15. Impairment of Non-Financial Assets

The book value of non-financial assets of the Bank, excluding deferred tax assets, and including investments treated according to the equity method, is examined at each reporting date in order to determine whether signs exist to indicate impairment. If such signs exist, an estimate of the recoverable amount of the asset is calculated. In periods subsequent to the first recognition date, the Bank assesses, once annually on a fixed date for each asset, the recoverable amount of intangible assets with an undefined lifetime, or which are unavailable for use; or more frequently if signs of impairment exist. The recoverable amount of an asset is the higher of the value in use and the net sale price (fair value net of selling expenses). In determining value in use, the Bank capitalizes the predicted future cash flows according to a pretax capitalization rate reflecting market estimates regarding the time value of the money and the specific risks related to the asset. For the purpose of examining impairment, assets which cannot be examined individually are aggregated into the smallest group of assets that generates cash flows from ongoing use, which are essentially non-dependent on other assets and groups (“cash-generating unit”). For the purposes of examining impairment of goodwill, cash-generating units to which goodwill was allocated are aggregated such that the level at which the impairment is examined reflects the lowest level at which goodwill was monitored for internal reporting purposes, but is not larger than an operating segment (before aggregating similar segments). Assets of the headquarters of the Bank do not generate separate cash flows. If there are signs of impairment of an asset belonging to the headquarters of the Bank, the recoverable amount of the group of cash-generating units served by the headquarters is determined. Losses from impairment are recognized when the book value of the asset or of the cash-generating unit to which the asset belongs exceeds the recoverable amount, and are charged to profit and loss. Losses from impairment recognized with regard to cash-generating units are first allocated to the amortization of the book value of the goodwill attributed to such units, and afterward to the amortization of the book value of the other assets in the cash-generating unit, proportionally. Loss from the impairment of goodwill is not cancelled. With regard to other assets, losses from impairment recognized in previous periods are reexamined at each reporting date, in order to test for signs that the losses have decreased or no longer exist. Loss from impairment is cancelled if a change has occurred in the estimates used to determine the recoverable amount, only if the book



196

value of the asset, after cancellation of the loss from impairment, does not exceed the book value net of amortization or depreciation that would have been determined if no loss from impairment had been recognized. Investments in associate companies dealt with according to the equity base method An investment in an associate company is examined for impairment when there is objective evidence indicating impairment in accordance with IAS 39 – Financial Instruments: Recognition and Measurement, and in accordance with “Securities Authority Decision 1-4 – Guidelines for Reviewing the Need for Depreciation of Permanent Investments” Goodwill that is part of an investment account in a company included on equity basis is not recognized as a separate asset, and is therefore not examined separately for impairment. Impairment is examined with regard to the investment as a whole, if there is objective evidence indicating that the value of the investment may have been impaired. The Bank conducts an examination of the recoverable amount of the investment, which is the higher of its usage value and its net selling price. When determining the usage value of an investment in an associate company, the Bank estimates its share of the present value of estimated future cash flows, which are projected to be produced by the associate company, including cash flows from the associate company’s activities and the proceeds from the final realization of the investment, or the present value of estimated future cash flows projected to be derived from dividends to be received and from the final realization. Losses from impairment are recognized when the book value of the investment, after applying the equity base method, exceeds the amount recoverable, and are recognized under “Banking corporation’s share in profits or losses from ordinary activities of companies included on equity basis, after taxes” in the statement of profit and loss. Losses from impairment are not allocated to any specific asset, included goodwill that represents part of the investment account in the associate company of in an entity under joint control. Losses from impairment are only canceled if there were changes in estimates used in determining the amount recoverable of the investment from the date the loss from impairment was last recognized. The book value of the investment, after canceling the loss from impairment, shall not exceed the book value of the investment that would have been determined under the equity base method if the loss from impairment had not been recognized. Canceling the loss from impairment is to be recognized under “Banking Corporation’s share in profits or losses from ordinary activities of companies included on equity basis, after taxes”. Initial Implementation of IAS 36 – Impairment of Assets The Bank implemented the standard retrospectively as of January 1, 2011. There was no material effect from the implementation of the standard.

16. Employee rights There are appropriate reserves for all liabilities regarding employer/employee relations, in accordance with the law, agreements, accepted practice, and management’s expectations. Liabilities for severance pay and pensions are covered mainly by amounts funded, which are deposited in providence funds for pension and severance pay. For amounts of liabilities not covered as stated, a provision is made in the financial statements - see Note 12. Instructions and Clarifications Regarding the Reinforcement of Internal Control Over Financial Reporting on Employee Benefits On March 27, 2011, the Banking Supervision Department issued instructions regarding the reinforcement of internal control over financial reporting on employee benefits. The instructions establish several clarifications regarding the assessment of the liability in respect of employee



197

benefits and instructions regarding internal control over the process of financial reporting on employee benefits, with requirements for the involvement of a licensed actuary, identification and sorting of liabilities in respect of employee benefits, maintenance of internal controls with regard to the reliance upon and validation of the actuary’s assessment, and certain disclosure requirements. In particular, the circular states that a banking corporation that expects a group of employees to be paid benefits beyond their contractual terms should take into account the percentage of employees expected to leave (including employees expected to leave under voluntary retirement programs or upon receiving other preferred terms) and the benefits that they are expected to receive upon leaving. Following the implementation of the Supervisor’s instructions, the liability in respect of severance pay for the group of employees is presented in the financial statements at the higher of the amount of the liabilities calculated on an actuarial basis, taking into account the additional cost expected to be incurred by the Bank in respect of the aforesaid benefits, and the amount of the liabilities calculated by multiplying the employee’s monthly wage by the number of years of employment, as required in Opinion Statement 20 of the Institute of Certified Public Accountants in Israel. The Bank commenced implementing the instructions included in the circular as of financial statements after April 1, 2011. The effect of implementation of the directive on the financial statements for 2011 is not material.

17. Contingent Liabilities

The financial statements include appropriate provisions for legal claims, in accordance with the estimation of the Management and based on the estimations of its legal counsels. Disclosure is in the format set forth in the directives of the Supervisor of Banks, so that claims filed against the Bank are classified into three groups: 1. Probable risk - probability of realization of the risk exposure exceeds 70%. For a claim included

in this risk group, a provision is included in the financial statements. 2. Reasonably possible risk - probability of realization of the risk exposure is between 20% and

70%. For a claim included in this risk group, a provision is not included in the financial statements but disclosure only is made.

3. Remote risk - probability of realization of the risk exposure is less than 20%. For a claim included in this risk group, a provision is not included in the financial statements and no disclosure is made.

A claim, for which there is a determination by the Supervisor of Banks that the Bank is required to repay funds, is classified as probable and a provision is made for it in the amount the Bank is required to repay. In rare cases the Bank has determined that, in the opinion of Bank Management, based on its legal counsels, it is not possible to evaluate the probability of realization of the risk exposure with regard to a normal claim and a claim approved as a class action, and so no provision was made. Note 16 on Contingent Liabilities and Special Commitments includes quantitative disclosure for all exposures whose probability of realization is not remote, for which no provision has been made, where the amount of each of them (or the joining of several claims on similar matters), according to the claim, is greater than an amount constituting approximately 10% of the capital of the Bank. In addition, the above-mentioned Note includes details of contingent liabilities whose possibility of realization is remote but the realization of the said liabilities or the maximum loss may cast doubt on the continued operation of the corporation in its present format.

18. Taxes on income Tax expense on income include current taxes and deferred taxes. Current and deferred taxes are charged to the statement of profit and loss, except if the tax derive from a transaction or an event charged directly to shareholders’ equity. In these cases, the tax expense on income is charged to shareholders’ equity. Current tax is the amount of tax expected to be paid (or received) on taxable



198

income for the year, calculated in accordance with the tax rates applicable by law that was passed or for which legislation has effectively been completed by the balance sheet date, as well as adjustments to the tax liability for previous years. The provision for taxes on the income of the Bank and its consolidated companies that are financial institutions for Value Added Tax purposes, include profits tax levied on the income according to the Value Added Tax Law. Value Added Tax levied on salaries in financial institutions is included in the statement of profit and loss under “Salaries and related expenses”. The Bank recognizes deferred taxes in respect of temporary differences between the book value of assets and liabilities for purposes of financial reporting, and their value for tax purposes. The Bank however does not recognize deferred taxes in respect of temporary differences deriving from investments in subsidiary companies and companies included on equity basis, if it is not expected that they will be reversed in the foreseeable future. Deferred taxes are measured according to tax rates expected to apply to the temporary differences at the time of their realization, based on laws that were passed or for which legislation has effectively been completed by the balance sheet date. The Bank offsets deferred tax assets and liabilities in the event that an enforceable legal right exists for the offsetting of current tax assets and liabilities, and they are attributed to the same taxable income taxed by the same tax authority for the same taxed company, or in different companies in the Group which intend to settle current tax assets and liabilities on a net basis, or the tax assets and liabilities are settled simultaneously. A deferred tax asset in respect of losses carried forward and in respect of right carried forward to offset tax is recognized in the books in cases in which the realization of the said tax in the foreseeable future is not in doubt. A deferred tax asset is recognized in respect of temporary differences when it is probable that a tax saving will be created in respect thereof at the reversal date. The creation of net deferred tax assets shall not exceed the current taxes in the accounting period, except in special cases in which the realization of the tax in the foreseeable future is not in doubt. The Bank may be obligated to add taxes in the case of distribution of dividends in respect of investee companies. This additional tax is not included in the financial statements, in view of the policy of the investee companies not to cause a distribution of a dividend that involves additional tax for the Bank, in the foreseeable future. In cases in which an investee company is expected to distribute a dividend from profits involving additional tax for the Bank, the Bank creates a reserve for tax in respect of the additional tax that it is likely to incur. Deferred tax in respect of intercompany transactions in the consolidated statement is recorded according to the tax rate applicable to the acquiring company.

19. Earnings per share – IAS 33

The Bank reports basic earnings per share data with regard to its ordinary share capital. Basic earnings per share is calculated by dividing the profit or loss attributed to the ordinary shareholders of the Bank by the weighted average number of ordinary shares that were in circulation during the period. There is no effect on the calculation of earnings per share of the Bank from implementation of the Standard.

20. Statement of Cash Flows

The statement of cash flows is presented classified under cash flows from operating activities, from activities in assets, and from activities in liabilities and capital. The cash flows from activities in assets and in liabilities, and in capital, are shown net, other than changes in securities for investment and in non-monetary assets. The item “Cash and cash equivalents” includes cash and deposits with banks, negotiable CD’s and deposits in central banks for an original period not exceeding three months.



199

21. Reporting on Operating Segments

An operating segment is a component in a banking corporation, engaged in activities from which it is likely to derive income and bear expenses, the result of its operations is regularly examined by Management and the Board of Directors, in order to make decisions regarding the allocation of resources and the evaluation of its performance, and with regard to which there is separate financial information. The format for reporting on operating segments of the Bank is set out in the Public Reporting Directives of the Supervisor of Banks. For further information, see Note 27 (b). The allocation of segments in the Bank is based on the characterization of the customer segments. These segments also include banking products. The segment results of a product not attributable to the relevant customer segments is included in “Amounts not allocated and adjustments”.

22. Transactions with Controlling Shareholders

a. Undertaking of a liability, indemnity, or waiver - the amount of the liability, indemnity, or waiver is charged to capital reserve.

b. Loan and subordinated note The granting of a loan or the issue of a subordinated note, carried out between the Bank and a controlling shareholder, for a defined period and not under market conditions, are presented in the financial statements at the present value of the expected repayments calculated according to the effective interest rate at the date of receipt of the loan or issue of the subordinated note, if on the day of the commitment the difference between the present value of expected repayments and the nominal amount in the subordinated note was five percent or more. The difference between the amount of the loan or the nominal amount in the subordinated note and the present value of expected repayments, calculated according to the said effective interest rate, is charged to capital reserve. The granting of a loan or the issue of a subordinated note, carried out between the Bank and a controlling shareholder, for which no repayment date was determined, and, on the date of the commitment the difference between the present value of expected repayments and the nominal amount in the subordinated note was five percent or more, are presented in the Financial Statements as a loan or as a subordinated note for the period of one year renewable annually. The difference between the amount of the loan or the nominal amount in the subordinated note and the present value of expected repayments, calculated according to the said effective interest rate, is charged to capital reserve. When the grantor of the loan or the issuer of the subordinated note does not intend to demand their repayment and the borrower does not intend to make early repayment of the loan or the subordinated note, for any reporting period, the Bank charges to capital reserve the difference between the financing expenses of the loan or subordinated note, calculated according to the rate of increase of the adjusted CPI for the reporting period, and these expenses calculated according to the interest rate under the terms of the loan or subordinated note.

c. Transfer of an asset Differences between consideration received from the sale of assets to a controlling shareholder and

the book value of the assets in the books of the Bank are charged to the capital reserve of the bank. Assets acquired from a controlling shareholder are recorded in the Financial Statements according to their book value in the books of the controlling shareholder at the time of their transfer to the Bank, and the difference compared with the amount paid for them less relevant taxes is charged to equity.

23. Reporting on the Bank’s Liability to the Maof Clearing House

In consequence of the Bank’s liability to the Maof Clearing House in respect of the General Risk Fund and the Maof transactions for which the Bank is liable on behalf of its customers, securities have been deposited in separate accounts in the name of the Clearing House.



200

Balances representing the collateral for any amount that the Bank owes the Maof Clearing House as mentioned above appear in the balance sheet under “Securities”. See Note 16 (C) (2) (3), 16 (D) (1), and 16 (F).

24. Structured deposits The Bank markets structured deposits to its customers. These deposits include combined options on interest rates, linkage bases and various indices. The options that are combined in the deposits were measured on the basis of the measurement rules for derivative financial instruments, as distinguished from deposits that are presented in accordance with accrual value. The deposits, including the options combined therein, are shown as deposits of the public.

E. New Accounting Standards and Directives of the Banking Supervision Department in the

period prior to their implementation 1. Directives on the format for the statement of profit and loss of a banking corporation and the

adoption of accounting standards generally accepted by US banks on the measurement of interest income A circular of the Supervisor of Banks was issued on December 29, 2011, with the aim of adjusting the Public Reporting Directives for the purpose of: - Establishing the manner of presentation of the statement of profit and loss – The directive

adjusts the format of the statement of profit and loss to the prevalent manner of presentation globally and in the United States. The new format changes the manner of presentation of the components of financing profit in the statement of profit and loss itself and in the accompanying notes; cancels the distinction between fees from financing business and operational fees; changes the classification of linkage differentials on principal as part of "interest"; and changes the classification and names of other items of the statement of profit and loss. In addition, the directive cancels the item "profit from extraordinary transactions" and adopts the customary approach in the United States, according to which special items are defined as items that are "unusual" and "infrequent," and states that the classification of any event as a special item shall only be possible with advance approval of the Supervisor of Banks. The directive also establishes changes in the format of additional notes to the financial statements. The directives with regard to the format of the statement of profit and loss will be implemented beginning with the financial statements for the first quarter of 2012, retroactively. The initial implementation of the directives is expected to have no effect, other than the change in presentation.

- Adoption of the rules established in US GAAP regarding nonrefundable fees and other costs –

The directive establishes rules for the treatment of loan origination fees and direct loan origination costs. The eligible fees and costs, according to the criteria established, shall not be recognized immediately in the statement of profit and loss, but shall be taken into account in calculating the effective interest rate of the loan. In addition, the directive changes the treatment of commitments fees and commitments costs, including credit-card transactions. The directive also sets forth rules regarding the treatment of changes in the terms of debt that do not constitute restructuring of problematic debt, treatment of early repayment of debts, and treatment of other credit granting transactions, such as syndicated transactions. The rules established in the directive represent a significant change relative to the existing rules in the Public Reporting Directives. The preparations for the implementation of the rules established in the directive are complex; the Banking Supervision Department intends to guide



201

the banking corporations in the preparatory process, especially in the area of identifying eligible costs. The circular states that the rules on this matter will be implemented from January 1, 2013, forward. The directives concerning the change in the definition of "interest" in respect of impaired debts will be implemented, with regard to debts classified as impaired, from January 1, 2012 forward only. The Bank is examining the expected implications of the initial implementation of the directives.

2. In July 2006, the Israel Accounting Standards Board published Accounting Standard No. 29,

Adoption of International Financial Reporting Standards (IFRS). The standard stipulates that entities subject to the Securities Law, 1968 and required to report under its regulations shall prepare their financial statements according to IFRS for periods starting as of January 1, 2008. The aforesaid does not apply to banking corporations whose financial statements are prepared according to the directives and guidelines of the Banking Supervision Department. In June 2009, the Banking Supervision Department issued a letter concerning reporting by banking corporations and credit-card companies in Israel in accordance with IFRS, which establishes the expected manner of adoption of IFRS by banking corporations. It was further clarified that subsequent to the completion of the process of adjusting the directives to the international standards, the Supervisor of Banks will retain the authority to set forth binding clarifications with regard to the manner of implementation of the requirements of the international standards, and to set forth additional directives in cases in which it is necessary due to the requirements of the supervisory agencies in developed countries globally, or on matters not addressed by the international standards. In addition, the Supervisor of Banks will retain the authority to establish disclosure and reporting requirements. Pursuant to the circular, the deadlines for reporting by banking corporations according to IFRS are as follows: (1) On matters related to the core business of banking – as of January 1, 2013. The Banking

Supervision Department intends to reach a final decision on this matter during 2011. The final decision will be made taking into consideration the schedule established in the US and the progress of the convergence process between international and American standards. A final decision on this matter has not yet been made.

(2) On matters not related to the core business of banking – January 1, 2011. However, the IFRS

listed below have not yet taken effect, and will be adopted in accordance with the directives of the Banking Supervision Department, when such directives are published, with regard to the timing and manner of the initial implementation of the standards: - IAS 7, Statement of Cash Flows; - IAS 12, Income Taxes; - IAS 19, Employee Benefits; - IAS 23, Borrowing Costs; - IAS 24, Related Party Disclosures. A circular concerning the adoption of certain IFRS was issued on November 30, 2011. Among other matters, the circular states that these IFRS, with the exception of IAS 19, Employee Benefits, shall be implemented by banking corporations as of January 1, 2012. Upon initial implementation of these IFRS, banks are required to act in accordance with the transitional directives set forth in the standards, including retroactive amendment of comparison figures if required. Additional details regarding the standards to be adopted as of January 1, 2012 are set out below:



202

- IAS 12, Taxes on Income The standard establishes the accounting treatment of taxes on income. Pursuant to the

standard, deferred taxes shall be recognized with reference to temporary differences between the book value of assets and liabilities and the value of the assets and liabilities for tax purposes, with the exceptions stipulated in the standard, according to which deferred taxes shall not be recognized in respect of temporary differences. The deferred taxes shall be measured in accordance with the tax rates expected to apply during the period in which the temporary differences will be realized, based on tax rates and tax laws legislated, or the legislation of which has been essentially completed, by the end of the reporting period. Current tax liabilities or assets in respect of the current period and in respect of previous periods shall be measured according to the estimated amount to be paid to the tax authorities or refunded by the tax authorities, using the tax rates and tax laws legislated, or the legislation of which has been essentially completed, by the end of the balance-sheet period. The standard further states that deferred tax assets shall be recognized in the books in respect of losses carried forward, tax credits, and deductible temporary differences when it is probable that taxable income against which they can be used will exist in the future. In accordance with the rules set forth in the standard, as adopted in the Public Reporting Directives of the Banking Supervision Department, the term "probable" shall be defined consistently with the application of the phrase "more likely than not," instead of the translation of the term "probable" in the Public Reporting Directives implemented today, in which the threshold is established as "beyond any reasonable doubt." In addition, in situations of uncertainty with regard to taxes on income, banking corporations shall be required to implement the rules set forth in FIN 48, Accounting for Uncertainty in Income Taxes, as long as these rules do not contradict IFRS, by establishing policies and procedures and implementing documentation requirements with respect to tax positions of various degrees of uncertainty. The initial implementation of this standard is expected to have no material effect.

- IAS 7, Statement of Cash Flows The standard states that information should be provided regarding changes in cash and cash equivalents during the reporting period through the statement of cash flows. Changes have been established in the Public Reporting Directives of the Banking Supervision Department in the present format of the statement of cash flows, to adjust this format to the requirements of the standard and to the reporting requirements established in certain other IFRS. Specifically, cash flows shall be classified into cash flows from operating activities, investing activities, and financing activities. In addition, a determination was made regarding the activities that shall be considered principal revenue-producing activities for the Bank, and that consequently shall be classified as operating activities. Guidelines were also established with regard to the presentation of cash flows in gross and net amounts. The effect of changes in exchange rates on cash and cash equivalents held in foreign currency or due for settlement in foreign currency shall be stated separately from other changes in cash and cash equivalents. Cash flows from interest and dividends received or paid and cash flows arising from taxes on income shall be given separate disclosure. In addition, the cash flow statement was adjusted to other changes that have occurred in the Public Reporting Directives, pursuant to the adoption of certain IFRS. The initial implementation of this standard is expected to have no effect, other than the change in presentation.



203

- IAS 23, Borrowing Costs The standard states that entities must capitalize borrowing costs attributable directly to the acquisition, construction, or production of a qualifying asset. A qualifying asset is an asset that requires a substantial period of time to prepare for its designated use or sale, including fixed assets, software assets, and other assets where a long period is necessary in order to bring the asset to a condition in which it can fulfill its designated function or be sold. However, it has been clarified in the directives of the Supervisor of Banks that banking corporations shall not capitalize borrowing costs without establishing clear policies, procedures, and controls with regard to the criteria for recognition of assets as qualifying assets and with regard to the borrowing costs that are capitalized. Accordingly, the initial implementation of this standard is expected to have no effect.

- IAS 24, Related Party Disclosures The standard establishes the required disclosures by an entity regarding its relationship with a related party and regarding transactions and unsettled balances with a related party. In addition, disclosure is required for compensation to key management personnel. Key management personnel are those persons having authority and responsibility for planning, directing, and controlling the activities of the entity, directly or indirectly, including any directors (whether executive or otherwise) of the entity. As part of the expected adoption of the standard by the Supervisor of Banks, the format of the required disclosure in the financial statements will be adjusted, in order to comply with the disclosure requirements of IAS 24 as well as the additional disclosures required under the Securities Regulations, 2010. The initial implementation of this standard is expected to have no effect, other than the change in presentation.

3. In December 2006, the Israeli Accounting Standards Board published Accounting Standard 23 –

“Accounting Treatment of Transactions Between an Entity and its Controlling Shareholder” (hereinafter: “the Standard”). The Standard replaces Securities Regulations (Presentation of Transactions between Corporations and Controlling Shareholders in Financial Statements), 1996, as adopted in the Public Reporting Directives of the Supervisor of Banks. The Standard requires that all assets and liabilities included in a transaction between the entity and its controlling shareholder will be measured on the date of the transaction at fair value and the difference between the fair value and the consideration arising from the transaction will be charged to equity. A debit difference essentially represents a dividend and accordingly reduces the balance of retained earnings. A credit difference essentially represents an investment by the shareholders and accordingly will be shown separately in equity under an item called “Capital Reserve from Transaction between an Entity and its Controlling Shareholder“. The Standard deals with three types of transactions between an entity and its controlling shareholder, as follows: (1) The transfer of an asset to the entity by its controlling shareholder, or alternatively, a transfer of

an asset from the entity to its controlling shareholder; (2) The assuming of liabilities of the entity vis-à-vis third parties, in whole or in part, by a controlling

shareholder, indemnification of the entity by the controlling shareholder in respect of an expense, a waiver by the controlling shareholder in favor of the entity of a debt due him from the entity, in whole or in part; and

(3) Loans given to the controlling shareholder or loans received from the controlling shareholder. In addition, the Standard sets out the required disclosure that must be provided in the financial statements regarding transactions between the entity and its controlling shareholder during the period.



204

On November 30, 2011, the Supervisor of Banks issued a circular on the adoption of certain IFRS. Among other matters, the circular states that as of January 1, 2012, for the purposes of accounting for transactions between a banking corporation and its controlling party or a company controlled by the banking corporation, GAAP for US banks should be implemented. In situations where these rules do not address the treatment method, the rules established in Standard 23 shall be applied, in a manner consistent with the principles of the adoption of IFRS on matters not related to the core business of banking. The initial implementation of this standard is not expected to have a material effect.

4. In April 2011, the FASB issued ASU 2011-03, Reconsideration of Effective Control for Repurchase Agreements, an update of the rules established in FAS 166 (ASC 860). The update requires a change in the manner of assessing the existence of effective control by a transferor in repurchase transactions. The assessment of effective control shall focus on contractual rights and contractual obligations of the transferor, and therefore shall not take into consideration (1) a criterion requiring the transferor to have the ability to acquire the transferred securities even in the event of default by the transferee, or (2) instructions regarding collateral requirements in connection with the aforesaid criterion. Additional criteria for the assessment of effective control were not changed by the ASU. These criteria indicate that the transferor retains effective control of the transferred assets (and the transfer of the assets shall therefore be treated as a secured debt) if all of the following conditions are fulfilled: - The assets to be repurchased or redeemed are identical or essentially identical to the assets

transferred; - The agreement is to repurchase or redeem the assets before the maturity date, at a fixed or

fixable price; and - The agreement is executed simultaneously with the transfer. The update will apply to periods beginning after December 15, 2011 (i.e. starting January 1, 2012), and will be implemented prospectively with regard to new transactions and existing transactions changed at the beginning of the first quarterly or annual period after the inception date. The initial implementation of this standard is not expected to have a material effect.

5. A New System of New Financial Reporting Standards Concerning the Consolidation of Financial Statements and Related Matters In May 2011, the IASB published a new system of standards, which is part of the consolidation project conducted jointly by the IASB and the FASB, and essentially replaces the existing standards concerning the consolidation of financial statements and joint transactions, and includes a number of changes with regard to equity-basis investees. Pursuant to the directives of the Banking Supervision Department, banking corporations shall routinely update the accounting treatment of matters adopted in the Public Reporting Directives. Such update is required prior to the inception date and according to the transitional directives established in new IFRS to be published on these matters, and in accordance with the adoption principles and clarifications of the Supervisor of Banks. In light of the foregoing, the implementation of the rules established in the new system of standards concerning the consolidation of financial statements and related matters shall be performed subject to the guidelines set forth in the Public Reporting Directives, among other matters, concerning the implementation of the standard, on matters regarding which specific rules were established or adopted in the Public Reporting Directives that differ from the rules set forth in the standard and/or in the guidelines referring to the standard.

a. IFRS 10, Consolidated Financial Statements This standard replaces the instructions of IAS 27, Consolidated and Separate Financial Statements, and SIC 12, Consolidation – Special Purpose Entities, with regard to the consolidation of financial statements, so that the instructions in IAS 27 will continue to apply only to separate financial statements.



205

The standard presents a new control model to be used in determining whether an investor controls an affiliate and must therefore consolidate it. The standard requires application of this model to all affiliated entities, both those currently covered by IAS 27 and those currently covered by SIC 12. Under the model, an investor controls an affiliate when the investor is exposed or entitled to variable returns deriving from the involvement in the affiliate, and has the ability to influence such returns through power over the affiliate. "De facto" circumstances are to be taken into consideration in evaluating control; thus, the standard essentially provides a model of effective control. In other words, if effective control exists, the consolidation of financial statements is required. In addition, in testing for control, all significant potential voting rights shall be taken into consideration, even if they cannot be exercised immediately. With regard to potential voting rights, the structure of the rights, the reasons for the existence of the rights, and the terms of the rights should be examined. Notwithstanding the foregoing, note that the accounting treatment of variable interest entities is defined as a matter related to the core business of banking, with regard to which banks are required to implement the rules set forth in FAS 167 (ASC 810-10). The standard will be implemented in annual periods beginning January 1, 2013 or later, by retroactive implementation. Early implementation is possible, subject to disclosure, and subject to early adoption of the two additional standards published concurrently: IFRS 11, Joint Arrangements, and IFRS 12, Disclosure of Interests in Other Entities. In light of the fact that at this stage the Supervisor of Banks has not established specific instructions regarding the manner of implementation of the new system of IFRS concerning the consolidation of financial statements and related matters, at this stage it is not possible to estimate the expected effect of the implementation thereof.

b. IFRS 12, Disclosure of Interests in Other Entities This standard contains comprehensive disclosure requirements regarding interests in subsidiaries, joint arrangements, equity-basis investees, and structured entities. “Structured entities” are entities constructed so that voting rights and similar interests are not the dominant factor in determining the controlling party. The definition of interests in the standard is broad, and includes contractual and/or non-contractual involvement that exposes the bank to changes in returns as a result of the performance of the affiliate. The goal of the new disclosure requirements is to enable users of financial statements to understand the essence and accompanying risks of the company’s interests in other entities, and to understand the effect of such interests on the financial condition, results of operations, and cash flows of the company. This goal is expressed in extensive, comprehensive disclosure requirements, including with regard to the judgment and significant assumptions used in establishing the essence of the interests in entities and arrangements, interests in subsidiaries, interests in joint arrangements and equity-basis investees, and interests in structured entities. The standard shall be implemented for annual periods beginning January 1, 2013, or later. Early implementation is possible, subject to early adoption of the two additional standards published concurrently: IFRS 11, Joint Arrangements, and IFRS 10, Consolidated Financial Statements. However, the additional disclosure requirements under IFRS 12 can be included early without the early adoption of the additional standards. The initial implementation of this standard is expected to have no effect, other than the change in presentation.



206

6. ASU 2011-04, Fair Value Measurement

This Accounting Standard Update updates the instructions regarding the manner of measuring fair value set forth in FAS 157 (ASU 820-10). The updates in the ASU include clarifications by the FASB of its intentions regarding the manner of implementation of fair value measurement rules and the current disclosure requirements, as well as updates that establish principles or specific requirements regarding fair value measurement and regarding the disclosure requirements pertaining to fair value measurements. Among other matters, these updates include additional clarifications and specific instructions with regard to the measurement of fair value of financial instruments managed within a portfolio; rules for the measurement of fair value of instruments classified in equity by the reporting entity; and clarifications regarding the application of premiums or discounts in calculating the fair value of an accounting unit of an asset or liability. In addition, the standard sets forth additional disclosure requirements, as follows: 1) With regard to fair value measurements classified as Level 3 in the fair value hierarchy:

- The assessment process implemented by the reporting entity; - Analysis of the sensitivity of the fair value measurement to changes in unobservable inputs

and the interaction between such unobservable inputs, if any. 2) Use of a nonfinancial asset in a manner different from the highest and best use, when the asset

is measured at fair value in the balance-sheet or when its fair value is included in the disclosures according to the assumption of highest and best use.

3) Classification into levels, within the fair value hierarchy, for items not measured at fair value in the balance-sheet, but for which the disclosure of fair value is required.

The standard will be implemented in annual periods beginning January 1, 2012. Early implementation is not permitted. The updates established in the ASU shall be implemented prospectively. The initial implementation of this standard is expected to have no effect, other than the change in presentation.



207

Note 2: Cash and Deposits with Banks Reported amounts

Consolidated Bank December 31 December 31

2011 2010 2011 2010

NIS millions

NIS millions

NIS millions

NIS millions

Cash and deposits with Bank of Israel 1,510.4 1,359.0 1,510.4 1,359.0

Deposits with commercial banks 513.1 795.0 512.2 794.6

Total cash and deposits with banks 2,023.5 2,154.0 2,022.6 2,153.6

Of which: cash, deposits with banks and deposits with Bank of Israel for an initial period not exceeding three months

2,023.5

2,063.61

2,022.6

2,063.21

1 Restated.



208

Note 3: Securities

Reported amounts

December 31, 2011


Balance sheet value

Amortized cost (shares-cost)1 Profits Losses7

Fair value2


1. Securities available for sale

Bonds

Government of Israel 899.5 906.1 1.8 (8.4) 899.5

Israeli financial institutions 47.3 47.3 0.4 (0.4) 47.3

Foreign financial institutions 16.9 17.5 - (0.6) 16.9

Others in Israel 93.3 99.4 0.4 (6.5) 93.3

Other foreign 3.6 3.6 - - 3.6

Total bonds 1,060.6 1,073.9 2.6 (15.9) 1,060.6

Shares3 32.6 32.6 - - 32.6

Total securities available for sale 1,093.2 1,106.5 2.64 (15.9)4 1,093.2

Balance sheet value

Amortized cost (shares-cost)1

Unrealized profits on adjustment to fair value

Unrealized losses on adjustment to fair value

Fair value2


2. Trading securities

Bonds

Government of Israel 1,184.8 1,187.5 3.5 (6.2) 1,184.8

Foreign governments 9.2 9.2 - - 9.2


Foreign financial institutions 31.8 31.8 - - 31.8

Others in Israel 32.8 39.4 - (6.6) 32.8

Other foreign 2.0 2.0 - - 2.0

Total bonds 1,340.4 1,348.7 4.7 (13.0) 1,340.4

Shares 0.3 0.3 - - 0.3

Total trading securities6 1,340.7 1,349.0 4.75 (13.0)5 1,340.7

Total securities 2,433.9 2,455.5 7.3 (28.9) 2,433.9



209

Reported amounts

December 31, 2011

NIS millions

3. Below is information on impaired bonds

Book balance of impaired bonds accruing interest income 5.5

1 Amortized cost after deducting provision for impairment of other than temporary nature. 2 The fair value of securities is generally based on market price, which does not necessarily reflect the price

obtainable in the event of sale of securities in large volumes. 3 Of which shares that do not have available fair value and are shown at cost in the amount of NIS 6.2 million.

Shares include: NIS 21.6 million in ETF’s and NIS 11.0 million in shares. 4 Included in equity under “Adjustments to fair value of securities available for sale”. 5 Charged to the profit and loss statement. 6 Of which securities in the balance sheet in the amount of NIS 117.9 million in respect of government bonds in the

trading portfolio of consolidated companies. 7 Unrealized loss positions with a duration of more than 12 months in the amount of NIS 5.4 million. 8 In 2011, a provision for impairment of a nature other than temporary was charged to profit and loss in the amount

of NIS 3.0 million – NIS 2.5 million in respect of shares and NIS 0.5 million in respect of bonds. The examination for impairment is made in accordance with that stated in the chapter on Accounting Policy on Critical Issues in the Directors’ Report and in accordance with the circular of the Supervisor of Banks from 1.3.09. See the chapter dealing with impairment of assets in Accounting Policy on Critical Issues. Regarding impairment of shares, see also Note 20.

9 Total swap transactions for 2011 is approx NIS 668.0 million. Notes: 1 Details of results of activity in investments in bonds – see Note 18. Details of results of activity in investments in

shares – see Note 20. 2 Regarding liens, see Note 16 – Contingent Liabilities, Commitments and Liens.



210

Note 3: Securities (cont’d)

Reported amounts

December 31, 2010


Balance sheet value

Amortized cost (shares-cost)1 Profits Losses7

Fair value2


1. Securities available for sale

Bonds

Government of Israel 1,543.5 1,544.2 3.4 (4.1) 1,543.5

Foreign governments 18.4 18.1 0.3 - 18.4


Foreign financial institutions 102.3 104.8 0.1 (2.6) 102.3

Others in Israel 148.1 145.5 4.2 (1.6) 148.1

Total bonds 1,847.9 1,848.2 8.1 (8.4) 1,847.9

Shares3 21.1 19.6 1.5 - 21.1

Total securities available for sale 1,869.0 1,867.8 9.64 (8.4) 4 1,869.0

Balance sheet value

Amortized cost (shares-cost)1

Unrealized profits on adjustment to fair value

Unrealized losses on adjustment to fair value

Fair value2


2. Trading securities

Bonds

Government of Israel 686.0 685.3 2.5 (1.8) 686.0


Foreign financial institutions 15.1 15.1 - - 15.1

Others in Israel 36.6 37.5 - (0.9) 36.6

Other foreign 10.6 10.6 - - 10.6

Total bonds 881.2 881.4 2.9 (3.1) 881.2

Shares 0.6 0.6 - - 0.6

Total trading securities6 881.8 882.0 2.95 (3.1)5 881.8

Total securities 2,750.8 2,749.8 12.5 (11.5) 2,750.8



211

1 Amortized cost after deducting provision for impairment of other than temporary nature. 2 The fair value of securities is generally based on market price, which does not necessarily reflect the

price obtainable in the event of sale of securities in large volumes. 3 Of which shares that do not have available fair value and are shown at cost in the amount of NIS 6.0

million. 4 Included in equity under “Adjustments to fair value of securities available for sale”. 5 Charged to the profit and loss statement. 6 Of which securities in the balance sheet in the amount of NIS 96.4 million in respect of government

bonds in the trading portfolio of consolidated companies. 7 Unrealized loss positions with a duration of more than 12 months in the amount of NIS 3.4 million. 8 In 2010, no provision for impairment of a nature other than temporary was recorded in the statement

of profit and loss. The examination for impairment is made in accordance with that stated in the chapter on Accounting Policy on Critical Issues in the Directors’ Report and in accordance with the circular of the Supervisor of Banks from 1.3.09. See the chapter dealing with impairment of assets in Accounting Policy on Critical Issues.

9 Total swap transactions for the year ending December 31, 2010 is approx NIS 732.4 million. Notes: 1 Details of results of activity in investments in bonds – see Note 18. Details of results of activity in

investments in shares – see Note 20. 2 Regarding liens, see Note 16 – Contingent Liabilities, Commitments and Liens.



212

Note 4: Credit to the Public and Allowance for Credit Losses General As of January 1, 2011, the Bank applies the new directive of the Banking Supervision Department concerning the Measurement and Disclosure of Impaired Debts, Credit Risk and Provision for Credit Losses. These condensed consolidated financial statements include the disclosure according to the new format, adapted to reporting requirements under the directive, as stated above. In view of the fact that the new directive was applied prospectively, without restatement of comparative figures, for purposes of making comparisons with the disclosure, data for the current period is shown below with the corresponding balances at December 31, 2010 (pro-forma figures) if the directive would have been implemented for the first time in this year. The effect of implementing the new directive for the first time on the allowance for credit losses in respect of debts and off-balance sheet credit instruments and the changes in the balance of the allowance, for the period of the year ending 31.12.2011, is as follows: Reported amounts

Allowance for credit losses

On an individual basis

On other group basis*

Total

NIS millions

NIS millions

NIS millions

Balance of allowance for credit losses1 as at 31.12.2010 (audited) 13.62 9.93 23.5

Year ending 31.12.2010

Accounting write-offs net recognized as at 1.1.2011** (42.1) (0.8) (42.9)

Other changes in the allowance for credit losses as at 1.1.2011 (charged to equity)**

28.5

6.2

34.7

Balance of allowance for credit losses as at 31.12.2010 - 15.3 15.3

Year ending 31.12.2011

Income in respect of credit losses (5.0) - (5.0)

Allowance for credit losses before accounting write-offs (5.0) 15.3 10.3

Accounting write-offs - -4 -4

Collection of debts written off in the books in prior years 5.0 - 5.0

Net accounting write-offs 5.0 -4 5.0

Balance of allowance for credit losses as at 31.12.2011 - 15.3 15.3 * Including an allowance on a group basis in respect of debts examined on an individual basis and found to be

unimpaired. ** As a result of the initial implementation of the new directives concerning the Measurement and Disclosure of

Impaired Debts, Credit Risk and Provision for Credit Losses. *** In accordance with the new directives concerning the Measurement and Disclosure of Impaired Debts, Credit

Risk and Provision for Credit Losses, as of 1.1.2011 banking corporations are not required to maintain a general, supplementary, and special provision for doubtful debts.

1 This amount appeared before 1.1.2011 under “Provision for doubtful debts”. 2 This amount appeared before 1.1.2011 under “Other specific provision”. 3 This amount appeared before 1.1.2011 under “Supplementary provision”. 4 Amount less than NIS 0.1 million.



213

A. Credit to the public Reported amounts

Consolidated and Bank Consolidated and Bank

December 31, 2011 December 31, 2010 (Proforma)

Recorded debt balance


Net debt balance



Net debt balance


Credit to the public examined on an individual basis1 1,708.8 (13.2) 1,695.6 1,649.0 (14.7) 6 1,634.36

Credit to the public examined on a group basis2 78.1 (0.4) 77.7 83.0 (0.5) 6 82.56

Total credit to the public 1,786.9 (13.6) 1,773.3 1,732.0 (15.2) 1,716.8 Of which: Customers' liabilities for acceptances - - - - - -

B. Credit to the public examined on an individual basis Consolidated and Bank Consolidated and Bank




Net debt balance



Net debt balance


1. Credit to the public examined on an individual basis includes:

Impaired credit to the public3 20.2 (0.1) 20.1 20.2 - 20.2 Unimpaired credit to the public, in arrears of 90 days or more4 - - - - - -

Unimpaired credit to the public, in arrears of 30 to 89 days4 0.2 -5 0.2 0.6 -5 0.6

Other unimpaired credit to the public4 1,688.4 (13.1) 1,675.3 1,628.2 (14.7)6 1,613.56

Total unimpaired credit to the public 1,688.6 (13.1) 1,675.5 1,628.8 (14.7)6 1,614.16

Total credit to the public examined on an individual basis 1,708.8 (13.2) 1,695.6 1,649.0 (14.7)6 1,634.36

1 Including credit examined on an individual basis and found to be unimpaired. The allowance for credit losses in

respect of this credit was calculated on a group basis. For further details regarding credit examined on an individual basis, see Note 4B.

2 Other credit that was not examined individually for which the allowance for credit losses was calculated on a group basis. See further details in Note 4C.

3 Impaired credit not accruing interest income, except for certain credit under restructuring, as stated in sub-section 4 below.

4 Credit examined on an individual basis and found to be unimpaired. The allowance for credit losses in respect of this credit was calculated on a group basis.

5 Amount less than NIS 0.1 million. 6 Reclassified. 7 For details on the types of credit examined on an individual basis and types of credit examined on a group

basis, see Note 1 to the financial statements.



214

Note 4: Credit to the Public and Allowance for Credit Losses (cont’d) B. Credit to the public examined on an individual basis (cont’d)

Further information on impaired credit to the public examined on an individual basis Reported amounts Consolidated and Bank December 31, 2011 December 31, 2010 (Proforma) NIS millions NIS millions 2. Impaired credit to the public in respect of which there is an allowance for credit losses on an individual basis - -

Impaired credit to the public in respect of which there is no allowance for credit losses on an individual basis 20.2 20.2

Total impaired credit to the public 20.2 20.2 3. Impaired credit to the public measured according to present value of cash flows 20.2 20.22

Impaired credit to the public measured according to collateral value - -2 Total impaired credit to the public 20.2 20.2

For the year 2011 NIS millions

4. Average recorded debt balance of impaired credit to the public in the reporting period 20.2

Total interest income recorded in the reporting period in respect of this credit in the period it was classified as impaired* 1.0

Total interest income that would have been recorded in the reporting period if this credit had accrued interest according to its original terms 1.0

*Of which: interest income recorded by the cash basis accounting method 1.0 The Bank has no commitments to extend additional credit to debtors for whom there was a restructuring of problematic credit in which changes were made to the terms of credit as at 31.12.2011 and at 31.12.2010. C. Credit to the public examined on a group basis includes: Other credit not examined on an individual basis for which the allowance for credit losses was calculated

on a group basis: Consolidated and Bank Consolidated and Bank December 31, 2011 December 31, 2010 (Proforma)



Net debt balance



Net debt balance

NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions Unimpaired credit to the public, in arrears of 90 days or more 0.2 -1 0.2 - - -

Unimpaired credit to the public, in arrears of 30 to 89 days 0.1 - 0.1 0.3 -1 0.3

Other unimpaired credit to the public 77.8 (0.4) 77.4 82.7 (0.5)2 82.22

Total 78.1 (0.4) 77.7 83.0 (0.5)2 82.52



215

D. Allowance for credit losses in respect of loans and off-balance sheet credit instruments Reported amounts

Consolidated and Bank



On other group basis3

Total

NIS millions

NIS millions

NIS millions

Balance of allowance for credit losses as at 1.1.2011 (Proforma) - 15.3 15.3

Year 2011

Income in respect of credit losses (5.0) - (5.0)

Allowance for credit losses before accounting write-offs (5.0) 15.3 10.3

Accounting write-offs - -1 -1

Collection of debts written off in the books in prior years 5.0 - 5.0

Net accounting write-offs 5.0 -1 5.0

Balance of allowance for credit losses as at 31.12.2011 - 15.3 15.3

E. Composition of balance of allowance

Consolidated and Bank Consolidated and Bank


Allowance for credit losses Allowance for credit losses


On other group basis3 Total


On other group basis3 Total


Composition of balance of the allowance:

In respect of credit to the public - 13.6 13.6 -2 15.22 15.2 In respect of off-balance sheet credit instruments (included in other liabilities item)

- 1.7 1.7 - 0.1 0.1

Balance of allowance for credit losses - 15.3 15.3 - 15.3 15.3

1 Amount less than NIS 0.1 million. 2 Reclassified. 3 Including allowance on a group basis in respect of loans examined individually and found to be unimpaired.



216

Note 4: Credit to the Public and Allowance for Credit Losses (cont’d) Reported amounts Consolidated and Bank December 31, 2011

Range Credit1 Off-balance

sheet credit risk1,3

NIS thousands No. of borrowers2 NIS millions NIS millions F. Credit to the public and off-balance sheet credit risk by amount of credit to borrower1:

Less than 10 1,070 0.7 3.3 From 10 to 20 436 1.5 5.6 From 20 to 40 482 4.1 10.3 From 40 to 80 802 11.6 34.4 From 80 to 150 428 13.0 34.2 From 150 to 300 288 20.9 41.4 From 300 to 600 163 21.7 48.0 From 600 to 1,200 141 44.7 79.2 From 1,200 to 2,000 88 51.7 89.9 From 2,000 to 4,000 132 163.5 199.0 From 4,000 to 8,000 79 169.4 269.8 From 8,000 to 20,000 60 334.1 432.3 From 20,000 to 40,000 24 277.0 359.2 From 40,000 to 200,0004 15 673.0 194.9

Total 4,208 1,786.9 1,801.5 December 31, 2010

Range Credit1 Off-balance

sheet credit risk3

NIS thousands No. of borrowers2 NIS millions NIS millions Less than 10 1,085 0.7 3.2 From 10 to 20 458 1.9 5.6 From 20 to 40 454 4.1 9.7 From 40 to 80 727 11.0 31.2 From 80 to 150 389 11.2 31.4 From 150 to 300 249 18.6 35.7 From 300 to 600 173 19.1 55.4 From 600 to 1,200 140 49.0 75.7 From 1,200 to 2,000 82 36.4 91.3 From 2,000 to 4,000 126 165.3 178.9 From 4,000 to 8,000 73 175.7 228.3 From 8,000 to 20,000 57 250.3 413.0 From 20,000 to 40,000 17 220.0 211.1 From 40,000 to 200,000 31 622.6 1,550.4 From 200,000 to 400,0004 1 175.4 41.7

Total 4,062 1,761.3 2,962.6 1 Credit and off-balance sheet credit risk are shown before the allowance for credit losses and before the effect of collateral eligible for deduction for

single borrower and group of borrowers purposes. 2 Number of borrowers according to total credit and off-balance sheet credit risk. 3 Credit risk of off-balance sheet financial instruments as calculated for purposes of the restriction on credit to a single borrower. 4 The highest loan balance in the top category is NIS 74.7 million (balance less eligible deductions - NIS 39.0 million)

(31.12.10 - NIS 217.1 million, balance less eligible deductions - NIS 69.3 million).



217

Note 5: Investments in Investee Companies Reported amounts

Consolidated Bank December 31

2011 2010 2011 2010

NIS millions

NIS millions

NIS millions

NIS millions

A. Composition:

(1) Consolidated companies

Investment in shares according to the equity method - - 301.4 282.5

Investments in shareholders’ loans and capital notes - - 4.0 4.0

Other investments - - 0.2 0.2

Total investments - - 305.6 286.7

Of which:

Profits accumulated post-acquisition less dividends distributed - - 205.4 186.5

(2) Companies included on equity basis

Investment in shares according to the fair value method1 - (1.4) - -

Investments in shareholders’ loans - 0.1 - -

Total investments - (1.3) - -

Of which:

Losses generated post-acquisition plus dividends distributed - (1.4) - -

1 Excess losses on investment in investment in company included on equity basis – appears in 2010 under “Other Liabilities”.



218

Note 5: Investment in Investee Companies (cont’d)

Reported amounts

Principal area of activity

Percentage of equity granting a right to profits

Percentage of voting rights

2011 2010 2011 2010

% % % %

B. Details of investee companies

Company name

Consolidated companies UBank Investments and Holdings Ltd.1,3 Holding company 100 100 100 100

UBank Mutual Funds Ltd. Mutual fund management 100 100 100 100

UBank Trust Company Ltd. Trustee services 100 100 100 100 UBank Underwriting and Consulting Ltd. 2

Underwriting company

100 100 100 100

UBank Financial Asset Management Ltd.

Portfolio management 100 100 100 100

UBank Finance (2005) Ltd.4

Until 11.07, provident fund management company

100 100 100 100

Equity-basis investees

Manif - Financial Services Ltd. 3 Financial services - 19.6 - 19.6

Share of ownership Total assets

Total liabilities

Capital deficit attributable to the owners of the company

Capital deficit attributable to non-controlling interest

Percentage NIS millions

NIS millions

NIS millions

NIS millions

C. Condensed information of the financial condition of a company included on equity basis is as follows:5

31.12.11 - - - - -

31.12.10 19.6 112.1 119.9 (1.3) (6.5) 1 Including a share in the profits (losses) of Manif Financial Services Ltd. profits, held by UBank Investments and Holdings Ltd. 2 UBank Underwriting and Consulting Ltd. (hereinafter: “the company”) is an underwriter in the securities issues market, mainly

as a secondary underwriter. For some issues, the company serves as one of the managers of the underwriting consortium. On 8.2.2011, the Board of Directors of the company decided to change the status of the company to non-active, under the provisions of the Securities Regulations (Underwriting), 2007.

3 On May 1, 2011, the Bank sold its entire holding in Manif Financial Services Ltd., a company included on equity basis. The profit from the sale amounted to NIS 1.5 million.



219

Investment in shares on equity basis

Other capital investments Contribution to net profit from current activities attributable to shareholders of the Bank for the year ended December 31

Contribution to net profit from extraordinary activities after tax attributable to shareholders of the Bank for the year ended December 31

2011 2010 2011 2010 2011 2010 2011 2010

NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions NIS millions

134.9 135.2 - - (1.8)3 0.3 1.53 - 19.9 19.7 - - 0.2 0.7 - -

129.7 111.1 - - 18.6 18.9 - -

4.9 4.8 1.6 1.6 0.1 (0.1) - -

10.8 10.5 2.6 2.6 0.3 1.0 - -

1.2 1.2 - - -4 -4 - -

301.4 282.5 4.2 4.2 17.46 20.86 1.5 -

- (1.4) - 0.1 (0.1) (1.3) - -

Share of ownership

Net profit (loss) for the

period1

Loss attributable

to the owners of

the company

Loss attributable

to non-controlling

interest

Percentage NIS millions NIS millions NIS millions

D. Condensed information of the results of the activity of a company included on equity basis is as follows:3

Up to the date of sale - 0.4 (0.1) (0.4)

31.12.10 19.6 (9.1) (1.3) (5.3) 4 Amount less than NIS 0.1 million. 5 The Bank deals with the associate company under the equity basis method, although the percentage of its holding is less than

20%, since there are qualitative indications of the existence of material influence, because of the right to appoint 20% of the directors of the company.

6 The net profit is after deducting tax of NIS 9.1 million (2010 – NIS 10.2 million).



220

Note 6: Buildings and Equipment

Reported amounts

Cost of assets

During the reporting year

As at beginning of reporting year Additions Disposals

As at balance

sheet date


A. Consolidated

Buildings and land (including leasehold improvements)2,3 23.1 1.9 - 25.0

Equipment and furniture 76.9 0.6 - 77.5

Total 100.0 2.5 - 102.5

B. Bank

Buildings and land (including leasehold improvements)2,3 21.3 1.8 - 23.1

Equipment and furniture 8.3 0.2 - 8.5

Total 29.6 2.0 - 31.6

Consolidated

December 31

2011 2010

Buildings, land, and leasehold improvements 6.3% 6.3%

Equipment and furniture 7.9% 8.3%

The average depreciation rate is calculated by weighting each depreciation rate relative to the relevant balance of net cost (before accumulated depreciation), and the balance of net cost (before accumulated depreciation) of all the depreciable assets.

_____________________________________________________________________ Note 6A: Intangible Assets

Reported amounts

Consolidated and Bank Cost of assets Depreciation Balance for depreciation

As at

beginning of reporting

year Additions

As at balance

sheet date

As at beginning

of reporting year

Depreciation for the

year

As at balance

sheet date

As at beginning

of reporting year

As at balance

sheet date

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Software 13.9 0.7 14.6 3.2 2.8 6.0 10.7 8.6



221

Depreciation1 Net book value

Accumulated at beginning of the

reporting year

Depreciation in the

reporting year

Accumulated on disposals

Accumulated at balance sheet date

At beginning of the

reporting year

As at balance

sheet date


8.7 1.4 - 10.1 14.4 14.9

72.6 0.8 - 73.4 4.3 4.1

81.3 2.2 - 83.5 18.7 19.0

8.1 1.1 - 9.2 13.2 13.9

6.6 0.4 - 7.0 1.7 1.5

14.7 1.5 - 16.2 14.9 15.4 1 Depreciation rates on average basis as at reporting date: 2 Including capitalized expenses in terms of cost in the amount of about NIS 1.9 million in both Consolidated and Bank figures (in

2010 the amount of about NIS 0.7 million in both Consolidated and Bank figures). 3 Including leasehold improvements in terms of cost in the amount of about NIS 12.3 million in Consolidated figures and about

NIS 10.4 million in Bank figures (in 2010, the amount of about 10.4 million in Consolidated figures and about NIS 8.6 million in Bank figures).



222

Note 7: Other Assets Reported amounts


2011 2010 2011 2010

NIS millions

NIS millions

NIS millions

NIS millions

A.

Deferred tax asset, net (see Note 24(E)) 23.9 6.0 21.2 3.8

Excess of advance payments over current provision for taxes 66.3 28.7 62.0 26.9

Excess of reserve for severance and retirement pay over the provision (See Note 12) 0.9 2.6 0.9 2.6

Net clearing balances in respect of securities activities 1.8 1.6 1.8 1.6

Prepaid expenses1 2.3 3.6 2.0 2.4

Assets in respect of operations in the Maof market 36.3 66.1 36.3 66.1

Other receivables and debit balances 2.5 9.3 1.6 3.2

Total other assets 134.0 117.9 125.8 106.6

1 There were no prepaid expenses for an operating lease in which the Bank is the lessee.

For the year ended December 31

2011 2010 2009

NIS millions

NIS millions

NIS millions

B. 1. Details of minimum lease payments and income from sub-leasing

charged to the profit and loss statement are as follows: (7.3) (5.2) (5.9)

Minimum lease payments recognized as an expense (0.8) (0.5) (0.4) Income from sub-leasing 1.8 2.1 0.9

2. For details of future lease amounts to be paid in respect of non-cancellable leasing contracts, see Note 16 –

Contingent Liabilities, Commitments and Liens. The Bank and its subsidiaries lease buildings under an operating ;ease, part with an option to renew the contract

at the end of the period, and some with increasing lease amounts with the aim of reflecting the expected rise in leasing income in the market. In addition, the lease payments are linked to the Consumer Price Index in Israel. In December 2010, the subsidiary company U-Bank Investments and Holdings Ltd. signed an updated rental agreement for the building housing the headquarters of the Bank (retroactively from November 2010). In the framework of this update, the rental period was extended until 30.9.29, and the rental tariffs payable were updated.



223

Notes 8-10 Reported amounts


2011 2010 2011 2010

NIS millions

NIS millions

NIS millions

NIS millions

Note 8: Deposits of the Public

Demand deposits 4,242.5 4,538.0 4,290.5 4,613.5

Fixed-term and other deposits 1,472.6 1,470.1 1,603.3 1,579.8

Total deposits from the public 5,715.1 6,008.1 5,893.8 6,193.3

Consolidated and Bank December 31 2011 2010 NIS millions NIS millions

Note 9: Deposits from Banks

Commercial Banks:

Demand deposits 25.8 43.9

Fixed-term deposits 9.1 21.7

Total deposits from banks 34.9 65.6

Note 10: Subordinated Note On December 28, 2010, the Bank issued a Subordinated Note to the parent company, FIBI, in the amount of NIS 80 million, bearing interest of 3.65% and linked to the Consumer Price Index, repayable on December 28, 2021. The Subordinated Note was recognized by the Supervisor of Banks as part of eligible Lower Tier 2 capital. Consolidated and Bank December 31, 2011 December 31, 2010

Duration1 IRR2 NIS millions Duration1 IRR2 NIS

millions In Israeli currency linked to CPI 8.2 3.8 82.1 8.8 4.0 80.0 1 The duration is the average of the weighted repayment periods in the cash flow, discounted in accordance with the internal rate

of return. 2 The internal rate of return is the interest rate at which the expected cash flow is discounted to the balance in the balance sheet

included in the financial statements. .



224

Note 11 – Other Liabilities

Consolidated Bank December 31 December 31 2011 2010 2011 2010

NIS millions

NIS millions

NIS millions

NIS millions

Excess of provision for current taxes over advance payments - 1.9 - -

Excess of reserve for severance and retirement pay over the provision (See Note 12) 0.1 - 0.1 -

Provision for vacation pay (see Note 12(F)) 4.7 3.8 4.5 3.6 Liabilities in respect of operations in the Maof market 36.3 66.1 36.3 66.1 Creditors in respect of credit card transactions 29.4 26.7 29.4 26.7 Expenses payable 30.8 31.9 24.0 25.5 Prepaid income 1.1 1.1 0.8 0.6 Other creditors and credit balances 8.0 13.8 11.6 14.5 Excess of losses over investment in equity-basis investee - 1.3 - -

Short sale of securities 1,019.7 722.7 1,019.7 722.7 Total other liabilities 1,130.1 869.3 1,126.4 859.7 Note 12: Employee Rights A. The liability of the Bank and its consolidated companies for severance pay to employees, including

increased severance pay, is covered by appropriate reserves. Amounts designated to cover the above liability (except for the liability for increased severance and adaptation pay) are deposited in senior employees' insurance policies. Regarding employees for whom a deposit was made in December 2007, funds are also deposited in the compensation fund managed by the Bank. The liability for severance pay is computed on the basis of one month’s salary per year of service, as is customary.

B. Increased severance compensation:

On July 21, 2004 the representatives of the Bank and the subsidiaries and of the Bank’s employees and subsidiaries’ employees reached agreement (hereinafter referred to as “the agreement”) with regard to the terms and conditions of the termination of employees’ employment, in the event they will end their employment against the background of the anticipated transfer of control of the Bank to FIBI (hereinafter referred to as “the acquisition”). The agreement includes principles for the payment of increased severance payments to the employees, who will terminate their employment in consequence of organizational changes that are likely to occur at the Bank and its subsidiaries in consequence of the anticipated acquisition and/or a deterioration in their employment conditions, at an additional rate of 50% - 100% (in accordance with the employee’s seniority) and also other related conditions. In 2004 - 2005, an assessment was made by Management based on the changes anticipated in the Bank’s business policy and the anticipated efficiency process, according to which a provision was made. Within the framework of the Bank’s personal agreements with some of its employees, they are entitled, in addition to the regular severance pay, to increased severance compensation. The Financial Statements include appropriate provisions in respect of these amounts.



225

C. 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 related duties. The resignation went into effect on March 3, 2010. On his resignation, Mr. Raviv was paid a bonus in accordance with the personal agreement together with an additional bonus approved by the Board of Directors of the Bank on March 2, 2010. On January 3, 2010, the Board of Directors of the Bank approved the appointment of Mr. Ron Bedny as General Manager of the Bank, effective April 1, 2010, under a personal agreement, for a period of two years, until April 1, 2012. It is the intention of the Board of Directors of the Bank to approve, prior to the end of the period of office, to duly approve the extension of the term of office of the General Manager for an unlimited period. Either party to the agreement may terminate the contract at any time and for any reason, by giving written notice six months in advance and in accordance with the terms set out in the employment agreement. On termination of his employment by the Bank, Mr. Bedny is entitled to severance pay in accordance with the amount provided in the individual compensation fund, without supplementary reserves. The Bank reserves the right not to make use of the prior notification period, in whole or in part, and to pay Mr. Bedny for the period that was not required. There is a period of restriction of competition for three months after cessation of work at the Bank. Mr. Bedny is entitled to an annual bonus of one monthly salary for each percent return on equity from ordinary activities over the eligibility threshold set by the Board of Directors for that calendar year. Payment of a bonus in excess of three monthly salaries requires the approval of the Board of Directors. For purposes of the calculation, components of a non-recurring nature are to be excluded. In addition, Mr. Bedny is entitled to an adjustment grant on cessation of work at the Bank, of three monthly salaries. Mr. Bedny’s salary is linked to the Consumer Price Index. In the event of a decline in the index, the salary will not change until a rise in the index offsets the decline in the index.

D. The members of management of the Bank (excluding the General Manager of the Bank) have a

personal agreement for an unlimited period. Either party to the agreement may terminate the contract at any time and for any reason, by giving written notice three months in advance and in accordance with the terms set out in the employment agreement. On termination of their employment, management members are entitled to severance pay of 100% of their last salary multiplied by the number of years of service. From these amounts will be deducted the redemption value of the provident fund to which the Bank made contributions on their behalf, except for one member of management who is subject to section 14 of the Severance Pay Law, 1963. In addition, on conclusion of their employment, members of management are entitled to an adjustment grant of three monthly salaries. The salaries of members of management are linked to the Consumer Price Index. In the event of a decline in the index, the salary will not change until a rise in the index offsets the decline in the index.



226

E. The amounts of the provision and fund for severance pay are as follows: Reported amounts Consolidated December 31 2011 2010 NIS millions NIS millions

Amount of provision 15.4 14.1 Amount of fund 16.2 (16.7) Excess fund over provision 0.8 (2.6) Excess funds included in other assets 0.9 2.6 Excess provision included in other liabilities (0.1) - The Bank and its consolidated companies may not withdraw the amounts deposited except for the purpose of payment of severance benefits. F. The liability of the Bank and consolidated subsidiaries for vacation pay to employees is calculated on

the basis of the employees’ last salary and the vacation days accruing to their credit. plus the required related expenses. There is a provision of NIS 4.7 million under “Other Liabilities” for unutilized vacation days (December 31, 2010 - NIS 3.8 million).



227

Note 13A: Share Capital Authorized Issued and paid up December 31 December 31

2011 2010 2011 2010

NIS NIS NIS NIS

1. Ordinary “A” Shares of NIS 1 each 6,000,000 6,000,000 3,123,865 3,123,865 2. All the shares issued are bearer shares. 3. No dividend was distributed for 2011.

In December 2010, a dividend in the amount of NIS 100 million was declared and distributed. In March 2010, a dividend in the amount of NIS 75 million was declared and distributed. The above dividends constitute a dividend per share of NIS 56 per share. In 2009, no dividend was distributed.

4. Limitations on the distribution of dividends In addition to limitations under the Companies Law, dividend distribution by a banking corporation is

subject to regulations applying to banking corporations in Israel in accordance with which no dividend is to be distributed: (a) If the balance of accumulated retained earnings of the bank according to its latest financial

statements published is not positive, or in the event such a distribution would lead to a negative balance.

(b) When one or more of three least calendar years resulted in a loss. (c) When the accumulated results of the three quarters ending at the end of the interim period for

which the last financial statement was published is negative. (d) If the distribution will result in the ratio of the capital of the bank to risk assets will fall below the

ratio required of it. (e) In the event that after its distribution, the non-monetary assets of the bank will exceed its capital

or; (f) In the event that the bank will not meet the requirements of section 23a of the Banking Law,

which prescribes a limitation regarding the percentage of capital the banking corporation is permitted to invest in non-banking corporations.

Notwithstanding the abovementioned, in certain cases the Bank may distribute a dividend, even if the above circumstances are fulfilled, if it received in advance or in writing the approvals of the Supervisor of Banks for a distribution, up to the amount approved as above. In addition, in the circular of the Supervisor from June 2010, it was stipulated that a banking corporation should not distribute a dividend if it does not comply with a core capital ratio of at least 7.5% or if such a distribution will lead to non-compliance with the above ratio.



228

Note 13B: Capital Adequacy according to the Directives of the Supervisor of Banks

Regulatory capital and capital adequacy calculated in accordance with Proper Conduct of Banking Business Directives 201-211 on “Measurement and Adequacy of Capital”.

December 31 2011 2010 NIS millions NIS millions

A. In consolidated terms 1. Capital for purposes of calculating capital ratio

Tier 1 capital, after deductions 431.9 420.0

Tier 2 capital, after deductions 90.6 89.0

Total capital 522.5 509.0 2. Weighted balances of risk assets

Credit risk 1,896.4 1,996.0

Market risks 354.0 336.3

Operational risk 417.8 435.5

Total weighted balances of risk assets 2,668.2 2,767.8

3. Ratio of capital to risk assets

Ratio of Tier 1 capital to risk assets 16.2% 15.2%

Ratio of total capital to risk assets 19.6% 18.4% Ratio of minimum total capital required by the Supervisor of Banks 9.0% 9.0%

B. Capital components for purposes of calculating the capital ratio (in consolidated terms)

1. Tier 1 capital

Equity 431.9 421.1 Less: net profits from adjustment to fair value of securities available for sale - 1.1

Total Tier 1 capital 431.9 420.0

2. Tier 2 capital

General provision for doubtful debts 8.5 8.5 With the addition of: 45% of net profits, before related tax effect, in respect of adjustments to fair value of securities available for sale

-

0.5 Total Upper Tier 2 capital 8.5 9.0

Lower Tier 2 capital

Subordinated Note 82.1 80.0 Total Tier 2 capital 90.6 89.0

Total capital 522.5 509.0



229

C. Capital adequacy target The Bank has a policy approved by the Board of Directors and management to maintain a level of capital adequacy in accordance with the capital target higher than the minimum ratio required as defined by the Supervisor of Banks. The capital target decided by the Board of Directors and management reflects, in the Bank’s opinion, the appropriate level of capital required taking into account its risk profile and risk appetite. On December 22, 2010, the Board of Directors of the Bank decided on capital targets up until the completion of the SREP process by the Bank of Israel. According to this decision, the minimum total capital ratio decided will be at the rate of 15%, and the minimum Tier 1 capital ratio will be at the rate of 10%.

D. Applicability of the implementation of the “Working Framework for Capital Measurement and Adequacy” According to Section 20 of the Provisional Directive on the subject of “Working Framework for Capital Measurement and Adequacy” (Basel II) (hereinafter: “the Directive”), a subsidiary company of a banking corporation whose risk assets, in accordance with this working framework, are less that NIS 50 million, is exempted from implementing the Directive. As detailed in Note 5(B), the consolidated companies of the Bank are UBank Investments and Holding Ltd., UBank Mutual Funds Ltd., UBank Trust company Ltd., UBank Underwriting and Consulting Ltd., UBank Financial Assets Management Ltd., and UBank Finance (2005) Ltd. The risk assets of each of the said companies are less than NIS 50 million, and in view of this, in accordance with that stated above, they are exempt from implementing the Directive.



230

Note 14: Assets and Liabilities by Linkage Basis Reported amounts

December 31, 2011 Israeli currency Foreign currency1

Unlinked CPI linked US dollar Euro Other

Non monetary items2

Total

NIS millions

NIS millions

NIS millions

NIS millions NIS

millions NIS

millions NIS

millions Assets Cash and deposits with banks

1,520.5

-

318.1

81.8

103.1

-

2,023.5

Securities 1,139.0 1,080.8 86.5 79.7 36.0 11.9 2,433.9

Borrowed securities 999.5 - - - - - 999.5

Credit to the public, net3 1,222.7 134.0 284.3 39.0 93.3 - 1,773.3

Buildings and equipment - - - - - 19.0 19.0

Intangible assets - - - - - 8.6 8.6 Assets in respect of derivative instruments - - 61.8 - 1.0 51.4 114.2

Other assets 95.3 - 0.8 - - 37.9 134.0

Total assets 4,977.0 1,214.8 751.5 200.5 233.4 128.8 7,506.0

Liabilities

Deposits from the public 3,040.7 145.1 2,081.6 258.3 189.4 - 5,715.1

Deposits from banks 25.7 - 9.2 - - - 34.9 Deposits of the government 17.4 - 1.7 - - - 19.1

Subordinated note - 82.1 - - - - 82.1 Liabilities in respect of derivative instruments 0.2 3.3 31.7 3.6 1.6 52.4 92.8

Other liabilities 216.1 876.5 0.8 - - 36.7 1,130.1

Total liabilities 3,300.1 1,107.0 2,125.0 261.9 191.0 89.1 7,074.1

Difference 1,676.9 107.8 (1,373.5) (61.4) 42.4 39.7 431.9

Non-hedging derivative instruments:

Derivative instruments (excluding options) (1,303.0) (91.2) 1,374.7 55.2 (35.7) - -

Options in the money, net (in terms of underlying asset) 1.6 - (1.6) - - - -

Options out of the money, net (in terms of underlying asset) 1.0 - (1.0) - - - -

Total 376.5 16.6 (1.4) (6.2) 6.7 39.7 431.9

Options in the money, net (discounted nominal value) (2.3) - 2.3 - - - -

Options out of the money, net (discounted nominal value) (19.1) - 19.1 - - - -

1 Including linked to foreign currency. 2 Including derivative instruments whose basis refers to a non-monetary item. 3 after deducting allowances for credit losses attributed to a debt in accordance with the relevant linkage segment in the sum of NIS 13.6 million

(2010 – after deducting provisions for doubtful debts in the sum of NIS 23.5 million). 4 The figures were reclassified in order to adapt to item headings and the method of presentation in the current period.



231

Reported amounts

December 31, 2010 Israeli currency Foreign currency1

Unlinked CPI linked US dollar Euro Japanese Yen Other

Non monetary items2

Total

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Assets Cash and deposits with banks

1,438.8

-

568.8

35.8

10.7

99.9

-

2,154.0

Securities 1,879.3 459.2 263.6 90.7 - 36.3 21.7 2,750.8

Borrowed securities 698.7 - - - - - - 698.7

Credit to the public 1,093.6 257.9 288.9 26.0 30.7 54.3 - 1,751.4

Buildings and equipment - - - - - - 18.7 18.7

Intangible assets - - - - - - 10.7 10.74 Assets in respect of derivative instruments 31.0 - 7.2 1.7 1.3 1.6 84.0 126.84

Other assets 48.2 - 3.4 - - - 66.3 117.94

Total assets 5,189.6 717.1 1,131.9 154.2 42.7 192.1 201.4 7,629.0

Liabilities

Deposits from the public 3,505.5 260.6 1,738.6 220.5 10.4 272.5 - 6,008.1

Deposits from banks 50.5 - 15.0 - - 0.1 - 65.6 Deposits of the government

2.5

11.7

1.6

-

-

-

-

15.8

Subordinated note - 80.0 - - - - - 80.0 Liabilities in respect of derivative instruments 50.9 7.5 20.6 3.1 1.7 1.3 84.0 169.14

Other liabilities 466.7 335.3 3.4 - - - 63.9 869.34

Total liabilities 4,076.1 695.1 1,779.2 223.6 12.1 273.9 147.9 7,207.9

Difference 1,113.5 22.0 (647.3) (69.4) 30.6 (81.8) 53.5 421.1

Non-hedging derivative instruments:

Derivative instruments (excluding options) (757.8) (59.6) 685.5 75.8 (28.9) 85.0 - -

Options in the money, net (in terms of underlying asset)

-

-

-

-

-

-

-

-

Options out of the money, net (in terms of underlying asset)

3.5

-

(3.5)

-

-

-

-

-

Total 359.2 (37.6) 34.7 6.4 1.7 3.2 53.5 421.1

Options in the money, net (discounted nominal value) - - - - - - - -

Options out of the money, net (discounted nominal value) - - - - - - - -



232

Note 15: Assets and Liabilities according to Linkage Bases and Maturity periods Reported amounts

December 31, 2011

Expected future contractual cash flow


One to three months2

Three months to one year

One to two years

Two to three years

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Unlinked Israeli currency

Assets 3,302.5 339.7 439.3 96.7 70.7

Liabilities 3,057.7 23.7 89.7 52.1 7.4

Difference 244.8 316.0 349.6 44.6 63.3

Derivative instruments (excluding options) (1,352.0) 83.5 (38.0) - -

Options (in terms of underlying asset) 2.6 - - - -

Israeli currency linked to CPI

Assets 125.2 1.1 113.5 200.2 295.1

Liabilities 125.6 1.0 39.6 132.5 34.0

Difference (0.4) 0.1 73.9 67.7 261.1

Derivative instruments (excluding options) (0.2) (0.2) (19.8) (19.8) (27.0)

Foreign currency4

Assets 692.6 189.3 64.5 39.9 30.8

Liabilities 2,354.3 124.2 94.1 2.2 1.7

Difference (1,661.7) 65.1 (29.6) 37.7 29.1

Derivative instruments (excluding options) 1,352.2 (83.3) 57.8 19.8 27.0

Options (in terms of underlying asset) (2.6) - - - -

Non monetary items

Assets 56.2 21.8 0.5 10.8 -

Liabilities 56.0 21.8 0.5 10.8 -

Difference 0.2 - - - -

Total

Assets 4,176.5 551.9 617.8 347.6 396.6

Liabilities 5,593.6 170.7 223.9 197.6 43.1

Difference (1,417.1) 381.2 393.9 150.0 353.5 1 As included in Note 14: “Assets and Liabilities by Linkage Basis” including off-balance sheet amounts in respect of derivatives. 2 Assets from one to three months include NIS 213.4 million of amounts of credit on revolving debit account terms. 3 There are no assets without maturity date the repayment of which is overdue. 4 Including linked to foreign currency. 5 The contractual rate of return is the interest rate discounting expected contractual future cash flows reported in this Note in respect of a monetary

item to the book value. Notes: a. Reported in this Note are the expected contractual future cash flows in respect of the assets and liabilities items by linkage basis, in accordance

with the periods remaining until the contractual repayment date of each cash flow. The figures appear after deduction of the effect of accounting write offs and allowances for credit losses.



233

Book value1

Three to four years

Four to five years

Five to ten years

Ten to twenty years

Over twenty years

Total cash flows

No repayment date3

Total Contractual rate of return5

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Percentage

73.9 52.6 726.3 158.8 - 5,260.5 11.3 4,977.0 4.38

7.6 41.2 55.4 4.5 - 3,339.3 - 3,300.1 2.58

66.3 11.4 670.9 154.3 - 1,921.2 11.3 1,676.9 -

- - - - - (1,306.5) - (1,303.0) -

- - - - - 2.6 - 2.6 -

30.3 57.0 273.2 241.5 - 1,337.1 - 1,214.8 1.84

393.0 15.2 404.1 17.6 53.5 1,216.1 - 1,107.0 3.53

(362.7) 41.8 (130.9) 223.9 (53.5) 121.0 - 107.8 -

(0.5) (0.5) (0.4) - - (68.4) - (66.5) -

24.3 74.6 95.6 0.9 2.8 1,215.3 31.9 1,185.4 5.71

1.1 (0.2) 1.4 - - 2,578.8 - 2,577.9 0.49

23.2 74.8 94.2 0.9 2.8 (1,363.5) 31.9 (1,392.5) -

0.5 0.5 0.4 - - 1,374.9 - 1,365.5 -

- - - - - (2.6) - (2.6) -

- - - - - 89.3 39.5 128.8 -

- - - - - 89.1 - 89.1 -

- - - - - 0.2 39.5 39.7 -

128.5 184.2 1,095.1 401.2 2.8 7,902.2 82.7 7,506.0 4.20

401.7 56.2 460.9 22.1 53.5 7,223.3 - 7,074.1 2.00

(273.2) 128.0 634.2 379.1 (50.7) 678.9 82.7 431.9 -



234

Note 15: Assets and Liabilities by Linkage Basis and Maturity (cont’d)

Reported amounts

December 31, 2010

Expected future contractual cash flow


One to three months2

Three months to one year

One to two years

Two to three years

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Unlinked Israeli currency

Assets 2,696.6 304.0 1,193.7 165.7 190.6

Liabilities 3,491.0 48.3 205.5 74.7 108.2

Difference (794.4) 255.7 988.2 91.0 82.4 Derivative instruments (excluding options)

(284.7)

(122.7)

(419.5)

-

-

Options (in terms of underlying asset) 3.5

-

-

-

-

Israeli currency linked to CPI

Assets 253.9 11.6 50.9 48.4 125.3

Liabilities 252.7 1.6 27.5 33.5 35.0

Difference 1.2 10.0 23.4 14.9 90.3 Derivative instruments (excluding options) (0.2) - (0.7) (18.4) (18.5)

Foreign currency4

Assets 773.6 348.0 54.0 69.5 75.1

Liabilities 1,962.6 190.9 119.4 10.3 3.7

Difference (1,189.0) 157.1 (65.4) 59.2 71.4 Derivative instruments (excluding options)

284.9

122.7

420.2

18.4

18.5

Options (in terms of underlying asset) (3.5)

-

-

-

-

Non monetary items

Assets 73.2 62.2 4.8 10.1 -

Liabilities 70.8 62.2 4.8 10.1 -

Difference 2.4 - - - -

Total

Assets 3,797.3 725.8 1,303.4 293.7 391.0

Liabilities 5,777.1 303.0 357.2 128.6 146.9

Difference (1,979.8) 422.8 946.2 165.1 244.1

1 As included in Note 14: “Assets and Liabilities by Linkage Basis” including off-balance sheet amounts in respect of derivatives. 2 Assets from one to three months include NIS 399.2 million of amounts of credit on revolving debit account terms. 3 Assets with no maturity date include assets in the amount of NIS 20.9 million the repayment of which is overdue. 4 Including linked to foreign currency. 5 The contractual rate of return is the interest rate discounting expected contractual future cash flows reported in this Note in respect of a monetary item to the

book value. 6 Reclassified. Notes: a. Reported in this Note are the expected contractual future cash flows in respect of the assets and liabilities items by linkage basis, in accordance with the

periods remaining until the contractual repayment date of each cash flow. The figures appear after deduction of accounting write-offs and allowances for credit losses.



235

Book value1 Three to four years

Four to five years

Five to ten years

Ten to twenty years

Over twenty years

Total cash flows

No repayment date3

Total Contractual rate of return5

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Percentage

121.7 52.5 673.8 56.4 - 5,455.0 1.4 5,189.66 3.23 24.4 6.4 171.9 2.4 - 4,132.8 - 4,076.1 1.52

97.3 46.1 501.9 54.0 - 1,322.2 1.4 1,113.5 -

- - - - - (826.9) - (757.8) -

- - - - - 3.5 - 3.5 -

32.7 29.8 143.0 65.8 0.9 762.3 - 717.1 1.86 56.4 165.2 91.9 83.0 - 746.8 - 695.1 3.49

(23.7) (135.4) 51.1 (17.2) 0.9 15.5 - 22.0 -

(25.0) - - - - (62.8) - (59.6) -

23.2 23.3 194.5 1.8 - 1,563.0 19.5 1,520.9 4.09

2.5 - 0.1 - - 2,289.5 - 2,288.8 0.45

20.7 23.3 194.4 1.8 - (726.5) 19.5 (767.9) -

25.0 - - - - 889.7 - 817.4 -

- - - - - (3.5) - (3.5) -

- - - - - 150.3 40.4 201.46 -

- - - - - 147.9 - 147.9 -

- - - - - 2.4 40.4 53.5 -

177.6 105.6 1,011.3 124.0 0.9 7,930.6 61.3 7,629.0 3.36

83.3 171.6 263.9 85.4 - 7,317.0 - 7,207.9 1.10

94.3 (66.0) 747.4 38.6 0.9 613.6 61.3 421.1 -



236

Note 16: Contingent Liabilities, Commitments and Liens Reported amounts


31.12.2011 31.12.2010 31.12.2011 31.12.2010

(Proforma data)

Balance of contracts1 Balance of allowance for credit losses

NIS millions

NIS millions

NIS millions

NIS millions

A. Off-balance sheet financial instruments Balances of contracts or their stated amounts at the end of the year:

Transactions the balance of which represents credit risk:

Guarantees securing credit 124.9 142.4 0.1 0.1 Guarantees and other liabilities3 95.3 123.1 0.2 - Unutilized revolving credit and other credit lines in demand accounts 1,061.2 1,268.1 0.8 -2

Unutilized facilities for activities in derivative instruments 926.2 1,891.0 - - Irrevocable commitments to give credit that was approved but not yet granted 305.7 698.4 0.4 -

Unutilized credit lines of credit cards 90.1 80.0 0.2 -2 Commitments to issue guarantees 17.3 49.5 - - Consolidated and Bank December 31

2011 2010

NIS millions NIS millions

B. Off-balance sheet commitments for transactions based on collections at end of the year4

Balance of credit from deposits based on collections Israeli currency unlinked 46.2 116.3 Foreign Currency 9.4 14.9 Total 55.6 131.2 1 Balance of contracts or their nominal amounts at the end of the year, before the effect of the allowance for credit losses. 2 Amount less than NIS 0.1 million. 3 Including the Bank’s commitments for its share in the Maof Clearing House Risk Fund in the sum of NIS 56.8 million (2010 –

NIS 91.0 million). 4 Credit and deposits whose repayment to the depositor is dependent on collection of the credit, with margin or collection fee.



237

Reported amounts


2011 2010

Up to one year

Up to one year

NIS millions

NIS millions

Cash flows in respect of interest margins on activities based on collections1

Israeli currency unlinked Future contractual cash flows 0.1 0.2 Israeli currency linked to the CPI Future contractual cash flows - - Foreign currency Future contractual cash flows -2 -2 1 Credit and deposits whose repayment to the depositor is dependent on collection of the credit, with margin or collection fee. 2 Amount less than NIS 0.1 million. General Comment: In this table, periodic data present the present value of future cash flows, discounted according to the internal rate of return of the balance sheet item. Future cash flows, discounted as above, include interest accrued until the earlier of the repayment date and the interest date.



238

Note 16: Contingent Liabilities, Commitments, and Liens (cont’d) C. Other Contingent Liabilities and Commitments - Consolidated and the Bank 1. The Trust Company of the Bank provides trustee services for businesses as well as

private individuals, which include mainly the holding and management of financial assets. The majority of the company’s activity is focused on trustee services to holders of units in mutual funds, and trustee services to holders of debentures of special purpose companies (SPC), and private trustee services in a variety of areas.

2. The Bank, as a member of the Maof Clearing House Ltd., has undertaken, jointly with

other members of the Maof Clearing House, to mutually indemnify the Clearing House in the event that it will suffer loss in connection with insufficient inventory or insufficient financial cover by one of the members of the Clearing House. The share of Clearing House members in the fund is derived from the volume of their activity in the Clearing House. The mutual guarantee, as at December 31, 2011, amounted to NIS 56.8 million. (December 31, 2010 - NIS 91.0 million). Furthermore, the Bank has undertaken to the Maof Clearing House to pay every monetary charge deriving from transactions for its customers and itself in respect of options traded within the context of the Clearing House. The balance of the liability to the Maof Clearing House that is based on Stock Exchange scenarios, is NIS 72.5 million (December 31, 2010 - NIS 307.9 million).

The amount of liability as at the balance sheet date deriving from transactions for customers and the Bank in respect of Maof options is included in the balance sheet under “Other assets” and represents the fair value of these transactions. The balance of the liability to the Maof Clearing House based on scenarios, above the amount recorded in the balance sheet, was NIS 39.1 million (before permitted deductions) (December 31, 2010 - NIS 206.0 million).

3. In accordance with the derivatives profile issued by Maof Clearing House Ltd. and its by-laws, the

Bank undertook to furnish the Maof Clearing House with sufficient collateral to discharge its liabilities under paragraph 2 above. Pursuant to a resolution of the Board of Directors of the Maof Clearing House, the Maof Clearing House’s by-laws and profile were amended and the Maof Clearing House’s collateral arrangement was changed. All of the members of the Maof Clearing House, including the Bank, signed pledge agreements to secure their liabilities in favor of the Maof Clearing House, and deposit only liquid collateral (bonds of the State of Israel and cash), in accordance with the requirements of the by-laws. Pursuant to the above resolutions, the Maof Clearing House opened an account in its name at the Stock Exchange Clearing House, on behalf of the Bank, in which the Bank has deposited collateral in favor of the Maof Clearing House. This account is pledged with a fixed and floating pledge in favor of the Maof Clearing House. The Bank also opened an account in its name at the Stock Exchange Clearing House, in which it also deposited liquid collateral. This account is pledged with a floating pledge in favor of the Maof Clearing House. In addition, the Maof Clearing House opened an account in its name at another bank, on behalf of the Bank, in which it will be possible to deposit cash as collateral and in which will be deposited cash paid to the Bank as income on securities of the Bank that were deposited and pledged as previously mentioned. This account is pledged with a fixed and floating pledge in favor of the Maof Clearing House. As security for the performance of the Bank’s, unlimited in total amount, obligations to the Maof Clearing House as aforesaid, on March 29, 2004 the Bank created fixed and floating pledges unlimited in their total amount, in favor of the Maof Clearing House, over the accounts of the Maof Clearing House at the Stock Exchange Clearing House and at another Bank, and a floating pledge on the account in the Bank’s name in the Stock Exchange Clearing House. See 16(D) (1) below with regard to a pledge to the Maof Clearing House.



239

4. The Tel Aviv Stock Exchange Clearing House Ltd. (hereinafter: “the Stock Exchange Clearing House”) established a risk fund (hereinafter: “the fund”), the object of which is to secure the Clearing House members’ liabilities in respect of the operations of each Clearing House member. The amount of the risk fund is updated on March 1 and on September 1 of each year and is in the sum of the average daily general clearing turnover in the six months ending prior to the date of the adjustment and in any event is not less than NIS 150 million. The Bank’s share amount to NIS 31.1 million (December 31, 2010 - NIS 30.5 million). Pursuant to a resolution of the Stock Exchange’s Board of Directors, the Clearing House bylaws were amended and as from May 15, 2005, the Clearing House’s collateral arrangement was changed. In consequence thereof, the Bank was required to deposit only liquid collateral (bonds of the State of Israel or cash) in accordance with the by-laws’ requirements, and also to sign a pledge agreement to secure its said liabilities. Pursuant to the said resolutions, the Stock Exchange Clearing House opened accounts in its name in the Clearing House on behalf of the Bank, in which the Bank deposited securities as collateral in favor of the Stock Exchange Clearing House. In addition, the Stock Exchange Clearing House opened accounts in its name at another bank, on behalf the Bank, in which it will be possible to deposit cash as collateral and in which the Clearing House will deposit cash that shall be paid to the Bank as income on its securities that were deposited and charged as previously mentioned. As surety for the performance of all the Bank’s liabilities to the Stock Exchange Clearing House as previously mentioned, unlimited in total amount, the Bank created on April 14, 2005, a first ranking charge and assignment by way of charge, in favor of the Stock Exchange Clearing House, over the Clearing House’s account at the Clearing House and over the Clearing House’s account at another bank. See note 16(D) (4) below with regard to a pledge to the Stock Exchange Clearing House.

5. On February 10, 2002, the Bank signed a collateral agreement with the securities clearing system

organized by S.A./N.V. Euroclear Bank (“Euroclear”), a foreign company registered in Belgium, according to which the Bank pledged, in favor of Euroclear, assets deposited by the Bank with Euroclear, unlimited in amount, for purposes of activity in securities by means of the above clearing system; and as collateral for the credit line of $15 million, which the operator of the clearing system provided in the Bank’s favor. Regarding the Bank’s pledge to Euroclear - see Note 16(D) (2), below.

6. Various claims and demands are pending against the Bank and consolidated companies.

In the opinion of the Management of the banking institution, based upon legal opinions with regard to the prospects of pending claims, including applications to approve class actions, appropriate provisions have been made in the financial statements, as needed, in accordance with generally accepted accounting principles, for all possible damages from all pending claims against the Bank.

7. In connection with lawsuits filed by the Bank against debtors and/or guarantors, and within

the framework of temporary orders requested, the Bank issues letters of undertaking to cover possible damage suffered by the defendants in the event that the Court finds against the Bank, or in the event that the temporary order expires for any other reason, unlimited in amount.

8. a. Pursuant to a resolution of the Bank’s Board of Directors on March 15, 2005, that was passed in

accordance with the Bank’s Articles of Association, the Bank exempted the Bank’s directors and officers (as defined in the Companies Law, 1999, including the internal auditor, chief accountant and secretary) from liability in respect of a breach of the duty of care to the Bank as from December 22, 2004 and a waived any claim by the Bank against them in respect of the above. The said exemption and waiver do not apply to cases in respect of which the Bank is not entitled under to the Companies Law to exempt the officer from his liability. At the same meeting of the Board of Directors, the Bank undertook to indemnify the said directors and officers in respect of a charge or expense that may be imposed upon them, in respect of acts committed by virtue of their positions at the Bank, as per the detailed conditions in the undertaking to indemnify officers.



240

Note 16: Contingent Liabilities, Commitments, and Liens (cont’d) The total of the indemnity amount that shall be paid by the Bank (in addition to and above amounts received under the insurance policy, whether paid to the Bank or paid to the officer) for each officer at the Bank and the subsidiaries, in aggregate, in accordance the letter of undertaking and/or letter of indemnity issued pursuant to this instrument, in respect of one of the events detailed therein, shall not exceed 25% (twenty five percent) of the Bank’s consolidated shareholders’ equity in accordance with the last financial statements (annual or quarterly) published immediately prior to the actual payment of the indemnity. The exemption and the indemnity undertaking set forth above were approved by a Special General Meeting of the Bank’s shareholders on May 18, 2005, insofar as such an approval is required.

b. Simultaneously, on December 21, 2004, the parent company of the Bank’s former controlling shareholder, Investec Bank (UK) Ltd., gave an undertaking to indemnify the Bank in respect of any payment that it would bear vis-à-vis the directors and other officers of the Bank or on their behalf, in accordance with the provisions of the exemption and indemnity instrument, in respect of actions that were effected until the date of the transfer of control of the Bank to FIBI. This undertaking was limited to the maximum indemnity amount of the exemption and indemnity instrument, as detailed in paragraph (a) above.

c. Further to the decision from March 15, 2005, the Bank’s Audit Committee approved in October 2006 granting indemnification to directors, appointed by the Bank to serve at UBank finance (2005) Ltd. (Hereinafter referred to as “the company”) who are not Bank officeholders. The letter of indemnification is given in the form of indemnification used for Bank officeholders, adjusted to the characteristics of the company. d. Amendment to the articles of association and update of the commitment to indemnify directors and other office holders in the Bank: In February 2012, the General Meeting approved, after receiving the approvals of the Audit Committee and the Board of Directors of the Bank, the following resolutions:

(1) An amendment to the articles of association of the Bank that expands the liabilities and/or the expenses for which the Bank is permitted to grant an indemnity and/or insurance to directors and other office holders, in accordance with the Streamlining of Enforcement in the Israel Securities Authority Law (Legislative Amendments) and the Companies Law (Amendment No. 16), 2011.

(2) Granting an indemnity commitment in a revised version, that expands the liabilities and/or the expenses for which there is an indemnity commitment as explained above in connection with the amendment to the articles (hereinafter: “amended deed of indemnity”), for directors, except for directors from the controlling owners, serving at the time of the approval of the General Meeting, and who will serve from time to time in the Bank and in companies owned by the Bank.

(3) It should be pointed out that in accordance with the abovementioned approval, all indemnity commitments granted by the Bank are amended also for office holders in the past, in accordance with the resolution of the General Meeting of June 29, 2004.

In addition, and in accordance with the resolution of the Board of Directors of the Bank (after receiving the approval of the Audit Committee and in light of the amendment to the articles) the granting of an amended deed of indemnity was also approved from the other office holders in the Bank who are not directors.

9. Indemnification for the sale of provident fund operations:

On January 9, 2007, the Bank entered into an agreement for the sale of the operations of its provident funds by transferring their management to a provident fund management company controlled by Yashir I.D.I Insurance Co. Ltd. The parties to the sale agreement were the Bank,



241

UBank Provident Fund Management (2005) Ltd. (hereinafter referred to as “the company”) of the one part and Yashir I.D.I. Insurance Co. Ltd., and a provident fund management company under its control (hereinafter: "the purchasing companies”) of the other part. The transaction was carried out simultaneously with the sale of the provident funds under the control of FIBI to the purchaser (hereinafter together: “the transactions”). In accordance with the terms of the transaction, the Bank and the company undertook to indemnify the acquiring companies for any claims which may be made against them during the period of four years from the date the transaction was completed, the grounds of which were in existence before the date the transaction was completed, but was not explicitly identified from the financial statements of the funds, provided that the total amount of the claims does not exceed the amount of the consideration, as well as additional conditions determined. The period of the indemnity ended on 9.1.2011.

10. Commitments between the Bank and the FIBI Group:

a. The Bank and its consolidated companies have entered into various agreements to receive services from FIBI in the following area: operating services for mutual funds, services for customers of the Haifa branch that was closed, security, office equipment procurement, internal audit and credit control services, operations with structured products, foreign trade, logistic, morgates and more. The agreements are in accordance with usual market terms and conditions.

b. In February 2005 an agreement was signed between U-Bank Mutual Funds Ltd. and Modus

Selective Investment Management & Counseling Ltd. (hereinafter: “Modus”), a subsidiary of FIBI, to receive investment management services for mutual funds, pursuant to which U-Bank Mutual Funds Ltd. will purchase investment management services from Modus for the mutual funds defined in the agreement. On December 28, 2010, the company advised Modus of the release of the agreement, and at the same time, an agreement was signed for providing investment counseling for four funds. In consideration of the counseling services, the company will pay Modus the percentage amounts of the average value of the assets of the fund set out in the agreement, less distribution commission, subject to the terms set out in the agreement.

c. In May 2005, a commitment was approved with Mataf Industrial & Financial Computerization

Ltd. (hereinafter: “Mataf”), a subsidiary of FIBI, for consolidation of infrastructure and operating activity with regard to information systems. Within this framework, the two bank’s computer infrastructures were amalgamated, as well as certain operating activities, such as the Bank’s clearinghouse and Swift operations.

d. Furthermore, the Bank and Mataf are cooperating in a computer applications

consolidation project that ended at January 1, 2009. The principles of the undertaking between the Bank and Mataf are such that, until the end of 2009, Mataf bore the costs of the process of combining applications of the banks, the Bank paid Mataf for routine computer services, and bore its agreed upon share in regulatory and Group applications agreed in the schedule to the agreement. As of 2010, a model was set up to determine the amount of routine payments for computer services based on the relative share of the bank in all computer activities carried out in the FIBI Group. In addition, there is a Service Level Agreement (SLA), which was signed on 13.11.2007.

e. In November 2005, the Bank’s Board of Directors approved cooperation with FIBI with regard to

U-Bank customers’ operations during the night via FIBI’s dealing room.

f. In the framework of the sale of provident fund activity of the Bank on 13.11.07, the assets of the provident funds were sold, excluding UBank’s assets as a member-employee in UBank Central Fund for Severance Pay. The Bank transferred the accumulated monies of UBank, which are in the Central Fund as well future deposits for severance pay to the management of Kidma Provident Fund Management



242

Note 16: Contingent Liabilities, Commitments, and Liens (cont’d)

Company Ltd. (Henceforth: “Kidma”). Kidma is a provident fund managing company, fully owned by FIBI. The accumulated monies of UBank are managed by Kidma in a separate Central Provident Fund for Severance Pay, which will be established for this, in which only employees of UBank, subsidiaries of UBank, and other companies that are wholly owned or almost wholly owned by UBank, can be members (“the new fund”). Monies of the Bank and of each of the subsidiaries of the Bank will be managed in a separate account in the new fund.

11. Commitments of the Bank and its consolidated subsidiaries:

December 31

2011 2010


Undertaking to invest in venture capital 0.3 0.8 Professional counseling services 0.1 0.5 Investment in fixed assets 0.1 0.1

12. Property Rental The Bank and its investee companies have rented buildings for extensive periods. The rent to be paid in the future in respect of these commitments is as follows:

December 31 2011 2010** NIS millions NIS millions First year 9.3 8.3 Second year 9.3 8.4 Third year 9.4 8.4 Fourth year 7.9 7.3 Fifth year 7.7 7.1 Sixth year 7.4 6.9 Seventh year 6.9 6.6 Eighth year 6.6 6.0 Ninth year 6.4 5.8 Tenth year and thereafter* 54.4 56.0 125.3 120.8

Rental payments are linked to the Consumer Price Index in Israel. In December 2010, the Bank signed a rental agreement for the building housing the headquarters of the Bank (retroactively from November 2010). In the framework of this update, the rental period was extended until 30.9.2029, and the rental tariffs payable were updated. * For the years 2021 – 2025, an annual amount of NIS 6.4 million, and for the years 2026 - 2028, an

annual amount of NIS 6.0 million, and in 2029 an amount of NIS 4.4 million. ** Restated.



243

13. Activity of the Bank as market maker for government bonds: On 21.7.06, the Accountant General announced the appointment of certain parties, including the Bank, as primary market makers for government bonds, under Section 6a of the Government Loans Law, 1979, in the framework of a reform initiated by the Ministry of Finance for the issue of government bonds and transactions in bonds in the secondary capital market, to encourage entry by more parties to the capital market in order to increase liquidity and transparency in trading, and in order to reduce the cost to the government in raising funds. The Bank commenced operating as a market maker on September 4, 2006. 14. Netting agreements The Bank strives to minimize counterparty risks by means of a number of generally accepted agreements for reducing exposures to third parties (Netting agreements). - The ISDA Master Agreement is the basic agreement used between banks and its main advantage is

the ability to offset (netting) liabilities in the event of bankruptcy of one of the parties, so that the exposure is reduced to the net exposure.

- The CSA Agreement is an agreement for creating and operating a mutual mechanism for transferring liquid assets to secure exposures in open transactions between two banks, after the calculation of the exposure. This mechanism is operated on an ongoing basis to reduce the exposure to the agreed threshold amount only.

Currently, the Bank has signed ISDA Master Agreements with 22 banks, and CSA Agreements with 15 banks, and has already made actual transfers of funds in accordance with some of them. D. Liens 1. In order to secure the Bank’s obligations to the Maof Clearing House for its customers and itself, as

stated in Note 16(C)(2), the Bank has given a first-lien floating charge over monies and/or securities in favor of the Maof Clearing House, pursuant to an agreement dated 29.3.2004, as stated in Note 16(C)(3).

Below is the balance of the collateral given by the Bank to the Maof Clearing House, in NIS millions: As at December 31, 2011 Average Balance in 2011* Highest Balance in 2011*

For Risk Fund

For customer and nostro activity

For Risk Fund


For Risk Fund


Deposits in banks 34.5 - 34.2 - 36.9 - Securities 22.3 58.0 42.0 223.7 57.4 302.8 As at December 31, 2010 Average Balance in 2010* Highest Balance in 2010*

For Risk Fund


For Risk Fund


For Risk Fund


Deposits in banks 34.6 - 31.2 - 34.6 - Securities 56.4 246.4 77.5 298.0 97.9 343.1

* Based on month-end balances.



244

Note 16: Contingent Liabilities, Commitments, and Liens (cont’d) 2. In order to provide security to Euroclear for the Bank’s activity in securities, as stated in

Note 16(C)(5), the Bank pledged assets deposited by the Bank with Euroclear. Below is the balance of the collateral given by the Bank to Euroclear in respect of customer and nostro activity, in $ millions: As at December 31, 2011 Average Balance in 2011* Highest Balance in 2011*

Securities 15.0 15.0 15.0 As at December 31, 2010 Average Balance in 2010* Highest Balance in 2010*

Securities 15.0 15.0 15.0

* Based on month-end balances. 3. Pledge to Bank of Israel

In the framework of the amendment to Proper Conduct of Banking Business Directive No. 336, which enabled banking corporations to pledge any of their assets in favor of the Bank of Israel, if the pledge is required to secure credit from the Bank of Israel, the banking corporations and the Bank of Israel formulated the agreed wording of bonds. In 2007, the Bank made a floating pledge in favor of the Bank of Israel of deposits made with the Bank of Israel and government bonds deposited in the account of the Bank of Israel in the Tel-Aviv Stock Exchange Clearing House. In order to expand the range of types of collateral that banking corporations are permitted to pledge in its favor for obtaining credit, the Bank of Israel allowed banks to pledge securities deposited for purposes of current activity. For this purpose, banking corporations were required to cancel the existing pledge agreement with the Euroclear Clearing House and sign a new debenture. Accordingly, the debenture created in favor of the Bank of Israel in 2007 was canceled. On 28.10.2010, the Bank created a first-lien fixed charge, and assignment by way of pledge unlimited in amount in favor of the Bank of Israel, on all assets and rights in all accounts maintained in the Tel Aviv Stock Exchange Clearing House and in Euroclear Bank (hereinafter: "the collateral accounts") to the credit and in the name of the Bank of Israel, including funds and securities deposited or recorded or that will be deposited or recorded, from time to time, the income on them, and the monetary proceeds from their sale or realization (“the pledged assets"). In addition, a first-lien floating charge, unlimited in amount, was created on the pledged assets in the collateral account or in any other collateral account held by the Euroclear Bank Clearing House outside of Israel. In addition to the above, the Bank gave a right of set-off and lien on all assets owed to it by the Bank of Israel to ensure the repayment of secured liabilities. In the framework of the system of agreements required for operating the pledge, an agreement was included for regulating operational aspects involved in managing the collateral (foreign securities) at Euroclear Bank. On October 28, 2010, the bond with the above agreed wording was registered with the Registrar of Companies. Following are details of bonds pledged to the Bank of Israel, in NIS millions:

Pledged Government bonds

Pledged Government bonds

2011 2010

Balance at the date of the balance sheet 30.0 29.5 Average balance during the year* 29.8 55.6 Highest balance during the year* 30.2 118.2

* Based on month-end balances.



245

4. In order to secure the Bank’s obligations Stock Exchange Clearing House, as stated in

Note 16 (C)(4), the Bank gave a first-lien fixed pledge on securities in favor of the Stock Exchange Clearing House.

Below is the balance of collateral the Bank gave to the Stock Exchange Clearing House, in NIS millions:

As at December 31, 2011 Average Balance in 2011* Highest Balance in 2011*

Deposits in Banks 18.3 18.1 18.3 Securities 12.8 11.2 12.9 As at December 31, 2010 Average Balance in 2010* Highest Balance in 2010*

Deposits in Banks 17.8 16.5 17.8 Securities 12.7 15.8 21.7

* Based on month-end balances. E. Sources and uses of securities received:

Below are the sources of securities that the Bank is permitted to sell before, the effect of offsetting: As at December 31

2011 2010


Securities received in securities borrowing transactions against cash 1,039.2 769.71

Below are the uses of securities received as collateral and securities of the Bank, before the effect of offsetting:

As at December 31

2011 2010


Securities loaned in securities lending transactions against cash - 23.91



246

Note 16: Contingent Liabilities, Commitments, and Liens (cont’d) F. Securities pledged to lenders:

Below are details of securities pledged to lenders: As at December 31

2011 2010


Securities available for sale 180.4 398.2

The Bank had no securities given as collateral to lenders that were not permitted to sell or pledge them. 1 Reclassified.



247

Note 16A: Activity in Derivative Instruments - Volume, Credit Risks and Repayment Dates Reported amounts December 31, 2011

Interest rate contracts - other

Foreign Currency contracts

Contracts in respect of shares

Commodities and other contracts

Total


A. Volume of activity on Consolidated and Bank basis

1. Nominal amount of derivative instruments A. Hedging derivatives Swaps 57.4 - - - 57.4Of which interest-rate swaps in which the banking corporation agreed to pay fixed interest-rate 57.4

B. ALM derivatives1,2

Option contracts traded on Stock Exchange: Options written - - - - -Options purchased - - - - -Other option contracts Options written - 54.2 - - 54.2Options purchased - 38.5 42.9 - 81.4Futures contracts - - 74.9 - 74.9Forward contracts - 3,894.0 - 7.2 3,901.2Swaps 35.8 - - - 35.8Total 35.8 3,986.7 117.8 7.2 4,147.5Of which interest-rate swaps in which the banking corporation agreed to pay fixed interest-rate 35.8

C. Other derivatives: Futures contracts - 410.3 2,284.2 198.9 2,893.4Forward contracts - - - - -Option contracts traded on Stock Exchange: Options written - 1,077.5 2,441.0 - 3,518.5Options purchased - 1,077.5 2,441.0 - 3,518.5Other option contracts Options written - 16.1 2.6 - 18.7Options purchased - 16.1 2.6 - 18.7Total - 2,597.5 7,171.4 198.9 9,967.8 D. Credit derivatives and spot foreign exchange contracts:

Spot foreign exchange contracts - 166.8 - - 166.8 1 Excluding spot foreign exchange contracts. 2 Derivatives, which are part of asset and liabilities management of the Bank, that are not designated for hedging.



248

Note 16A: Activity in Derivative Instruments - Volume, Credit Risks and Repayment Dates (cont'd) Reported amounts December 31, 2011





Total


2. Gross fair value of financial derivative instruments1

A. Hedging derivatives Gross positive fair value - - - - -Gross negative fair value 3.9 - - - 3.9 B. ALM derivatives2

Gross positive fair value - 60.1 - - 60.1Gross negative fair value 1.8 30.4 2.9 - 35.1 C. Other derivatives: Gross positive fair value - 8.3 51.5 - 59.8Gross negative fair value - 8.3 51.5 - 59.8 1 Includes gross positive fair value of embedded derivatives in the amount of NIS 1.7 million and gross negative fair value of

embedded derivatives of NIS 2.0 million. 2 Derivatives, which are part of asset and liabilities management of the Bank, that are not designated for hedging.



249

Reported amounts December 31, 2010





Total


A. Volume of activity on Consolidated and Bank basis

1. Nominal amount of derivative instruments A. Hedging derivatives Swaps 149.1 - - - 149.1Of which interest-rate swaps in which the banking corporation agreed to pay fixed interest-rate

149.1

B. ALM derivatives1,2

Option contracts traded on Stock Exchange: Options written - - - - -Options purchased - - - - -Other option contracts Options written - 42.4 - - 42.4Options purchased - 47.5 - - 47.5Forward contracts - 4,976.1 - 4.3 4,980.4Swaps 319.4 - - - 319.4Total 319.4 5,066.0 - 4.3 5,389.7Of which interest-rate swaps in which the banking corporation agreed to pay fixed interest-rate

319.4

C. Other derivatives: Futures contracts - 316.9 2,116.5 397.5 2,830.9Forward contracts - - - - -Option contracts traded on Stock Exchange: Options written - 747.2 4,666.4 - 5,413.6Options purchased - 747.2 4,666.4 - 5,413.6Other option contracts Options written - 14.9 0.9 - 15.8Options purchased - 14.9 0.9 - 15.8Total - 1,841.1 11,451.1 397.5 13,689.7 D. Credit derivatives and spot foreign exchange contracts:

Spot foreign exchange contracts - 298.6 - - 298.6 1 Excluding spot foreign exchange contracts. 2 Derivatives, which are part of asset and liabilities management of the Bank, that are not designated for hedging.



250

Note 16A: Derivative Financial Instruments - Volume, Credit Risks and Repayment Dates (cont’d) Reported amounts December 31, 2010

Interest

rate contracts

other



Commodities and other

contracts

Total


2. Gross fair value of financial derivative instruments1

A. Hedging derivatives Gross positive fair value 0.5 - - - 0.5Gross negative fair value 13.3 - - - 13.3 B. ALM derivatives2

Gross positive fair value - 44.7 - -3 44.7Gross negative fair value 0.3 70.4 - -3 70.7 C. Other derivatives: Gross positive fair value - 4.9 84.0 - 88.9Gross negative fair value - 4.9 84.0 - 88.9 1 Includes gross positive fair value of embedded derivatives in the amount of NIS 3.5 million and gross negative fair value of

embedded derivatives of NIS 0.1 million. 2 Derivatives, which are part of asset and liabilities management of the Bank, that are not designated for hedging. 3 Amount less than NIS 0.1 million.



251

Reported amounts

December 31, 2011

Stock exchanges

Banks Brokers Others Total


B. Consolidated and Bank credit risk in respect of derivative instruments by counter party to the contract

Gross positive fair value of derivative instruments

14.9

15.23

18.33

71.5 119.9Less set-off agreements - 0.4 - 3.6 4.0Balance sheet amounts of assets deriving from derivative instruments1 14.9 14.8 18.3 67.9 115.9

Off-balance sheet credit risk in respect of derivative instruments2

-

108.9

-

133.9 242.8Total credit risk in respect of derivative instruments

14.9

123.7

18.3

201.8 358.7

December 31, 2011

Up to three

months

Three to twelve

months

One year to five years

Over five years

Total


C. Repayment Dates - nominal amounts: Year-end balances on consolidated and Bank basis

Other interest rate contracts - - 11.5 81.7 93.2Foreign currency contracts 6,307.4 290.5 153.1 - 6,751.0Contracts in respect of shares 7,014.6 20.2 254.4 - 7,289.2Commodities and other contracts 25.6 175.8 4.7 - 206.1Total 13,347.6 486.5 423.7 81.7 14,339.5 1 Of which at 31.12.11 the balance sheet value of stand-alone derivative instruments in the amount of NIS 114.2 million included

under assets in respect of derivative instruments. 2 Off-balance sheet credit risk in respect of derivative instruments (including derivative instruments with negative fair value) as

calculated for the purposes of the single borrower restrictions (before permitted deductions). 3 Of which at 31.12.11 foreign banks and brokers in the amount of NIS 25.7 million, with a minimum rating of A.



252

Note 16A: Derivative Financial Instruments - Volume, Credit Risks and Repayment Dates (cont’d)

Reported amounts

December 31, 2010

Stock exchanges

Banks Brokers Others Total


B. Consolidated and Bank credit risk in respect of derivative instruments by counter party to the contract

Gross positive fair value of derivative instruments

37.2

35.33,4

8.93

52.74 134.14

Less set-off agreements - 0.44 - 3.44 3.84

Balance sheet amounts of assets deriving from derivative instruments1 37.2 34.9 8.9 49.3 130.3

Off-balance sheet credit risk in respect of derivative instruments2

-

298.7

-4

567.14 865.8

Total credit risk in respect of derivative instruments

37.2

333.6

8.94

616.44 996.1

December 31, 2010

Up to three months

Three to twelve months

One year to five years

Over five years

Total


C. Repayment Dates - nominal amounts: Year-end balances on consolidated and Bank basis

Interest rate contracts – other - 319.4 10.6 138.5 468.5Foreign currency contracts 6,479.9 616.3 108.5 1.0 7,205.7Contracts in respect of shares 11,110.0 128.8 212.3 - 11,451.1Commodities and other contracts 397.5 4.3 - - 401.8Total 17,987.4 1,068.8 331.4 139.5 19,527.1 1 Of which at 31.12.10 the balance sheet value of stand-alone derivative instruments in the amount of NIS 126.8 million included

under assets in respect of derivative instruments. 2 Off-balance sheet credit risk in respect of derivative instruments (including derivative instruments with negative fair value) as

calculated for the purposes of the single borrower restrictions (before permitted deductions). In view of the amendment to Proper Conduct of Banking Business Directive 313, comparative figures are not comparable.

3 Of which foreign banks and brokers in the amount of NIS 22.3 million, with a minimum rating of A. 4 Reclassified.



253

Note 16B: Balances and Fair Value Estimates of Financial Instruments Reported amounts

December 31, 2011

Balance sheet value Fair value

(a) (b) Total


A. Composition - consolidated: Financial assets Cash and deposits with banks 2,023.5 - 2,023.5 2,023.5Securities 2,427.7 6.2 2,433.9 2,433.9Borrowed securities 999.5 - 999.5 999.5Credit to the public, net 534.5 1,238.8 1,773.3 1,770.5Assets in respect of derivative instruments 114.2 - 114.2 114.2Other financial assets 38.1 68.8 106.9 106.9Total financial assets 6,137.5 1,313.8 7,451.3 7,448.3 Financial liabilities Deposits of the public 2,953.3 2,761.8 5,715.1 5,715.4Deposits from banks 25.8 9.1 34.9 34.9Deposits of the government - 19.1 19.1 19.1Subordinated note - 82.1 82.1 81.3Liabilities in respect of derivative instruments 92.8 - 92.8 92.8Other financial liabilities 1,056.0 62.1 1,118.1 1,118.1Total financial liabilities 4,127.9 2,934.2 7,062.1 7,061.6 Off-balance sheet financial instruments Transactions of which the balance represents credit risk 0.3 - 0.3 0.3

Notes: a. Financial instruments whose book value in the balance sheet equals the fair value (instruments shown in the balance sheet at

fair value). b. Other financial instruments.



254

Note 16B: Balances and Fair Value Estimates of Financial Instruments (cont'd) Reported amounts

December 31, 2010

Balance sheet value Fair value

(a) (b) Total


A. Composition - consolidated: Financial assets Cash and deposits with banks 1,670.5 483.5 2,154.0 2,153.3Securities 2,744.8 6.0 2,750.8 2,750.8Borrowed securities 698.7 - 698.7 698.7Credit to the public, net 909.12 842.32 1,751.4 1,757.6Assets in respect of derivative instruments1 126.8 - 126.8 126.8Other financial assets1 67.7 38.0 105.7 105.7Total financial assets 6,217.62 1,369.82 7,587.4 7,592.9 Financial liabilities Deposits of the public 2,337.92 3,670.22 6,008.1 6,007.8Deposits from banks - 65.6 65.6 65.6Deposits of the government 11.7 4.1 15.8 15.8Subordinated note - 80.0 80.0 81.4Liabilities in respect of derivative instruments1 169.1 - 169.1 169.1Other financial liabilities 788.8 74.3 863.1 863.1Total financial liabilities 3,307.52 3,894.22 7,201.7 7,202.8 Off-balance sheet financial instruments Transactions of which the balance represents credit risk 0.3 - 0.3 0.3

Notes: a. Financial instruments whose book value in the balance sheet equals the fair value (instruments shown in the balance sheet at

fair value). b. Other financial instruments. 1 The figures were reclassified to comply with the headings and method of presentation in the current period. 2 Restated. Amounts of securities loaned against short sales of customers, measured at fair value, were moved from column (b)

to column (a).



255

B. Fair value of financial instruments

The Note includes information regarding the fair value of financial instruments. For most of the financial instruments in the Bank, a “market price” cannot be quoted, as there is no active market in which they are traded. Consequently, the fair value is estimated by means of generally accepted pricing models, such as the present value of future cash flows discounted at a rate of interest that reflects the level of risk inherent in the financial instrument. Estimating fair value by means of an evaluation of future cash flow and the determination of a discount rate are subjective. Therefore, for most financial instruments, the attached estimate of fair value is not necessarily an indication of the realizable value of the financial instrument on balance sheet date. The estimate of the fair value is carried out at rates of interest effective at the time, and does not take into account the volatility of interest rates. If other rates of interest are assumed, substantially different fair values may be received. The aforesaid applies mainly to financial instruments bearing a fixed rate of interest or not bearing interest at all. Furthermore, when determining fair value, commissions receivable or payable in respect of business activity are not taken into account, nor is the tax effect included. The gap between the book value and fair values may not be realized, since in most cases the Bank may hold the financial instrument until redemption. In view of the above, it should be stressed that the data stated in this Note does not indicate whether the banking institution constitutes a going concern. Similarly, given the wide range of valuation techniques and possible estimates usable in calculating fair value, caution should be taken when comparing fair values of different banks.

C. Methods and principal assumptions for estimating the fair value of financial instruments

1. Deposits with banks, unquoted bonds, and credit to the Government - The method is the discounting of future cash flows at rates of interest used by the Bank for similar transactions the reporting date.

2. Quoted securities - According to market value in the principal market. When there are several

markets where the instrument is traded, the evaluation is made according to the most efficient market.

3. Credit to the public - The fair value of the balance of credit to the public is estimated the present

value method of future cash flows discounted at an appropriate discount rate. The balance of credit is segmented into homogenous categories. In each category, the cash flow of future receipts (capital and interest) is calculated. These receipts are discounted at a rate of interest that reflects the level of risk inherent in credit in that category. Generally, this rate of interest is determined according to the rate at which similar transactions were made on the reporting date.

The fair value of impaired debts is calculated by using discount rates that reflect the high credit

risk inherent in them. In any event, these discount rates were not less than the high rates of interest used by the Bank in its transactions at the reporting date.

Future cash flows for impaired debts and other debts are calculated after deducting the effects of

accounting write offs and allowances for credit losses in respect of the debts.



256

Note 16B: Balances and Fair Value Estimates of Financial Instruments (cont’d) Accounting write offs and allowances for credit losses are attributed to the periods when the specific debt was classified, when it is possible to do so (for example, when the allowance was calculated on an individual basis according to the present value of the cash flows). In the absence of this data, accounting write offs and the balance of allowances are attributed on a relative basis to the loan balance by repayment dates at the end of the period.

4. Deposits and notes - The fair value is determined by the method of the discounting of future

cash flows at a rate of interest at which the Bank accepts similar deposits, or at which the Bank issues similar notes (if there is no available price quoted in an active market) on the reporting date.

5. Derivative financial instruments - Derivative financial instruments that have an active market

are revalued according to the market value determined in the principal market. When there are several markets where the instrument is traded, the evaluation is made according to the most efficient market. Derivative financial instruments that are not traded in an active market are revalued in accordance with models that the Bank uses in its regular activity and which take into account the risks inherent in the financial instrument (market risk, credit risk, etc.).

6. Off-balance sheet financial instruments whose balance represents credit risk – The fair

value is estimated in accordance with the commissions for similar transactions at the reporting date after adjustment for the balance of the period of the transaction and the credit quality of the counterparty.



257

Note 16C: Items Measured for Fair Value on a Recurring Basis Reported amounts December 31, 2011

Fair value measurements utilize the following:

Prices quoted in an active market (Level 1)

Other significant observable inputs (Level 2)

Significant unobservable inputs (Level 3)

Effect of netting agreements

Balance sheet value

NIS millions

Assets Securities available for sale: Government bonds and loans 839.2 60.3 - - 899.5 Financial institutions in Israel 47.3 - - - 47.3 Foreign financial institutions - 16.9 - - 16.9 Others in Israel 66.7 26.6 - - 93.3 Other foreign - 3.6 - - 3.6 Shares 26.4 - - - 26.4 Total securities available for sale 979.6 107.4 - - 1,087.0 Shares for trading: Government bonds and loans 1,184.8 9.2 - - 1,194.0 Bonds of others 112.7 33.7 - - 146.4 Shares of others 0.3 - - - 0.3 Total securities for trading 1,297.8 42.9 - - 1,340.7 Securities borrowed 999.5 - - - 999.5 Assets in respect of derivative instruments: Foreign currency contracts 8.1 54.7 - - 62.8 Share contracts 51.3 0.1 - - 51.4 Total assets in respect of derivative instruments 59.4 54.8 - - 114.2 Other: Credit in respect of borrowing securities by customers 287.3 - - - 287.3 Assets in respect of activity in the Maof market 36.3 - - - 36.3 Total 323.6 - - - 323.6 Total assets 3,659.9 205.1 - - 3,865.0 Liabilities Liabilities in respect of derivative instruments: Interest rate contracts - 5.6 - - 5.6 Foreign currency contracts 8.1 26.6 - - 34.7 Share contracts 52.4 0.1 - - 52.5 Total liabilities in respect of derivative instruments 60.5 32.3 - - 92.8 Other: Nostro short sale of shares 1,019.7 - - - 1,019.7 Deposit in respect of lending securities to customers 287.3 - - - 287.3 Liabilities in respect of activity in the Maof market 36.3 - - - 36.3 Total 1,343.3 - - - 1,343.3 Total liabilities 1,403.8 32.3 - - 1,436.1

During the year, there were no transfers from Level 2 to Level 1.



258

Note 17: Interested and Related Parties A. Balances - Consolidated Reported amounts

December 31, 2011

Interested Parties5 Interested Parties5

Shareholders Directors and General Manager8

Controlling Shareholders6 Others7

As at December 31, 2011

Highest balance during the year13






Assets Cash and deposits with banks 3.2 191.3 1.4 3.9 - - Credit to the public - - - - - - Borrowed securities - - - - - - Other assets 5.4 5.5 - 4.4 - - Liabilities Deposits of the public -1 0.1 -1 -1 -1 0.2 Deposits from banks 2.3 118.0 2.0 7.3 - - Subordinated note 82.1 84.9 - - - - Other liabilities 0.7 11.9 2.1 13.4 - - Shares (included in shareholders’ equity)11 431.9 432.5 - - - -

Credit risk related to off-balance sheet financial instruments12 1.7 23.9 2.1 9.9 -1 -1

Note: see notes to the table on page 264. 1 Amount less that NIS 0.1 million.



259

Other related parties held by the Bank

Interested Parties5 Equity-basis investees Others10

Others9 As at December 31, 2011







15.3 48.2 - - - - - - - - - - - - - - 4.9 5.0 0.5 3.2 - 6.0 - -

1.2 1.9 - - - - 0.8 4.0 - - - - - - - - - - 7.3 7.8 - 1.5 - -

- -

- - - -

1.3 3.1

- 21.4 - -



260

Note 17: Interested and Related Parties (cont'd) A. Balances - Consolidated Reported amounts

December 31, 2010

Interested Parties5 Interested Parties5

Shareholders Directors and General Manager8









Assets Cash and deposits with banks 1.3 252.8 3.314 6.314 - - Credit to the public - - - - - -1 Borrowed securities - - - - - - Other assets 12.2 14.714 0.3 0.3 - - Liabilities Deposits of the public 0.1 0.1 -1 -1 0.2 0.6 Deposits from banks 23.5 23.5 1.414 2.414 - - Subordinated note 80.0 80.0 - - - - Other liabilities 4.5 12.114 - 3.0 - - Shares (included in shareholders’ equity)11 421.1 560.5 - - - -

Credit risk related to off-balance sheet financial instruments12 44.714 55.614 3.514 12.214 - 0.2

Note: see notes to the table on page 264. 1 Amount less that NIS 0.1 million. 2 Restated.



261

Other related parties held by the Bank

Interested Parties5 Equity-basis investees Others10

Others9 As at December 31, 2010







34.314 57.914 - - - - - - - 1.1 - - - - - - 4.6 5.2 3.1 14.314 6.1 8.1 - -

1.8 4.8 - - - - 0.714 2.014 - - - - - - - - - - 8.2 8.7 1.3 1.32 - -

- -

- - - -

7.214 60.914

19.9 19.9 - -



262

Note 17: Interested and Related Parties (cont’d) B. Condensed business results with interested and related parties - Consolidated Reported amounts

For the year ending December 31, 2011

Interested Parties5 Related Parties held by the Bank

Shareholders Directors and General Manager 8

Others9 Equity-basis investees Others10



Results of financing operations before provision for credit losses2

2.7

-

-

0.8

(0.1)

- Provision for doubtful debts - - - - - - Operating and other income 1.7 - - 0.3 - - Operating and other expenses3 (6.7) - (3.6) (30.2) - - Total (2.3) - (3.6) (29.1) (0.1) -


Interested Parties5 Related Parties held by the Bank

Shareholders Directors and General Manager 8

Others9 Equity-basis investees Others10



Results of financing operations before provision for credit losses2

0.2

-1

-

0.2

0.8

- Provision for doubtful debts - - - - - - Operating and other income 2.0 - - 0.9 - - Operating and other expenses3 (6.8) - (4.6) (28.4) - - Total (4.6) -1 (4.6) (27.3) 0.8 - 1 Amount less than NIS 0.1 million. 2 See D below. 3 See C below. 4 Not including salary tax.



263

C. Benefits to interested parties Reported amounts


Shareholders - interested parties6

Directors and General Manage 8

Total benefits

No. of persons receiving benefit

Total benefits4



Interested parties employed by the corporation or on its behalf - - 1.8 1

Directors not employed by the corporation or on its behalf - - 1.8 7


Shareholders - interested parties6

Directors and General Manage 8

Total benefits


Total benefits4



Interested parties employed by the corporation or on its behalf - - 2.7 2

Directors not employed by the corporation or on its behalf - - 1.9 6

D. Results of financing operations (before allowance for credit losses)

For the year ending December 31

2011 2010 2009

Consolidated Of which:

equity-basis investees

Consolidated Of which: equity-basis investees

Consolidated Of which: equity-basis investees


In respect of assets From deposits with banks 3.9 - 0.8 - (2.0) - In respect of liabilities On deposits from the public - - - - -1 - On deposits from banks (0.4) - (0.4) - (0.5) - Other Commissions on financing business - - - - -1 -

Other financing income (expenses) (0.1) (0.1) 0.8 0.8 2.2 2.2

Total results of financing operations before allowance for credit losses

3.4 (0.1) 1.2 0.8 (0.3) 2.2



264

Note 17: Interested and Related Parties (cont’d) E. Change of Control of the Bank:

On July 29, 2004 an agreement (hereinafter: “the agreement”) was signed between Investec (Israel) B.V. and the First International Bank of Israel Ltd. (hereinafter: “FIBI”), according to which FIBI would purchase from Investec (Israel) B.V. all its holdings in the shares of the Bank (hereinafter: “the transaction”). On December 22, 2004, the transaction was completed and full ownership of the Bank (100%) passed to FIBI. Within the context of completing the transaction, Investec Bank (UK) Ltd., the controlling shareholder of Investec (Israel) B.V., gave the Bank collateral and indemnities in respect of a number of debts and claims, in the amount of some NIS 94.5 million, linked to the terms of the debts and the claims. The amount of the collateral, as at December 31, 2011, is about NIS 17.9 million.

F. See details in Note 16(C) (10) regarding commitments between the Bank and FIBI Group. G. The Bank and its consolidated companies conduct business with interested parties.

These transactions are made in the ordinary course of business and under terms similar to those of transactions with non-related parties.

5 Interested party - as defined in the Securities Regulations. Related party - as defined in Opinion 29 of the Institute of Certified

Public Accountant in Israel - that is not an interested party. 6 Controlling shareholder: as defined in the Securities Law. 7 Whoever holds 5% or more of the issued share capital of the banking corporation, or of its voting rights, or whoever is

authorized to appoint one or more of its directors or its General Manager. 8 Including spouses and their minors. 9 A corporation, in which an interested party holds 25% or more of the issued share capital or its voting rights, or is authorized to

appoint 25% or more of the directors. 10 A corporation in which the banking corporation holds 10% or more of the issued share capital or of its voting rights, or is

authorized to appoint 10% or more of the directors, or is authorized to appoint the General Manager. Another corporation in which a related party holds 25% or more of the issued share capital or of the voting rights, or of the authority to appoint directors.

11 Interested and related parties holdings’ in the equity of the banking corporation. 12 Credit risks of off-balance-sheet financial instruments, as calculated for the purpose of single borrower restrictions. 13 Based on month-end balances. 14 Reclassified.



265

Note 18: Profit from Financing Operations before Allowance for Credit Losses Reported amounts


2011 2010 2009


Composition - consolidated:

A. In respect of assets1 From credit to the public 112.0 0.4 17.8 From deposits with Bank of Israel and cash 51.6 31.9 21.1 Securities borrowed 21.1 11.3 6.2 From deposits with banks 5.0 (14.1) 61.1 From bonds4 60.6 (7.9) 50.5 B. In respect of liabilities1 On deposits from the public (191.8) 104.3 (19.8) On deposits from Bank of Israel and cash - - - On deposits from banks 6.2 (3.6) (0.4) On subordinated notes (5.0) - - On other liabilities (2.2) - - C. In respect of derivative financial instruments and hedging activities

Net expenses in respect of ALM derivative instruments2 22.2 (52.3)6 (49.3)6

Net income from other derivative instruments 3.6 3.56 2.76 Non-effective component of hedging relationships (see F below)5 (0.8) (1.1) 0.6

D. Other Commissions from financing business 0.3 1.4 0.6 Other financing income3 27.6 34.2 69.3 Total income from financing operations before allowance for credit losses 110.4 108.0 160.4

Of which: exchange-rate differences, net (46.0) 44.9 54.2 1 Including the effective component of hedging relationships. 2 Derivative instruments that constitute part of the assets and liabilities management of the Bank that were not designated as

hedging relationships. 3 Including interest from doubtful debts and non-income bearing debts in 2010 and 2009 of NIS 0.8 million and NIS 4.1 million,

respectively. 4 In 2011, the Bank did not have any investment is asset-backed bonds, and in 2010 and 2009 this includes interest and

exchange-rate differences from an asset-backed bond in the amount of NIS 1.0 million and NIS (0.1) million, respectively. 5 Except for the effective component of hedging relationships. 6 Reclassified.



266

Note 18: Profit from Financing Operations before Allowance for Credit Losses (cont'd) Reported amounts


2011 2010 2009


E. Detailed results of investment activity in bonds

Financing income on accrual basis from bonds: Available for sale bonds 64.0 (12.8) 53.3 For trading (3.4) 4.9 (2.8) Total included in profit from financing activities in respect of assets

60.6

(7.9)

50.5

Profits from sale of bonds available for sale 15.0 13.9 47.3 Losses from sale of bonds available for sale (2.5)2 (0.2) (16.5)2 Realized and unrealized profits from adjustments to fair value of bonds for trading, net3

12.7

18.1

31.5

Total included in other financing income 25.2 31.8 62.3 Total from investments in bonds 85.8 23.9 112.8 F. Non-effective component of hedging relationships

Fair value hedging Non-effectiveness of hedges (0.8) (1.1) 0.6 G. Details of net effect of hedging derivative instruments on profit from financing operations

Financing income (expenses) in respect of assets (paragraph A)1

(1.4)

(1.9)

(7.8)

1 Details of effect of hedging derivative instruments on sub-paragraph A above. 2 Including provisions for impairment. 3 Including part of the profits and losses related to bonds for trading which are still held on the balance sheet date in the amount

of NIS (8.3) million (2010 – NIS (0.2) million, 2009 - NIS 6.9 million).



267

Notes 19 - 20 Reported amounts

Consolidated Bank

For the year ending December 31 For the year ending December 31

2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Note 19: Operating Commissions Ledger fees 6.8 7.22 5.8 6.8 7.22 5.8 Credit cards 1.3 1.5 1.0 1.3 1.5 1.0 Activity in securities 51.1 52.7 53.5 50.9 52.5 53.5 Commission on distribution of financial products 1.0 0.7 0.4 1.0 0.7 0.4

Management, operations, and trusteeship for institutional bodies1 47.0 48.6 37.5 - - -

Conversion differentials 20.4 18.2 20.1 20.4 18.2 20.1 Foreign trade activity 0.3 0.7 0.4 0.3 0.7 0.4 Net income from servicing loan portfolios 0.6 0.62 0.5 0.6 0.62 0.5 Handling credit 0.3 0.92 0.6 0.3 0.92 0.6 Other 1.3 1.2 1.0 - - - Total operating commissions 130.1 132.3 120.8 81.6 82.3 82.3

Consolidated Bank


2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Note 20: Profits (losses) from investments in shares, net

Profits from sale of shares available for sale 1.1 0.9 - 1.1 0.9 -

Provision for loss from impairment of shares available for sale

(2.7) (0.8) (3.8) (2.7) - (1.2)

Realized and unrealized profits from adjustments to fair value of shares for trading, net

0.6 0.3 1.0 0.3 0.3 0.9

Dividend from shares available for sale 1.1 0.4 0.1 0.8 0.1 0.1 Total profits (losses) from investments in shares, net 0.1 0.8 (2.7) (0.5) 1.3 (0.2)

1 Mutual funds and managers of long-term savings. 2 Reclassified.



268

Notes 21 - 22 Reported amounts

Consolidated Bank


2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Note 21: Other income Management fees from related companies - - - 2.9 3.0 2.8 Rent 1.8 2.1 0.9 0.4 0.4 0.3 Profits from severance payment fund - 0.9 4.9 - 0.9 4.7 Other - 0.1 0.1 - -1 0.2 Total other income 1.8 3.1 5.9 3.3 4.3 8.0

Consolidated Bank


2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Note 22: Salaries and related expenses

Salaries 48.3 44.7 45.0 43.2 40.1 41.1 Bonus 4.1 6.0 10.2 3.8 5.5 9.4 Severance pay, provident fund, vacation pay and further education fund

10.4 8.0 9.5 9.4 6.9 8.0

Addition to provision in respect of related expenses due to changes in salary during the accounting year

1.1 0.8 0.3 1.0 0.8 0.3

National Insurance, salary tax and deductions 11.8 11.0 10.8 10.5 9.8 9.7

Total salaries and related expenses 75.7 70.5 75.8 67.9 63.1 68.5 1 Amount less than NIS 0.1 million.



269

Note 23: Other Expenses Reported amounts

Consolidated Bank


2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Marketing and advertising 8.1 6.7 6.3 6.6 5.6 5.8

Communications 10.4 10.51 11.21 10.2 10.31 10.91

Computer 26.7 25.2 22.9 26.7 25.4 22.9

Office expenses 1.3 1.8 2.2 1.3 1.7 2.2

Insurance 0.5 0.7 0.7 0.4 0.5 0.6

Professional services 11.4 12.0 13.0 5.7 6.9 7.6

Directors’ fees 1.1 1.1 0.9 0.6 0.7 0.6

Staff training 0.8 0.7 0.6 0.7 0.6 0.6

Commissions 13.7 12.2 17.0 11.7 10.4 16.0

Travel expenses 0.7 0.6 0.7 0.7 0.6 0.7

Fees and memberships 1.1 1.4 1.1 0.3 0.4 0.9

Fund operating services 2.8 2.7 - 2.8 2.7 -

Miscellaneous 4.0 3.51 4.21 3.6 3.21 3.11

Total other expenses 82.6 79.1 80.8 71.3 69.0 71.9

1 Reclassified.



270

Note 24: Provision for Taxes on profit from ordinary operations

Reported amounts

Consolidated Bank


2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

A. Current taxes in respect of accounting year 25.8 29.5 45.1 16.1 17.4 36.4 Current taxes in respect of previous years (1.2) 0.4 1.0 (1.2) 0.4 1.0 Total current taxes 24.6 29.9 46.1 14.9 17.8 37.4 In addition (deduction): Deferred taxes in respect of accounting year (2.5) (0.2) (1.5) (1.9) 1.0 (1.3) Deferred taxes in respect of previous years

1.2

(0.4)

(1.2)

1.2

(0.4)

(1.2)

Total deferred taxes (1.3) (0.6) (2.7) (0.7) 0.6 (2.5) Total provision for taxes 23.3 29.3 43.4 14.2 18.4 34.9 B. Reconciliation between the theoretical amount of tax computed on the operating profit, using the

statutory tax rate applying to banks in Israel, and the adjusted provision for taxes on operating profit appearing in the consolidated statement of profit and loss:

Consolidated Bank

2011 2010 2009 2011 2010 2009 Statutory tax rate applying to a banking corporation

34.48% 35.34% 36.21% 34.48% 35.34% 36.21%

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Amount of tax based on the statutory tax rate 21.7 28.1 39.8 12.5 16.5 31.4 Tax (tax saving) in respect of: Non-deductible expenses 0.3 0.5 0.4 0.5 0.5 0.3 Allowance for credit losses - (0.2) 0.1 - (0.2) 0.1 Adjustment differences in depreciation and amortization

(0.1) (0.1) 0.3 (0.1) (0.1) 0.2

Exempt income or income taxed at lower tax rates

0.2 (0.3) (0.4) 0.1 0.1 0.1

Taxes in respect of previous years -1 - (0.2) - - (0.2) Timing differences in respect of which deferred taxes were not recorded

(0.1)

(0.2)

0.4

-1

(0.1)

0.4

Change in balance of deferred taxes (tax provision) due to change in tax rate

(1.1)

0.2

0.4

(1.1)

0.2

0.1

Additional amounts payable on problem debts 0.5 0.72 1.02 0.5 0.7 1.0 Other 1.9 0.62 1.62 1.8 0.8 1.5 Provision for taxes on income 23.3 29.3 43.4 14.2 18.4 34.9

1 Amount less than NIS 0.1 million. 2 Reclassified.



271

C. 1. Final tax assessments have been issued to the Bank for all tax years up to and including the

2006 tax year, consolidated companies have been issued final assessments up to and including the 2007 tax year.

2. Orders have been issued to the Bank in respect of deduction assessments for the years 2004 - 2006, against which the Bank has filed appeals in court. In the opinion of the Bank, the financial statements include appropriate provisions in respect of these orders.

D. The balance of accumulated losses for tax purposes, for which no deferred tax assets were recorded

in the consolidated statements, is in the amount of NIS 0.7 million (in 2010 - NIS 0.4 million). E. Deferred tax assets and a provision for deferred taxes in the consolidated statements were recorded

in respect of: Reported amounts Deferred tax assets Average tax rate

December 31 December 31

2011 2010 2011 2010

NIS millions NIS millions % %

Liability in respect of termination of employee-employer relations (0.3) (0.6) 35.06 29.00

Provision for vacation 1.7 1.3 35.34 34.48 Allowance for credit losses 15.5 0.1 35.06 34.48 Adjustment of securities 6.1 2.9 32.31 32.00 Provisions not yet paid 1.2 2.3 35.34 34.48 Depreciable non-monetary assets (1.2) (1.0) 35.06 29.00 Other non-monetary items 0.8 0.9 25.00 18.00 Losses brought forward 0.1 0.1 25.00 24.00 23.9 6.0 December 31

2011 2010


Deferred taxes included in the consolidated balance sheet: In “Other assets” 23.9 6.0 In “Other liabilities” - - Deferred tax assets, net 23.9 6.0



272

Note 24: Provision for Taxes on profit from ordinary operations (cont’d) F. 1. Realization of deferred taxes is based on a forecast of the existence of future taxable income,

and calculated according to a tax rate of 25% - 35.34% (in 2010 – 18% - 34.48%). 2. Included in the statement of changes in equity is a change of NIS (2.4) million in 2011 (2010 -

NIS 1.6 million) in the balance of deferred tax assets, in respect of an adjustment in the presentation of unquoted securities available for sale according to fair value.

3. Included in the statement of changes in equity is a change of NIS 14.2 million in 2011 in the

balance of deferred tax assets in respect of the initial implementation of the directives of the Banking Supervision Department on Measurement and Disclosure of Impaired Debts, Credit Risk and the Allowance for Credit Losses.

G. Taxes on income On July 25, 2005, the Income Tax Ordinance (Amendment No.147), 2005, was passed in the Knesset. The Amendment provides, inter alia, for a gradual reduction of the rate of Companies Tax to 25% for the tax year 2010 and thereafter. On 14 July 2009, the Knesset approved the Improved Economic Efficiency Law (Statutory Amendments for Implementation of the Economic Plan for 2009 and 2010), 2009, which, among others, gradually reduces the rate of Companies Tax to 18% for the year 2016 and thereafter. In accordance with the above amendments, the rates of Companies Tax for tax year and thereafter are: for the tax year 2009 - 26%, for the tax year 2010 - 25%, for the tax year 2011 - 24%, for the tax year 2012 - 23%, for the tax year 2013 - 22%, for the tax year 2014 - 21%, for the tax year 2015 - 20%, and for the tax year 2016 and thereafter, the rate of Companies Tax rate will be 18%. On December 5, 2011, the Amendment to the Tax Burden Law (Legislative Amendments), 2011, was passed in the Knesset. In accordance with the law, the tax reduction set out in the Improved Economic Efficiency Law, mentioned above, is to be canceled and the rate of Companies Tax commencing in 2012 and thereafter will be 25%. Further to the abovementioned amendment, the statutory tax rate applying to the Bank is 34.48% in 2011. The statutory tax rates applying to the Bank in the tax year 2012 is 35.34%, and in the tax year 2013 and thereafter – 35.06% Current taxes for periods reported in these financial statements are calculated in accordance with the rates of tax as set out in the Improved Economic Efficiency Law. The balances of deferred taxes at 31.12.2011 were calculated in accordance with the new rate of tax, as set out in the Amendment to the Tax Burden Law, in accordance with the rate of tax expected at the changeover date. The effect of the change in the tax rate on the balance of deferred taxes as December 31, 2011, is income in the sum of NIS 0.4 million.



273

Note 25: Profit from Extraordinary Operations after Tax Reported amounts

Consolidated Bank


2011 2010 2009 2011 2010 2009

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

NIS millions

Sale of shares in equity-basis investee1 1.5 - - - - - Tax expenses on profit from extraordinary activities -2,3 -3 - - - -

Profit from extraordinary activities after tax 1.5 -3 - - - - Bank’s share in profit from extraordinary activities after tax of investee companies - - - 1.5 -3 -

Profit from extraordinary activities after tax 1.5 -3 - 1.5 -3 -

1 On May 1, 2011, the Bank sold its entire holding in Manif Financial Services Ltd., a company included on equity basis. The

profit from the sale amounted to NIS 1.5 million. 2 Addition to tax provisions in respect of sale of provident fund operations in November 2007. 3 Amount less than NIS 0.1 million. Note 26: Earnings per Share Reported amounts

2011 2010 2009

NIS thousands

NIS thousands

NIS thousands

Below are the amounts of profit and the number of shares used in calculating basic earnings per share:

Net profit for calculating earnings per share 40,900 49,000 65,600 Weighted average of number of ordinary shares used in weighting of the basic profit (in thousands)

3,123.9

3,123.9

3,123.9



274

Note 27: Operating Segments Reported amounts


Private Banking

NIS millions

A. Consolidated: Profit from financing operations before income in respect of credit losses:

From external entities 27.9 Inter-segmental 19.1 Operating and other income: From external entities 48.0 Inter-segmental (2.5) Total income 92.5 Income in respect of credit losses (3.5) Operating and other expenses, (including depreciation and amortization):

To external entities 73.9 Inter-segmental 21.0 Profit from ordinary activities before taxes 1.1 Provision for taxes on profit from ordinary activities 0.5 Profit from ordinary activities after taxes 0.6 Bank’s share in operating losses of equity-basis investees -

Net profit from ordinary operations 0.6 Profit from extraordinary operations after tax - Net profit 0.6 Net return on equity (percent) 0.6 Average balance of assets 969.1 Of which: Investment in equity-basis investees - Average balance of liabilities 2,728.1 Average balance of risk assets 894.4 Average balance of mutual fund assets 713.0 Average balance of other assets under management 558.0 Margin from credit activity 20.8 Margin from deposits activity 21.6 Other 4.6 Total profit from financing operations before income in respect of credit losses 47.0



275

Corporate Banking Financial

Segment Amounts not allocated and adjustments

Total Consolidated

NIS millions NIS

millions NIS millions NIS

millions

(17.6) 108.1 (8.0) 110.4 45.1 (77.3) 13.1 -

74.3 6.9 2.8 132.0 (0.3) 2.8 - -

101.5 40.5 7.9 242.4 - - (1.5) (5.0)

45.4 19.1 46.2 184.6 12.3 8.6 (41.9) - 43.8 12.8 5.1 62.8 15.1 4.4 3.3 23.3

28.7 8.4 1.8 39.5 - (0.1) - (0.1)

28.7 8.3 1.8 39.4 - 1.5 - 1.5

28.7 9.8 1.8 40.9

29.0 3.8 - -

771.4 4,846.4 152.4 6,739.3

- 5.7 - 5.7

3,072.7 341.1 157.3 6,299.2 749.3 948.0 124.0 2,715.7

- - - 713.0 - - - 558.0

2.3 - 3.5 26.6 19.9 - 0.9 42.4

5.3 30.8 0.7 41.4

27.5

30.8 5.1 110.4



276

Note 27: Operating Segments (cont’d) Reported amounts


Private Banking

NIS millions



From external entities 68.6 Inter-segmental 17.2 Profit from ordinary activities before taxes 0.2 Provision for taxes on profit from ordinary activities 0.1 Profit from ordinary activities after taxes 0.1 Bank’s share in operating losses of equity-basis investees -

Net profit from ordinary operations 0.1 Profit from extraordinary operations after tax - Net profit. 0.1 Net return on equity (percent) 0.1 Average balance of assets 855.4 Of which: Investment in equity-basis investees - Average balance of liabilities 2,839.3 Average balance of risk assets 762.0 Average balance of mutual fund assets 782.3 Average balance of other assets under management 741.9 Margin from credit activity 17.7 Margin from deposits activity 17.5 Other 4.3 Total profit from financing operations before income in respect of credit losses 39.5

1 Reclassified 2 Amount less than NIS 0.1 million.



277

Corporate

Banking Financial Segment Amounts not allocated and

adjustments Total

Consolidated

NIS millions NIS


millions

(7.6) 101.2 (4.6) 108.0 35.3 (63.0) 7.2 -

77.0 8.2 3.6 136.2 (0.2) 2.3 - -

104.5 48.7 6.2 244.2 - (2.7) (3.3) (7.2)

43.8 18.2 41.2 171.8 11.3 8.5 (37.0) -

49.4 24.7 5.3 79.6 17.5 8.7 3.0 29.3 31.9 16.0 2.3 50.3

- (1.3) - (1.3)

31.9 14.7 2.3 49.0 - - -2 -2

31.9 14.7 2.3 49.0

36.0 5.1 - -

1,039.7 5,457.3 57.6 7,410.0

- 5.7 - 5.7 3,595.6 256.1 189.0 6,880.0

664.7 859.7 31.0 2,317.4 - - - 782.3 - - - 741.9

1.9 - 1.4 21.0 21.7 - 1.2 40.4

4.1 38.2 - 46.6

27.7

38.2 2.6 108.0



278

Note 27: Operating Segments (cont’d) Reported amounts


Private Banking

NIS millions



From external entities 67.0 Inter-segmental 16.7 Profit from ordinary activities before taxes (3.9) Provision for taxes on profit from ordinary activities (1.4) Profit (loss) from ordinary activities after taxes (2.5) Bank’s share in operating losses of equity-basis investees -

Net profit (loss) from ordinary operations (2.5) Profit (loss) from extraordinary operations after tax - Net profit (loss) (2.5) Net return on equity (percent) (3.5) Average balance of assets 709.0 Of which: Investment in equity-basis investees - Average balance of liabilities 2,704.5 Average balance of risk assets 466.0 Average balance of mutual fund assets 651.9 Average balance of other assets under management 596.8 Margin from credit activity 13.0 Margin from deposits activity 21.8 Other 5.5 Total profit from financing operations before income in respect of credit losses 40.3

1 Reclassified



279

Corporate

Banking Financial Segment Amounts not allocated and

adjustments Total

Consolidated

NIS millions NIS


millions

7.0 143.5 (3.9) 160.4 21.2 (53.7) 6.0 -

75.8 2.8 3.9 124.0 (1.1) 3.4 - -

102.9 96.0 6.0 284.4 (0.2) - (3.4) (3.9)

46.4 21.5 43.6 178.5 13.2 9.3 (39.2) -

43.5 65.2 5.0 109.8 15.8 23.6 5.4 43.4 27.7 41.6 (0.4) 66.4

- (0.8) - (0.8)

27.7 40.8 (0.4) 65.6 - - - -

27.7 40.8 (0.4) 65.6

38.4 37.7 - -

1,080.0 5,662.2 33.0 7,484.2

- 8.8 - 8.8 3,883.6 203.0 168.6 6,959.7

341.8 902.2 25.2 1,735.2 - - - 651.9 - - - 596.8

1.8 - 0.9 15.7 23.4 - 1.2 46.4

3.0 89.8 - 98.3

28.2

89.8 2.1 160.4



280

Note 27: Operating Segments (cont’d) B. Additional information: 1. The Bank operates the EVA (Economic Value Added) model, which is an accepted model

around the world for the purposes of measuring the contribution of each unit to the Bank’s overall profitability. Income, expenses and capital are allocated to each operational segment in implementing the model, as follows: The segments’ income from external sources: - The Private Banking Segment’s income derives from financing profit and operating income

deriving from private customers attributed to this segment. In addition, the segment’s income includes income from management of investment portfolios and investment counseling, income from managing the Bank’s mutual funds and the income from public and private trust services.

- The Corporate Banking Segment’s income derives from financing profit and operating income from customers whose main activity is in the capital market. Furthermore, the division’s income includes the income from operating mutual funds and trustee services for mutual funds.

- The Financial Segment’s income is principally from financing profit that derives from managing the sources and applications of the Bank in the various linkage sectors, and from nostro operations in the Bank’s securities. Furthermore, the division’s income includes income from dealing room operations in managing basis and interest rate exposures of the Bank, and profits (and losses) from investments in equity-basis investees.

Inter-segmental income: - Inter-segmental profit from financing operations before income from credit losses:

The financing income/expenses are first attributed to the segment to which the customer belongs. Thereafter the Financial Segment, which is responsible for the management of the sources and applications of the Bank, debits/credits the other segments with the cost of raising funds, calculated in accordance with the relevant linkage sectors and average duration.

- Inter-segmental operating and other income: Operating and other income is first attributed to the segment to which the customer belongs. Thereafter a proportionate part of that income (as was determined for each type of income) is transferred to other segments that also provide a service to the same customer.

Expenses of the segments: Salary and related expenses are allocated between the segments according to actual expenses. Other major expenses are allocated in accordance with the number of employees or a weighted number of employees and capital or the relative area of the building used by the segment, as the case may be. Depreciation expenses are specifically allocated to the segments according to the assets they use. The allowance for credit losses was split specifically according to each segment’s customers. The cost of central services and management are charged to the operating segments reporting as part of the application of the model (Central services include all the departments in the Headquarters Division and the Chief Accountant Division, the Bank Corporate Secretary and also the internal audit and information systems departments). Net return on equity is calculated on the average capital allocated to the reporting segments, at a rate of 12% of each segment’s risk assets. Where the reporting segment does not have risk assets allocated to it for the purposes of its operations, the capital allocated to the segment is calculated according to a multiple of the segment’s expenses.



281

Risk assets in 2011 and 2010 are shown in accordance with Basel II Directives, and are not comparable with risk assets for 2009 that are shown in accordance with Basel I.

2. The average balance of assets in the “Amounts not allocated and adjustments” column includes the

average balance of buildings and equipment and other assets. The average balance of liabilities in the “Amounts not allocated and adjustments” column includes the average balance of other liabilities.

3. The profit (loss) in the “Amounts not allocated and adjustments” column includes the balance of tax

expenses, after tax expenses are attributed to the reporting segments at a theoretical tax rate of 34.48% (in 2010 - 35.34%).

Results of activities of a non-reporting segment were NIS 3.4 million in 2011, NIS 3.4 million in 2010, and NIS 3.2 million in 2009,

4. Allocation between operating segments is based on types of customers and defined areas of activity.

It is derived from the customer-focused activity strategy employed by the Bank. As there are no uniform criteria in the banking system for assigning customers to the above operating segments, each bank assigns its customers to operating segments corresponding to its management concept and business strategy. Data of the results of the segments are presented in accordance with the Directives of the Supervisor of Banks - “Principal Operating Segments”. In the framework of preparation of this Note, inter alia, a reconciliation is made between management reports relating to the above operating segments, based partly on management’s assessment of the operational segments, with reporting carried out in accordance with the directives of the Supervisor of Banks.



282

Note 28: Condensed Financial Data of the Bank in Historical Values Reported amounts

December 31

2011 2010


Total assets 7,693.4 7,800.1 Total liabilities 7,265.5 7,383.5 Shareholders’ equity 427.9 416.6 Net profit 41.3 49.4

Note 29: Updates in Legislation

Joint Investment Trust Law (Amendment No. 14), 2010 This amendment came into effect with the coming into effect of rules for holding the required tender that were published on 28.6.11 and came into effect on 28.12.11. On 16.2.10, the amendment to the law was published in the Official Gazette (Reshumot). The main amendment is a change to section 69 in the Joint Investment Trust Law, 1994. 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 financial year. U-Bank and the U-Bank Trust Company Ltd. have completed preparations for implementation of the provisions of the above-mentioned legislation. As a result of implementing the directive, the Bank expects a decline in its income that will not materially affect the current activities of the Bank.

annual report 2011 u-bank ltd. · annual report 2011 \ ... – government bonds and makam in the...

Documents