USAID-Funded Economic Governance II Project

Assessment of Iraqi State-Owned Banks

15 NOVEMBER 2005

USAID-Funded Economic Governance II Project

Assessment of Iraqi State-Owned Banks

15 November 2005

The USAID-Funded Economic Governance II program is pleased to present this report entitled Assessment of Iraqi State-Owned Banks. The report provides the findings of a team of commercial bank restructuring experts assigned to six of the seven Iraqi state-owned institutions. This document contains analyses based on employee-provided data. Given significant weaknesses in the operational and finance functions, the validity of financial indicators remains in question. As well, given the ongoing security concerns in Iraq, the advisory team’s onsite presence was significantly impacted. Under such limitations, the ability to conduct an in-depth review of each banking department was not possible.

The purpose of this assessment was to determine the financial condition of the institutions in light of the emergence of a new Iraqi financial system. Efforts have been in place since summer 2004 to identify a strategic approach to the state-owned banking dilemma in Iraq, focusing on possible options to be conducted by the new Government of Iraq (GoI). As a critical foundation of economic reform, it was determined that a baseline assessment must be conducted in order to provide the necessary data to the GoI. As experienced throughout the emerging markets, a key component of economic reform is a well-regulated, vibrant banking system that can not only provide credit to the emerging private sector but to do so in a transparent manner. In order to begin such steps in Iraq, a baseline must be established whereby these six institutions may be addressed to support the reform.

The focus of this review was on the six historical state-owned banking institutions. These six banks comprise 90 percent of the total banking system assets. Rafidain Bank and Rasheed Bank account for approximately 86 percent of the total banking assets and about the same share of the banking system deposits. These two large commercial institutions account for about $6.5 billion in assets. Rafidain Bank and Rasheed Bank maintain approximately 310 domestic branches, of which about 286 are currently open.1 Together, the two banks have more than 2.8 million deposit accounts and employ approximately 13,000 individuals.

Iraq also has four smaller, specialized, state-owned banks: the Agricultural Bank, the Industrial Bank, the Real Estate Bank and Iraq Bank (formerly known as the Socialist Bank). Collectively, these banks account for approximately 7 percent of the total banking system assets, and 67 branches are operational.2 Although they were originally founded to support particular sectors of the Iraqi economy, in 1997 they were authorized by the former regime to conduct general commercial banking activities. They now are direct competitors of the two large state-owned banks as well as the emerging private commercial banking sector.

1 November 2005 data. 2 November 2005 data.

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In June 2005, the advisory team contributed to a co-authored workplan with members of the US Treasury – Iraq Reconstruction Management Office (IRMO) banking team. The purpose of this collaborative effort was to conduct the necessary investigations in each of the six institutions to support a strategic banking system options paper for the GoI. Thus, the findings of our assessment are of a financial and operational nature and do not provide recommendations, rather the assessment provides critical information to the US Treasury IRMO team.

We believe the findings of this report provide the data components necessary to develop appropriate options for the financial remediation of the Iraqi state-owned banks. We encourage your thorough review of the information presented herein.

Very truly yours,

Gareth Davies Chief of Party USAID-Funded Economic Governance II Project

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USAID-Funded Economic Governance II Project

Assessment of Iraqi State-Owned Banks

1 INTRODUCTION...... 6

2 SCOPE OF ASSESSMENT...... 8

3 BACKGROUND...... 11

4 ASSESSMENT ...... 13

4.1 RAFIDAIN BANK...... 13 4.1.1 EXECUTIVE SUMMARY – RAFIDAIN BANK ...... 13 4.1.2 ASSESSMENT OF RAFIDAIN BANK...... 15 4.1.3 FINDINGS – RAFIDAIN BANK...... 38

4.2 RASHEED BANK ...... 42 4.2.1 EXECUTIVE SUMMARY – RASHEED BANK ...... 42 4.2.2 ASSESSMENT OF RASHEED BANK ...... 44 4.2.3 FINDINGS – RASHEED BANK...... 62

ANNEXES

Annex A Rafidain Bank Financial Condition and Viability Annex B Sample Assessment Questionnaire Annex C Transaction and Activity Statistics Annex D Staffing and Salary Distribution Annex E Rafidain Bank Total Foreign Debt Annex F Rafidain Bank Loans and Facilities Annex G Rafidain Bank Lending Authorities Annex H Rafidain Bank Credit Approval Process Annex I Loans Classification Report for Rafidain and Rasheed Banks Annex J Rafidain Bank Debt and Delinquencies Annex K Rasheed Bank Financial Condition and Viability Annex L Rasheed Bank Total Foreign Debt Annex M Rasheed Bank Credit Approval Process Annex N Rasheed Bank Loans and Facilities Annex O Rasheed Bank Debt and Delinquencies

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INTRODUCTION ______

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1 INTRODUCTION

Following the 2004 Coalition Provisional Authority’s handover to the new sovereign Interim Government, international donor organizations enacted broad economic reform programs. The United States Agency for International Development (USAID) has been a key implementer in these programs. As a component of the Iraqi reconstruction, the financial sector has been identified as a fundamental component to support these efforts. As such, focus on the condition of the State-owned banking system became of key concern.

The USAID-Funded Economic Governance II program has taken critical steps in providing the information necessary to contribute to the larger State-owned Banks restructuring program. This document, Assessment of the Iraqi State-Owned Banks, represents USAID’s contribution to the development of a broad-based banking strategy for the Government of Iraq (GoI). As a component of the IMF’s 2004 Emergency Post-Conflict Assistance (EPCA), criteria were developed which would set the framework for State-owned banking reform. As well, the United States Treasury – Iraq Reconstruction Management Office (IRMO) banking team will propose a banking strategy for consideration of the GoI. USAID BearingPoint provides critical data to the US Treasury team in the body of this document.

BearingPoint was tasked under the USAID-Funded Economic Governance II Project and in conjunction with US Treasury’s IRMO office to assess the Financial Condition and the Operational Status of the six Iraqi state-owned banks: Rafidain, Rasheed, Agricultural, Industrial, Real Estate, and Iraq (formerly Socialist). The seventh State-owned Bank, Trade Bank, was excluded from the Assessment at the request of the Iraqi Minister of Finance.

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SCOPE OF ASSESSMENT ______

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2 SCOPE OF ASSESSMENT

The Assessment covered six of the seven wholly owned government banks, as stipulated by the Minister of Finance at the outset of the reviews. The Government feels that the Trade Bank of Iraq is well enough capitalized, established sufficiently recently, and managed capably enough that it can be considered separately in any future bank-restructuring project. The Assessment was carried out from July 2005 through November 2005.

The project goal was to ascertain the actual current condition and viability of each of the six banks through detailed data gathering and review. This was not meant to be an audit, as such effort was beyond the scope and capability of the five reviewers’ time and terms of reference. An audit could be conducted in the future in preparation for whatever final action the shareholder may plan to take, but this was not deemed necessary nor appropriate for this effort.

One standard set of guidelines often followed in diagnostic reviews and financial assessments of banks is based on the Uniform Financial Institutions Rating System (UFIRS), commonly known as the “CAMELS” system (Capital adequacy, Asset quality, Management, Earnings, Liquidity, Sensitivity to market risks). This review, however, assessed the functional areas of each bank for financial condition and viability, operational standards, organizational efficiency, compliance with modern operating, credit, and reporting standards.

The Review covered the subject areas at the head office levels, with reviews of branch positions via standard, periodic consolidating reports and spot visits. Data and information were obtained from monthly, quarterly, and annual financial statements as available, and from worksheets, interviews, first hand observations, and questionnaires. The conversion rate of IQD 1460 to one US dollar is used throughout this report.

Two major constraints were encountered during the Assessment. Due to the universal manual accounting, transacting, and reporting procedures of the banks, and due to poor communications between head offices and branches, regular delays were experienced, and amounts and data could not always be reconciled or considered reliable or accurate. Normally during a detailed assessment, full, frequent, and first hand access to bank staff and records is necessary to obtain the fullest responses and details. Due to the security situation in Baghdad and surrounding areas, advisors were not able to travel to head offices or branches as often as desired, which placed restrictions on timing and length of meetings and ability to gather report data.

Five advisors were engaged to conduct the Assessment, each with experience in the major banking areas of responsibility. Each advisor conducted in-depth investigation of those their respective areas for each of the six State-owned banks according to the terms of reference outlined below:

Accounting and Reporting Advisor ƒ Select and train a task force of nationals to assist in implementing Assessment tasks. ƒ Conduct detailed review of accounting department and functions of State-owned banks. ƒ Determine, to the extent possible, the reasonableness, accuracy and reliability of accounts. ƒ Prepare financial statements for December 31, 2004, conforming with IAS where possible. ƒ Assess financial viability of banks.

Credit Management Advisor ƒ Select and train a task force of nationals to assist in implementing Assessment tasks. ƒ Review organization of credit department in each bank. ƒ Estimate level of competency of the staff of the credit departments. ƒ Assess credit policies and procedures presently in effect in each bank. ƒ Review loan portfolios to determine the present status of the loans and action to be taken. ƒ Undertake a “classification” of portfolios to determine “current” status of loans.

Loan Recovery and Bad Debt Resolution Advisor ƒ Select and train a task force of nationals to assist in implementing Assessment tasks.

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ƒ Establish loan classification criteria, review loan portfolios, and classify all problem loans. ƒ Segregate problem loans and remove them from bank for eventual separate follow up and resolution. ƒ Compile relevant information on problem loans (name, balance, collateral, estimated recovery, etc.). ƒ Feed other assessment areas with information as required to complete their assessments. ƒ Supervise establishment and management of Remedial Asset Unit (repository of all bad debts). ƒ Constitute work out committees and set parameters for collections and/or write offs. ƒ Identify viable banks and close-down candidate banks.

International Accounts and Debt Reconciliation Advisor ƒ Ascertain State-owned banks’ total correspondent bank account balances confiscated. ƒ Work with MoF and US Treasury advisors to link balances to DFI and OFAC records and assist in reconciliation. ƒ Identify and list unpaid Letters of Credit balances booked as loans and L/C deposits. ƒ Identify total foreign bank and commercial claimants and amounts due. ƒ Coordinate with Ernst & Young on the reconciliation of these banks’ accounts obligations and letters of credit and correspondent bank accounts and balances. ƒ Determine impact of reconciliation of external debt (Paris Club, non-Paris Club, and Commercial Claimants) on the State owned banking sector.

Bank Operations, Automation, and Human Resource Advisor ƒ Select and train a task force of nationals to assist in implementing Assessment tasks. ƒ Determine if the banks have a centralized database. ƒ Assess the banks’ capability to perform central processing. ƒ Determine the capability of the banks having a Transaction History file. ƒ Analyze and assist Rafidain to conclude current RFP process and three final bidders. ƒ Review the head office operations and staffing levels. ƒ Review the branch office operations and staffing levels. ƒ Obtain and analyze branch transactional activity to determine if staffing levels are appropriate. ƒ Review Branch security procedures. ƒ Select and train a task force of nationals to assist in implementing Assessment tasks. ƒ Review existing personnel and staffing policies, including job descriptions, and organization charts. ƒ Assess numbers of staff per department and ascertain optimal number needed. ƒ Review compensation policies and salary scales and benefits. ƒ Assess existing retirement and pension programs with view toward large scale RIF program. ƒ Review banks’ organization charts.

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BACKGROUND ______

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3 BACKGROUND

Iraq’s six State-owned banks have suffered twenty-five years of deterioration stemming from continuous government pressure, interference, directed lending to support a dictatorial and war torn economy, and some thirteen years of economic sanctions, leaving the banks vastly overstaffed, under trained, undeveloped, and undercapitalized.

In general, the six State-owned banks are in poor physical condition and require substantial rehabilitation of their facilities. During the recent conflict and its aftermath, the banks were subjected to severe damage and looting; a significant number of bank branches and, in a few cases, headquarters buildings, were destroyed and remain closed. In addition, many bank files and records were lost, and essential communications and information systems were destroyed. Several of the banks have worked hard to reconstruct and renovate branches, and all but a few are once again open and operating. All banks’ branches located in the Northern governorates, cut off since the Gulf War days, are still operating separately with no communications with Baghdad head offices and without being consolidated into the global financial statements. This includes 10 branches of Rafidain, 12 branches of Rasheed, 3 of Real Estate, and 3 of the Agricultural Bank. A breakdown of all bank branches is shown in Annex A, Rafidain Bank Financial Condition and Viability, Exhibit X.

Funds distribution and a transfer network remain completely manual and cash-based. The communication and transfer of data between bank branches and headquarters is inadequate and will require major investment in information technology. All banking functions, transactions, and reporting continue to be performed manually, and accounting procedures are weak in all six banks.

Iraq’s State-owned banks offer a very limited product range. They primarily serve the Government ministries and State-owned enterprises and act as salary and pension payments offices for State and military employees. This is a very labor intensive, manual, and inefficient system. Additionally, the State banks offer the general public current and limited checking accounts, savings and time deposits, overdraft and bills discounted facilities, as well as short-term loans and advances. ATM services, credit cards, wire transfers, online services, drive-in facilities and other customary retail products and services are not available.

Of particular concern for these banks are the unresolved issues of attachment risk, contingent and foreign liabilities, currency revaluation losses, and non-performing loans resulting from an extended period of Government-directed lending, repayment of which has been prevented by sanctions.

The six State-owned banks account for approximately 90 percent of banking system assets and about the same share of banking system deposits. Iraq has two large commercial State-owned banks, Rafidain Bank and Rasheed Bank, that together account for about USD 6.5 billion in assets, or about 86 percent of the total assets in the banking system. These two banks maintain about 310 domestic branches, of which about 286 branches are currently open (as of November 2005). Together, the two banks have more than 2.8 million deposit accounts and 13,000 employees.

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ASSESSMENT

RAFIDAIN BANK ______

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4 ASSESSMENT

4.1 RAFIDAIN BANK

4.1.1 EXECUTIVE SUMMARY – RAFIDAIN BANK

Rafidain Bank is the largest and oldest of the State-owned banks, having been formed in 1941 and employing over 6,500 people in its head office, with 142 branches in Iraq, and 8 branches abroad, and with an estimated annual payroll of 20.6 billion Iraqi Dinars (approximately USD 14 million). The Bank services approximately 2 million accounts. Operationally, accounting and processing procedures are weak. The vast overstaffing and the low daily transaction volumes, and the Bank- wide manual accounting and reporting system, result in a very low transaction/staff ratio and inefficient services.

The Bank currently uses a locally made and outdated banking application, with very limited functionality and low performance and with no connectivity between the head office and the branches. The Bank has developed a simple in-house standalone transaction-booking application that supports current and savings accounts activities, in addition to a simple human resources application. Rafidain Bank issued an RFP (Request for Proposal) in 2004 in preparation for bank automation. Furthermore, there is a commitment by the MoF for approximately USD 10 million to purchase software and hardware. The lack of automation and telecommunications however continues to hamper modernization.

The Bank’s financial condition is weak. Year-end 2004 financial statements reveal negative performance due to high levels of non-performing assets from the prior regime, coupled with the financial impact of economic sanctions and war. Management’s failure to revalue most of its foreign currency asset accounts from the old IQD/USD rate of 0.312 at the end of 2003 has now impacted the 2004 statements. In addition, loans require a major adjustment to create additional allowances for loan losses (especially for pre-war loans). Major write offs of looted cash and destroyed premises have not been recognized and are still maintained on the Bank’s books in anticipation of Government compensation

After restating the 2004 accounts, the following is noted:

ƒ Based on the restatement of the Bank’s 2004 Consolidated Statement of Condition, adjusted total capital and retained earnings is negative 66.4 trillion IQD [USD 45.5 billion]. This reflects balance sheet liabilities of 72.1 trillion IQD and assets of 5.7 trillion. According to these findings, the Bank is insolvent. ƒ The Bank’s earning base does not provide for adequate income generation. The bank has historically held significant levels of cash and foreign currency (year-end 2004 figures totaling IQD 1.7 trillion, or USD 1.2 billion), significant levels of correspondent banking deposits, with lesser levels of Iraqi T-bills and investments. The unusually large proportion of non-earning assets, 79percent, has seriously impacted the Bank’s earning potential. ƒ Additionally, as presented in Exhibit XI only 13 branches out of 146, or 8.9 percent, have direct net income, totaling IQD 29,651,301,000. The remaining 133 branches have a net loss of IQD (38,985,907,000), which results in an overall loss of IQD (9,604,607,000) for the entire branch network. The direct expenses of the 133 branches with losses are IQD 55,008,625,248. ƒ Exhibit XI also provides the details of domestic branch deposits by individual branch, and states the average deposits based on the number of employees per branch, and by total for the entire branch network, and by total number of Bank employees. Total deposits for branches with deposits ranges of IQD 25-49 billion, and 1-10 billion are IQD 1,088,144,765,000, and total employees in these categories are 3,102, which represent 17.4% of total Bank deposits and 58.8% of the total number of branch employees. ƒ The Bank’s local liabilities consist of private sector deposits of IQD 4 trillion (USD 2.8 billion), and of Government related deposits of IQD 4.2 trillion (USD 2.9 billion). Foreign liabilities on the Bank’s books under Past Due Long-term Debt, Past Due Interest Payable,

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Pending Litigation, and huge Off Balance Sheet (OBS) liabilities totaling USD 44 billion need to be investigated and included in adjustments. ƒ The Bank’s operational systems lack proper internal controls, and have weak, outdated policies and procedures, coupled with a senior management team that has survived the prior dictatorial environment. These current leaders within each Bank are not motivated to take initiative or to change. In addition, a vast pool of middle and junior management who have had no training or exposure to modern banking or management techniques also lack motivation, and are double the number of staff needed to run a bank of this institution’s size.

Detailed analyses and financial statements can be reviewed in the separate report, Rafidain Bank Financial Condition and Viability, attached hereto as Annex A.

The June 2005 half-yearly accounts reveal some improvement, following a year of recovery in 2004 and a return to more normal activities. Income improvement was due primarily to increased income from higher yielding T-Bills and from CBI’s newly instituted overnight facility where substantial investments of previously idle cash (especially USD 900 million of dollar notes in the vault) were placed at interest. However, the impact of this marginal increase in earnings does not contribute to any improvement in the Bank’s overall financial condition.

A review of the Credit Department of Rafidain Bank shows the present organization and functions improving during the past twelve months but still does not meet international standards. Though credit initiation and documentation are fair, the process of credit analysis, approvals, and risk rating (a new concept to the Bank) are still weak. Lending is based strictly on collateral and not on creditworthiness or cash flow, save for a few exceptional cases of very large industrial loans where, additionally, a business plan is required. Risk management is perfunctory and ineffective. Specific training and a change in credit culture are required Bank-wide.

Bad and Doubtful Debts resulting primarily from the past decades of strife and sanctions, but also from poor credit policies, have left an inordinate number of past due and uncollectable loans (over 7,700 accounts) on the books of the Bank. The follow up, collection, administration, and prosecution efforts of the Bank’s delinquent borrowers, including Government entities, are informal and inefficient. There are no written procedures and only inadequate documentation of actions taken. This represents a difficult and potentially costly area for future correction by the Bank.

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4.1.2 ASSESSMENT OF RAFIDAIN BANK

4.1.2.1 Accounting and Reporting – Financial Condition

Assets

Cash and Banks As at year-end 2004, the Bank held the equivalent of USD 1.2 billion in the vaults and held operating, clearing and deposit balances in banks totaling IQD 2.8 trillion (USD 1.9 billion), of which IQD 2.5 trillion (USD 1.7 billion) was non-interest bearing accounts with CBI. In addition, none of the unusually large cash and foreign currency note balances was invested at that time, creating an enormous non-earning asset portion of assets. This situation finally changed after March 2005 when the CBI offered an overnight facility to banks at 3 percent and allowed the T-Bill rate to rise to as much as 10 percent, thus improving the Bank’s income stream during the current year, as illustrated in following paragraph.

Investments During 2004, nearly 80 percent of the Bank’s total Investments, IQD 708 billion (USD 485 million) was placed in CBI 90-day T-bills at an average of 3 percent. This primary earning asset of the Bank was significantly below the prevailing loan rates. Balance of investments is recorded as local and foreign investment. Financial Investments increased substantially in 2005 when the Bank shifted nearly all of its surplus cash and foreign notes to the Central Bank for placement in Overnight and T- Bills and as of June 30, 2005 financial investments (per CBI books) appeared as follows:

12-31-04 06-30-05 06-30-05 06-30-05 T-Bill T-Bill Overnight IQD Overnight USD

IQD 571 billion IQD 871 billion IQD 1.0 trillion USD 400 million

Loans The Bank shows gross loans at year-end 2004 in the amount of IQD 485 billion (USD 332 million) with Allowances for Loan Losses of IQD 50 billion (USD 34 million) giving a net loan balance of IQD 435 billion (USD 298 million). However, after reclassifications and write offs, gross loans would actually amount to IQD 229 billion. Additionally, not reported in the above loan totals are Employee Loan outstandings of IQD 9 billion, which brings total outstandings up to IQD 445 billion. A large amount of outstandings in the Discounted Bills Facilities totaling IQD 147 billion is actually checks and drafts purchased (mostly personal checks) pending payment by drawee banks. These should be removed and recategorized as Bills Under Collection or Other Assets.

In 1988, the Bank borrowed a dollar denominated loan for USD 90,578,299 from the Gulf International Bank (GIB) and then on-lent the funds to the Iraq Government sector. Interest has occasionally been paid to GIB and paid by the Government sector when billed. Accrued Interest Receivable amounts to USD 40.3 million (IQD 58.8 billion), and neither interest receivable nor interest payable has been reflected in the Bank’s past financial statements. This illustrates the lack of consistency and integrity of data in the Bank’s accounting process.

In 1989, the Bank granted a loan (recorded as a private investment) to UBAF in Paris for USD 10,168,724 with two equal payments of USD 5,084,382.00 to be paid on June 2, 2003, and on June 4, 2004. Interest of LIBOR + 1 percent, was to be paid every six months but the last interest paid was on June 5, 1990. One comment by Bank staff stated that this was actually two loans for USD 8,172,742.00 and USD 1,996,022 for a total USD 10,168,764. No additional data was provided to clarify this comment. Rafidain Bank is a shareholder in UBAC Curacao N V, which owns 100 percent of UBAC Nederland B.V., which in turn owns 25.40 percent of the stock of UBAF. According to Bank staff, “From 6/5/1990 till 12/4/2000, USD 7,575,867.42 of interest matured. This amount was confirmed by the UBAF itself and it was booked in Suspense Account in its ledgers but never listed in our account”. In June 2003 UBAF requested to extend the maturity date of the loan for

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another four years, with installment payments to be made on June 4, 2007 and on June 4, 2008. Rafidain Bank granted the request. The Bank has not accrued interest receivable for this loan since 1990. It is unclear why a bank (UBAF) would put accrued interest payable, due to another bank, in a suspense account.

The Bank has not accrued interest receivable for this loan since 1990. In fact, at the time of the above-mentioned renewal of the loan, interest earned but not collected by Rafidain Bank for the period of June 15, 1990 – December 4, 2000, amounted to $7,575,867.42. This amount was added to the existing principal, thus capitalizing the interest, and the new loan amount was $17,744,631.42. At our request, the additional interest due the Bank as of December 31, 2004 was calculated by Bank staff and amounts to $2,434,967.28 due the Bank. At the time the loan the was renewed and the interest added to the loan, the Bank did not record the increase in the loan amount, and the International Division trial balance still depicts the original loan amount.

Loan Charge-offs and Reserves for Loan Losses Rafidain Bank, in 2004, charged-off as cancelled debt, IQD 47.3 billion, of which IQD 36.5 billion represented wedding loans or advances. Only IQD 10.3 billion of other loans were charged-off. The Bank did not record any recoveries of previously charged-off loans to account 4833, Recoveries of Written-off Loans. The foreign branch reserves of IQD 28.5 billion represents 57 percent of the total Bank loan loss reserves. Based on the total foreign branches’ gross loans of IQD 72.2 billion, the Abu Dhabi foreign branch loan reserves are 39.4 percent of this total. Using IQD 85 billion as the desired amount of Loan Loss Reserves, and deducting existing reserves of approximately IQD 50 billion, another IQD 35 billion was added to the reserves and this amount deducted from retained earnings. (For details and calculations of these amounts, please see Annex A, Rafidain Bank Financial Condition and Viability, pages 9-10)

Other Assets This account conceals enormous accounting and foreign currency translation problems. Revaluations, rather than being booked to retained earnings, have been held in this account (and Other Liabilities), thus not really adjusting the Bank’s books for revaluation gains or losses. The Bank awaits official word from the Government, again anticipating compensation from the MoF. Additionally, items such as unreconciled interbranch transactions and bills (checks) purchased – unpaid (on collection) artificially inflate both sides of the Bank’s balance sheet. Immediate action needs to be taken to net out or adjust these accounts to reflect the Bank’s assets more realistically.

Fixed Assets The Bank shows net value of fixed assets at IQD 25 billion (USD 17 million). This item may be undervalued in view of recent and future rising real estate values and strengthening Dinar. In general however, except for the head office, most premises are in only fair or poor condition and will require massive repairs, rehabilitation, and modernization.

Liabilities

Deposits The Bank’s profile of deposits breaks down into IQD 8.5 trillion (USD 5.6 billion) in local currency deposits of which IQD 2.4 trillion (USD 1.6 billion) is in foreign currency. Private Sector and Other local currency deposits comprise IQD 4.1 trillion, or 48.5 percent of total deposit liabilities, while Government-related deposits total IQD 4.2 trillion, or 49 percent of total deposits. This profile presents two concerns: one, if the Government should withdraw all of its deposits into a single treasury account at CBI this would deplete IQD 4 trillion of the Bank’s IQD 5.2 trillion in cash, banks, and liquid investments. Should there be in the future any cause to repay deposit holders (IQD 4 trillion) the Bank would not have sufficient resources to repay depositors; second, if dollar deposit holders (or the Government) demanded repayment of dollar deposits in dollars, the Bank would have to come up with USD 1.6 billion in foreign currency. This represents an enormous and risky oversold position in dollars. Although the Bank may have large dollar investments in the overnight facility under the foregoing scenario, these would per force be liquidated to pay off the Government.

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Foreign Debts The foreign obligations of the Bank constitute a serious threat to the survival of the Bank. After adjustments and considering all potential claims the total foreign debts could, before Paris Club reduction amount to the following:

Past due debt, Interest payable, and other liabilities USD 44 billion Claims collected / reported by Ernst &Young under Paris Club 1 USD 21 billion Registered, pending litigation against the Bank USD 17 billion

It is not clear at this point how much of this debt will be included in and reduced by Paris Club, but the amounts do not reconcile with the Bank’s books and in any case will represent a major deduction from capital. For detailed analysis, please refer to Annex A, Rafidain Bank Financial Condition and Viability, pages 4-8. Additionally, Annex E, Rafidain Bank Total Foreign Debt, summarizes the foreign claims against the Bank (USD 21 billion) assembled by Ernst & Young up through September 2005.

Other Liabilities This account has, like its contra, Other Assets, been a catch all for items of doubt, deferral, and diversion. As mentioned, foreign currency revaluations and unreconciled interbranch accounts need to be untangled, resolved, and passed to appropriate accounts, ultimately to profit and loss. These represent potentially large write offs.

Earnings

Income reported over the years has been inaccurate and overstated as a result of not providing for adequate provisions for loan losses, of the limiting amount of loans written-off, of not recording all accrued income and expense, and of not recognizing losses for various assets such as confiscated or blocked accounts. Exhibit III Consolidated Statement of Income and Exhibit VI Comparative Consolidated Income Statements in Annex A provide the details of the Bank’s recent losses. Understandably, the year 2003 was extraordinary, and throughout 2004 the Bank continued to experience difficulties. The mentioned, Exhibits were based on revalued data for the years 2003 and 2004. The Bank did not revalue foreign currency monetary assets or liabilities for 2002.

A summary of the major income and expense categories, after adjustments, is as follows:

(IQD 000s) 2002 2003 2004

Interest Income 10,542,348 12 174,253 13,635,709

Investment Income 53,423,651 67,027,998 37,349,259

Total Interest Income 63,965,999 79,202,251 50,983,968

Less Interest Expense (29,407,833) (35,740,602) (38,037,963)

Non interest Revenue 6,656,555 3,135,127 18,651,929

Total Operating Income 36,064,388 36,596,776 31,597,934

Less Gen. & Admin. Expenses (11,800,982) (19,902,372) (36,823,023)

Net Income (loss) 24,263,406 16,694,404 (5,085,089)

Detailed explanations are provided in Annex A, Rafidain Bank Financial Condition and Viability.

Additionally, as presented in Annex A Exhibit XI only 13 branches out of 144, or 8.9 percent, have direct net income, totaling IQD 29,651,301,000. The remaining 133 branches have a net loss of IQD

1 In 2004 Ernst & Young were engaged by the Minister of Finance to issue a global RFI inviting all holders of Iraqi debt to submit documented claims to Ernst & Young for review and record matching, and for submission to MoF for acceptance of the debts by GOI. The final claims cut off date was April 15, 2005 and Ernst &Young have collated the total foreign debt collected and are preparing a final report for the Paris Club.

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(38,985,907,000), which results in an overall loss of IQD (9,604,607,000) for the entire branch network. The direct expenses of the 133 branches with losses are IQD 55,008,625,248.

Exhibit XI also provides the details of domestic branch deposits by individual branch, and states the average deposits based on the number of employees per branch, and by total for the entire branch network, and by total number of Bank employees. Total deposits of 140 branches were IQD 6.26 trillion and number of employees totaled 5,274, demonstrating a very inefficient deposit to employee ratio. (see Annex A Exhibit XI)

Capital

The Bank’s net worth is under serious threat of being completely consumed, throwing the Bank into an irrevocable negative position. Taking all potential losses and write offs into a restated pro forma Capital, the new position becomes equivalent to a negative USD 45 billion. Even though the Bank has improved income during the nine months of 2005, the potential negative adjustments still overwhelm any positive effect this may bring. Many unresolved and unidentified potential loss items remain in the Bank’s accounts that, once resolved, will have heavy impact on Capital. For instance:

Confiscated Correspondent Bank Accounts: The unknown portion of USD 1 billion confiscated and remitted to OFAC in 1990s, plus USD 484 million taken in 2003 are still recorded as balances with correspondent banks on the Bank’s books – unreconciled and not written off.

Off Balance Sheet (OBS) Items: During the course of the Assessment, Bank staff provided several different versions of OBS, with totals initially of IQD 11.5 trillion, including the foreign branch offices amount, which was the amount reported in the Annual Report to the Minster of Finance. After the validity of this amount was questioned, several additional versions were presented, ranging from IQD 15-27 trillion. Advisors have been working to obtain accurate data in this area since the last week of June 2005. Finally, an OBS total adjustment of IQD 45.3 trillion was reached.

1. Accounts 1922/2922 represent the Client’s/Bank’s Obligations under Foreign Letters of Guarantee (LOG) and were initially listed as IQD 5.2 billion, based upon the old Dinar rate of USD 3.21. The new, revalued amount, including a small portion from the foreign branches, amounted to IQD 24.3 trillion.

2. Confusion exists within the Bank as to which Division should account for certain OBS items. It appears it is the branches’ responsibility, but they do not properly account for these items, and neither the International nor Financial Divisions review this area. It appears that letters of credit (LOCs) were not revalued or included in the Bank’s consolidated financial statements. These LOCs are categorized as: a) public sector, amounting to IQD 9.3 trillion and b) private sector, amounting to IQD 626 billion, totaling IQD 9.9 trillion.

Adjusting these two OBS items onto the balance sheet as direct liabilities adds IQD 34.2 trillion (USD 23.4 billion).

Nearly 33,000 letters of credit items, opened and unpaid, are outstanding from 1981.

Financial Viability

It is clear from the findings and from the foregoing that the Bank is technically insolvent and would be illiquid if all depositors were to withdraw their funds. The Bank cannot, or is reluctant to, adopt International Accounting Standards and publish its report, as this would disclose insolvency and could create serious and widespread concern and possible loss of faith in the Bank and the Government. Survival of the Bank is dependent upon the Government’s immediate assumption of all foreign debt, amounting to IQD 64.4 trillion (USD 44 billion) plus any additional foreign debt interest expense, and for continued provision of non-interest bearing funds to Rafidain Bank.

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4.1.2.2 Credit Management and Policies

Credit Department Organization Overview

The credit function of Rafidain Bank, under the supervision of a very experienced senior manager, comprises some 100 employees working at the head-office. The department is divided into five units as described in the next section. Each unit is in a separate office. Most of the department employees are women, except for a few men in the Investigation Section, part of the Credit Information Unit. It is these men who go into the market and check on the clients and develop “financial estimations”.

The facilities sections are in charge of short-term loans – overdrafts and discounted commercial paper, while the loans unit deals mostly with long-term domestic loans. International loans are processed within the International Department, which causes a separation of portfolio control, leaving reporting incomplete and risk management diluted. A summary of loan and facilities outstandings may be seen in Annex F, Rafidain Bank Loans and Facilities.

Branches are in charge of the global relationship with the clients. Loans are originated in the branches. They are analyzed and assessed, documentation is gathered and then the files are sent to the Credit Department for checking, processing and submission to the Credit Committee. The Credit Department relies on other entities: the credit information unit for all questions pertaining to the loans administrative and legal documentation, and an outside consultant, when necessary, for collateral assessment.

When a loan request has been completed and all documentation requirements satisfied, it is sent to the Credit Committee for approval.

The entire lending process is done manually. There are now, as of November 2005, three computers available to the Credit Department, one of which is dedicated to inputting risk rating data.

Credit Department Units

Domestic Loans This section, under the supervision of an experienced manager, deals exclusively with domestic loans. The tenor of the loans is short-term up to one year, medium-term from two to five years, and long- term for loans above five years. The bank’s policies provide for a minimum or a maximum amount. Presently, the largest loans are for USD 250,000 (two loans only). Twelve employees, including the head of the unit, work in this section. The unit is divided into four groups. Each group reviews the loans originated in branches throughout Iraq.

During the Assessment it was learned that two unusually large loans were approved in amounts of USD 100 million for rehabilitation of Ministry of Industry and Metals and USD 4.5 million for the Medical Equipment Manufacturing Company as requested by the Ministry of Industry and Metals. Details of loan terms are not yet known, and final agreements have not yet been signed. Additionally, a loan of USD 7 million was granted to the Ministry of Foreign Affairs for the Iraq Embassy in Beirut.

Facilities within Baghdad Facilities within Baghdad deal exclusively with short-term credits, such as overdraft and discounted bills, originating from the 49 branches located in Baghdad. This unit has 23 employees, including the Head of the unit. There is a group of eleven persons dealing with specific branches, and the remaining staff members serve as administrative support and back up. There are two levels of authority to certify the conformity of the documentation. Two persons have B authority and one person an A authority.

Facilities outside Baghdad Facilities outside Baghdad deal with short-term credits originating from branches located outside Baghdad. This unit has 26 employees, including the head of the section. The section is divided into

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two groups covering the South and the North of the country. Each group comprises 13 persons and takes care of 56 branches. There are three persons with authority level B and one with level A.

Advances to Employees This unit monitors advances to Bank’s employees. It has five employees plus the head of the section. There are two groups, one for files originating from the branches in Baghdad with two employees, and one for files originating outside Baghdad with one employee.

Credit Information Department This unit comprises 25 employees, including the head of the section. A group of five men, including four experts and one supervisor, is in charge of all investigations, which need to be undertaken outside the Bank, all over Iraq. They always work in pairs, to enhance the accuracy of information gathered. Each expert has a college degree, together with experience in commerce, accounting, or real estate. A second group of nine checks the guarantees and the financial strength of the guarantors. Another group of nine deals exclusively with the branches. The remaining staff members process and maintain microfilms for the Credit Department files.

Domestic Loans

Products Until the fall of 2003, all loans were made in Iraqi Dinars, and were extended to a range of industries, services and agriculture. Terms were up to one year (short-term), two to five years (medium-term) and more than five years (long-term) with a maximum of ten years. Interest charged was fixed at 14%. It now varies from 13% to 15%.

Since September 2003, clients have been granted loans in USD, called “stable deals.” Terms are usually for one to three years, depending on the nature of the client’s business. Usually, traders will be granted a one-year loan, and industries, loans for two years. Interest for these loans currently ranges between 9% and 10%. In addition, an administration fee of 1% is charged. Most new loans range from USD 10,000 to 150,000, though there is no specific limit.

Repayment of interest is made quarterly. Principal is repaid in two or three installments, starting six months from loan issuance.

These loans are more attractive to borrowers because of the lower rates. Loans are funded, granted and repaid in USD. In turn, clients deal mostly in USD, thus avoiding FX risk.

Most requests come from Individuals, rather than from companies, though the funds are always for businesses purposes.

Process At Branch Level: Domestic loans originate in the branches. The branch manager and his staff are responsible for all aspects of the business relationship with clients. For credit, all requests, documents, certificates, ID’s, deeds, leases and other information are collected at the branch level. The branch manager discusses with potential borrowers their needs and requests. For loans, the branch credit section receives and handles the request (Annex G, Rafidain Bank Lending Authorities).

The customer fills a special Loan Request form, creating a file. Many legal, administrative and commercial documents are required, but little financial information is provided. In some cases such as industrial, agricultural and real estate projects, a business plan established by an external business consultant may be provided. The most important information still pertains to collateral, though in recent months, following some training and guidance from advisors, the staff has been trying to gather more detailed financial information and projections. Collateral is considered essential, and effectively the primary source of repayment. The value of collateral can be as much as four times the amount of the loan, in large part because, in general, collateral, such as real estate, is not insured. The Bank wants to make sure that in case of damage to structures, the value of the land is sufficient to repay the

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loan. The Credit Committee consists of five members: the manager, the chief accountant, one engineer, one outside expert, and a representative of the land registry office to assess collateral value.

The branch manager assesses the loan request based on his knowledge of the borrower, his business, the borrower’s character and the value of the collateral. An investigation of the borrower is completed to verify and cross- check the information provided. Once satisfied, the branch manager transmits the file to the Head of Domestic Loan Unit of the head-office with his recommendation for approval, usually cutting arbitrarily the amount requested by the borrower, which is often inflated in anticipation of that cut. The file is sent forward with original documents, with the branch keeping copies.

The Credit Committee advises the originating branch of the approval, and the branch then contacts the treasury department to request funds.

At Head Office Level: The Head of the Credit Department receives the file, with the recommendation of the Branch manager. The file is given to the Domestic Loan unit for complete review.

The task of the unit consists of reviewing the file and checking that all policies and procedures have been followed. The review focuses on three elements:

ƒ Supply of proper documentation ƒ Assessment of client financial situation ƒ Appraisal and registration of collateral

The employee in charge of the region where the loan originates performs the following tasks:

ƒ Complete review of the file ƒ Checks the accuracy of the documents ƒ Checks legitimacy of the request ƒ Checks that the collateral has been appraised and registered ƒ Reviews the financial documents and business plan, if any ƒ Checks all official certifications ƒ Prepares the recommendation for the Credit Committee

After the review, the unit has two options:

ƒ If the file is complete and the information deemed accurate, it goes to the head of the Credit Department for final review and presentation to the Credit Committee. The recommendation is based on the information provided, the knowledge of the client and experience with the business.

ƒ If the file or the information is not satisfactory, further information may be requested from the branch, or the Unit Head may ask the Information Section to make additional enquiries.

The domestic loan unit does not have the authority to turn down a loan request. A loan request takes two to three weeks to be processed, from the time the client presents it to the branch to the time the Credit Committee approves it.

Facilities

Products Facilities cover all types of short-term lending such as overdrafts, discounted bills and domestic L/Cs. They are usually secured by collateral with a maximum loan to value ratio of 50%. Facilities to Individuals are granted in Iraqi Dinars and are small, generally IQD 4 millions or less. There is no maximum for individual facilities, but each branch has a global limit.

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ƒ Overdrafts have no maturity and no clean-up period. They can rollover forever, with an interest rate of 13%. ƒ Discounted bills have a six months term, with a discount rate of 13%. Rafidain purchases the bills with recourse against the seller in case the debtor defaults at maturity. ƒ For facilities backed by a blocked account in another branch, the interest is 13%, plus a 1,500 IRD fee for administration and phone calls. ƒ Currently, only domestic L/Cs can be opened by the branch (since imposition of sanctions there is no access to international accounts). ƒ In the past International L/C’s were opened by the International Department, which assessed and approved the facility independently. Thus, facilities for the same client could be approved and booked in two separate units, and total exposure not recorded in the Credit Department. This is a weakness in risk management. ƒ Inventory financing with collateral on goods.

Few new facilities have been granted in the recent past, and the tendency is to replace facilities by loans with fixed maturities, thereby expanding the potential gap between long-term assets and short- term sources/liabilities.

Process At Branch Level: The analysis and approval process for Facilities follows the same steps as for Loan requests, with only slight differences in the credit application forms. As facilities are usually for less than one year and inherently less risky, branch managers are given slightly higher credit authority (see Annex G, Rafidain Bank Lending Authorities).

At Head Office Level: Facilities are processed at the head-office in a manner very similar to the process for Domestic Loans. The main difference resides in the different levels of lending authority delegated to the senior officers of the Bank and the documents processed, as outlined in Annex G. As already mentioned, very few new facilities have been granted recently, only two to three per month.

Some 90% of facilities are delinquent and have been transferred to the Settlement Department. Fifty percent of the clients are insolvent, but it is likely that many simply take advantage of this difficult period not to repay their obligations.

All requests originating in the branches have to be sent to the head-office, even if the amount is within the lending authority of the Branch Manager. Here, the review focuses on collateral registration, documentation, certifications and the business.

When the file has been reviewed, an authorization to lend will be sent to the Branch Manager if the amount requested falls within his delegation. If the amount is above his delegation, the request will be sent to a higher authority. There are six levels of authority. Above these delegations, the approval of the Credit Committee is required.

During the past difficult and risk-filled years, low approval limits have been an advantage (albeit incidental) since risks were greater during this time, the lower limit prevented more and larger loans being extended – but not purposefully reduced or delegated by management as a precaution. In normal conditions, however, such low limits, lack of trained credit analysts, and a complex approval process, with six approval levels, will hamper development. The extra levels and reviews add no additional expertise or security to risk management.

Advances to Employees

Products Personal Advances are exclusively granted to the employees of the Bank. The advances do not need to have any specific purpose. They are merely cash advances to cover employees’ cash needs. Advances have a maximum term of three years. The amounts allowed are as follows.

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If the employee has been with the Bank for:

ƒ 5 to10 years: 500,000 IQD ƒ 10 to15 years: 750,000 IQD ƒ 15 and up: 1,000,000 IQD

Employees who are over 63 years of age cannot receive an advance. Recently, most personal advances were granted for computer acquisitions, under a scheme devised by the Bank. Instead of cash, the employees were given a check to be redeemed for a computer in specialized shops.

Repayment is effected bi-monthly, either in cash or through direct deduction from wages. There is no general policy on this issue. When an employee leaves the Bank he must repay the loan, although the source of that repayment may be uncertain.

Process Personal loans can be granted at either the level of the branch or the Head Office.

Employees of branches fill a request form that is approved by the Branch Manager and paid by the branch cashier. Employees of the head office fill the form and submit it to the Head of their department. Once approved, they cash the advance at the main branch or another designated location. In order to get an advance, the employee must provide:

ƒ Identification Card ƒ ID from Oil for Food program ƒ Housing Card ƒ A Personal Guarantee from a third party

Advances are granted without collateral. Employees merely assign their salary to the Bank. Each file containing the documents is sent by the branches or the various departments of the head office to the Personal Advances Section for control, follow-up and monitoring of the repayments. The section also discusses potential payments problems. Both Operations and Credit Advisors recommended that this section be disconnected from the Credit Department and attached to the Human Resources Department. However, no action on this has been taken by the Bank to date.

Credit Information Unit

This unit is in charge of performing investigations of borrowers on behalf of the facilities units of the Credit Department. Occasionally, it may also intervene at the request of the Domestic Loan Section. Its territory covers only Baghdad and the surrounding towns. The regional delegates cover the rest of Iraq (North, Central and South). This unit appears to be well organized and diligent in its duties and credit checking is considered in the approval process.

The task of the employees is to review the Form (C5) provided by the branch, for facilities that exceed the branch lending delegations. They investigate the borrowers and the guarantors, their character, assets and financial strength. They focus on the following issues:

ƒ Verification of identity ƒ Financial information, balance sheet, income statement ƒ Inventory ƒ Fixed assets ƒ Cross check value of real estate ƒ Check commercial invoices ƒ Check the books

At the present time, the unit in charge of outside calls is on the road two to five times a month and spends one to five days for each borrower. An annual review is completed for clients with no

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collateral, every three years for facilities with guarantors, and every five years for facilities collateralized by real estate.

The sedentary staff members deal mainly with the guarantees and the guarantors. They check the validity of the guarantee, the credit worthiness, the balance sheet and income statement, the status, and ID of the guarantors. They ask the Central Bank and other local banks if they have other commitments. They also solicit the Chamber of Commerce to find if it has financial information on the subject.

A guarantor cannot commit over 50% of total assets, on a consolidated basis.

The Information Unit also acts as a Microfilm Center for the Credit Department. Many records were lost during the war, but most of the information has been reconstructed thanks to hard copies and duplicate microfilms.

Credit Portfolio

The total performing short-term and long-term loans and facilities (open lines of credit) portfolio amounts, as of August 31, 2005, to IQD 144,473,849,354 (USD 99 million), out of which IQD 30,283,794,196 (USD 20.7 million) is for loans and IQD 114,190,055,158 (USD 78.2 million) for facilities. These amounts do not include advances to employees, which represent some IQD 7.8 billion (USD 5.3 million), or loans extended by the International Department (see Annex F, Rafidain Bank Loans and Facilities).

The quality of the portfolio had deteriorated since 2003, due to the political situation. Many people either could not repay their debt or took advantage of the situation to avoid payments. According to the management, the loans granted after the war show a better quality, i.e. better and regular repayments, fewer delinquencies, and fewer problems. This has yet to be verified. In general, Iraqis are honoring their post-war obligations, while using the war/Government as justification not to repay pre-war loans that they claim destroyed businesses and cash flow sources.

During the last few months, the Bank has taken little action to recover past-due loans. Non- performing loans are taken care of by the Legal Department.

According to our information, non-performing loans and facilities to private companies and individuals represent IQD 27 billion. These loans are secured by real estate. The Bank expects to recover all the funds lent when the political situation normalizes. In reality, this amount is much bigger, as facilities to Government Sector, IQD 67 billion, are all past due and interest is capitalized.

Recently Rafidain Bank granted an IQD 100 billion line of credit to the Central Bank of Iraq, which will be used to provide housing and real estate loans to the employees of the CBI. This line is for four years and bears a 5% rate of interest and is managed by the Rafidain’s Main Branch. As these amounts have only been granted and disbursed since September 2005, they were not included in the Assessment data gathered earlier and therefore do not appear in tables presented herein.

Credit Approval Authority

The Head of the Credit Department and/or Heads of the Loan and Facilities Units present credit requests to the Credit Committee or other higher approval authorities.

Domestic Loans go to the Credit Committee, with the exception of loans in IQD up to 10,000,000, for which delegation has been given to the Head of the Loan Section, and up to 15,000,000 to the Head of the Credit Department. In addition, a recent decision of the Board has given the branch managers authority to approve short-term loans for small projects up to USD 5,000, or IQD 7,500,000 (Minimum amount USD 1,000, or IQD 1 million). Details are included in Annex G.

The Credit Committee can approve loans up to USD 100,000. Above this amount the Credit Committee merely recommends the loan to the Executive Committee for loans up to USD 200,000 and to the Board of Directors for loans above this amount.

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Facilities do not systematically go to the Credit Committee. Senior Officers have been given limited delegations. There are six levels of authority: ƒ Branch Manager ƒ Head of Facility Section ƒ Head of the Credit Department ƒ Regional Advisors ƒ Deputy General Manager, Advisor ƒ General Manager

Credit Committee Functioning and Procedure

The Credit Committee consists of five senior officers: ƒ Mr. Dhia’a Kayoun, General Manager and Chairman ƒ Mrs. Hanna' Abuna, Head of the Credit Department ƒ Mr. Mohamed Al Sahan, Chief Inspector ƒ Mr. Zuhair Abdul Samad Al Naib, Deputy General Manager and Head of Accounts ƒ Mrs. Effat Abd Al Ridah, Head of the Loan Section

The Credit Committee usually convenes twice a week, on Sunday and Wednesday. The Credit Committee members agree among themselves if the loan should be approved. A graphic of this process is shown in Annex H, Rafidain Bank Credit Approval Process.

Loan and facilities requests are presented to the Committee by the Head of the Credit Department, together with the Head of the different sections. The loan officers in charge of the files are never invited to the presentation. There is a specific form designed for the recommendation to the Committee. The recommendation form indicates:

ƒ Name and Address of borrower ƒ Name of the branch ƒ Date of beginning of relationship with the Bank ƒ Obligations with other banks ƒ Financial estimation of the borrower ƒ Other facilities at the Bank and outstanding amount ƒ Cost of the project ƒ Amount requested ƒ Purpose of the loan ƒ Terms and conditions ƒ Collateral description and value ƒ Income, expenses, profit of the borrower ƒ Financial projections if available ƒ Recommendations, suggestions of the branch and recommendation to the Committee by the Head of the Credit Department

The Credit Committee focuses mainly on the collateral, its type, location and value. The Committee also looks at the borrower’s revenues, but without real conviction. The quality of the presentation materials is sometimes poor or the financial data has not been thoroughly reviewed and contains erroneous information.

Loans may be sent back for additional information or simply rejected for lack of proper documentation. Often the Committee, with no apparent or consistent logic, reduces the amount requested without concern for the impact on client business or the feasibility of the project.

Work Out/Bad Loans

The originating branch deals with past-due loans, principal or interest. The clients are contacted either by phone and/or by mail, asking them to fulfill their obligations. This seems to be a very informal and ineffective process.

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In case the client does not pay after several reminders, the branch may try to reach an agreement to reschedule facilities, which are within its delegation. For domestic loans and facilities above its authority, or if an agreement cannot be reached with the client, the files are sent to the Settlement Unit for Facilities, and to the Litigation/Recovery Unit for Domestic Loans. Both units report to the Legal Department.

Once problem loans have been sent to the Legal Department, this department assumes full control of the files. The Credit Department is relieved of the files.

Risk Management

Risk Rating Recently the Central Bank of Iraq sent to all the banks a memo providing the credit rating system according to Basel II principles, for the banks’ review and comments. A report on this matter is outlined in Annex I, Loan Classification Report on Rafidain and Rasheed Banks. The Advisor requested that the Bank perform the ratings of the loans and guided them in the process, initially during the data gathering stage of the Assessment. Classification of the loans has been completed. Facilities will also be classified in the next phase by the Bank staff themselves.

Risk Diversification Information concerning portfolio diversification was not obtained, as no standard portfolio allocation reports are produced other than the sector breakdowns mandated by CBI in the monthly reports.

In the past, through 2002, the Department of Statistics prepared a quarterly report for each type of loan and facility, by branch, indicating industry concentration for the following sectors:

ƒ Agriculture ƒ Oil ƒ Electricity ƒ Trade ƒ Construction ƒ Real Estate ƒ Restaurants ƒ Financial sector ƒ Insurance

Loan Reviews Loan reviews are not performed. Nothing is done to anticipate or manage potential problems, as long as the loan is being repaid. Once a borrower defaults, only then does the Bank launch an investigation.

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4.1.2.3 Bad and Doubtful Debts – Loan Recovery

Delinquent Loan Collection Procedures of Rafidain Bank

Rafidain Bank has developed over time a method of administrating delinquent loans. These procedures are informal and by tradition and have never been put into a comprehensive written form. This means that there is no documentation to judge the performance of the handling of delinquent loans, and no ability to assign responsibility for specific actions. Also, the procedures are changeable without notice or review. Annex J, Rafidain Bank Debt and Delinquencies, states the Bank’s outstanding loans by department. The Annex also differentiates between Government and Private Debt. A summary review of this annex demonstrates that overwhelmingly the major source of delinquencies is from the Iraqi Government. Since decisions regarding the handling of this debt are political, no analysis was made of this portion. Also, a review shows that a large percentage of the Private Debt is severely delinquent. Since the progress of the economy of Iraq in the future will be more dependent on private development, this issue is addressed more thoroughly.

Branches The branches of Rafidain are responsible for originating loans and facilities. Each debt is assigned to a lending specialist, who is supervised by the branch manager. Subsequently if a loan becomes delinquent, the specialist assigned to the credit has the primary responsibility for collecting and resolving the debt. This responsibility remains with the branch. Purportedly, in some branches there are staff members whose primary responsibility is to contact delinquent borrowers, to persuade them to make payment on their debts. Collection activities at the branch level ceased during the recent hostilities, and collection efforts have only been restarted in late 2005. There has also been an attitude among borrowers that debt incurred before the hostilities began would be forgiven by the new Government. This has led to a great increase in loan delinquencies. The bank has attempted to allow easy restructuring of debt when borrowers make a request; however, there has been only limited success to date in restructuring repayments. The branches are primarily responsible for negotiating restructuring, which is subject to the approval of the Bank management (see delegations of authority in the settlement section of this report). If the amount of the credit exceeds delegated authority, approval goes through the single loan committee process like any other credit request. Given the number of delinquencies outstanding, this is not an efficient way to handle approvals.

International Branches The Bank’s international branches have complete control over their operations, including the handling of delinquent loan facilities. These branches offer only Facilities (Open Lines of Credit). They report to the parent Bank through the International Branch Department located at the headquarters of the Bank. Because they are located outside of Iraq, it was not possible to analyze fully their delinquent loan collection procedures. Lending is all denominated in the local currency where the branch is located, except in Cairo where the lending is denominated in U.S. Dollars. These amounts have been converted to Iraqi Dinars for this report. The Settlement Department, and the Legal/Litigation Department, are not used in the collection of these delinquent credits. The international branches carry 296 delinquent loans (90 days or more past due) totaling IQD 71,672,516,487 equivalent (amounts have been converted to IQD).

International Department A small number of loans and facilities are handled by the International Department of Rafidain Bank. Although few in number, these credits individually are significantly large. Of special note is one loan in the principal amount of USD 10,168,724 (IQD 14.5 billion), which originated in 1989, to mature in 6/4/2004. The loan was taken from all shareholders as a subordinated loan for capital support purposes. Installments had not been paid, and interest was last paid in June of 1990. In June of 2003, the loan was extended to a final maturity of June of 2007. This was done with no repayment of interest or principal. Although the loan is not technically past due, its handling does not comply with acceptable standards. This loan is to a viable foreign financial institution of which Rafidain is a stockholder.

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In addition to the foregoing loan, the International Department carries two loans to the Ministry of Finance, with outstanding balances totaling USD 42,493,103 (IQD 62,039,930,628). The loans originated when Rafidain Bank took out two loans on behalf of the Ministry from Gulf International Bank, Bahrain. The Bank carries on its books identical amounts in notes payable, and notes receivable representing this debt. The debt is severely delinquent, but there is no effort on the Bank’s part to resolve this issue. An attempt was made to locate corresponding claims made by Gulf International in the Paris Club claims against either the Ministry of Finance, or Rafidain Bank, but no corresponding claim was located.

Credit Department The responsibility for current and performing loans lies with the Credit Department. It maintains the files, and assures that documentation for the client is maintained. Although Rafidain Bank continues its lending activities, its loan originations have been greatly reduced since the recent conflict. When a loan or facility reaches a delinquency of 90 days either in its final maturity, or in a scheduled payment, the Credit Department is supposed to turn over the file and all documentation to the Settlement Department. At that time the Credit Department relinquishes all responsibility for the debt. This procedure is not strictly adhered to, and several loans exceeding 90-day delinquency remain with the Credit Department.

Loans are only segregated when they become past due. There is no mechanism for reviewing the loan portfolio on a continuing basis to identify problem loans before they become delinquent. Also, the Bank does not require the ongoing collection of financial information on borrowers and guarantors, necessary in order to make any review effective. Recently, an advisor has started a rating system for loans based on the perceived credit quality. Currently, this is being attempted with very limited information. This could be a first step in quantifying risk in a loan portfolio.

The Credit Department, with 94 employees, maintains the records on 1,045 delinquent loans (90 days or more), totaling IQD 1,270,488,729.

Settlement Department The Settlement Department receives the borrower’s file when it is transferred from the Credit Department. The Settlement Department operates as a part of the Legal Division of the Bank. It is charged with maintaining the documentation file from the Credit Department, and it also sends out a series of letters to delinquent borrowers, requesting repayment and threatening legal action. In some cases, the department handles negotiations with borrowers to arrange repayment, or restructuring. It also determines when a debt should be moved to the Legal Department for litigation. A credit is moved to the Legal Department when the Head of the Settlement Department determines that the borrower is not responsive to attempts to negotiate settlement.

A further responsibility of the Settlement Department of Rafidain is to collect information on delinquent accounts at all banks and to create a monthly report, which is distributed to all Rafidain Branches. The report contains a list of all borrowers and guarantors who have been reported by all banks as delinquent (90 days) on their debt. The list is not sequenced alphabetically, and there are no identifying criteria, other than the debtor’s name. With these monthly lists sent to each branch of Rafidain, before any form of credit is extended, the branch is supposed to check to ensure the borrower is not delinquent on another loan. Over several months, thousands of loans are put in the monthly reports. Since there are many similar names in Iraq, sometimes a name is missed on review, and at other times a creditworthy borrower can experience problems in obtaining credit when his name is similar to that of a delinquent borrower. It is the borrower’s responsibility to prove he is not the delinquent party. This creates a system that is cumbersome at best and unworkable at worst. In addition, when a borrower pays his outstanding delinquency, the Collection includes this in its monthly report.

The Rafidain Settlement Department currently employs 42 people. It is responsible for approximately 3,482 loans, for a total amount of IQD 5,605,533,320. Over the last two years, the Settlement Department and the IT department have been developing a database to identify and track the Bank’s

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delinquent credits. Currently, the database is operating, and about 80% of the subject credits are loaded into the system.

The Settlement Department does not account for the whole amount of outstanding delinquent credit: It does not maintain information on the amount of delinquent interest outstanding on the loans, and does not record the interest on the loans. When asked why this was not done, the response was that the branch was responsible for the interest; only the principal was the responsibility of the Settlement Department. There was no explanation about how the Settlement Department and the branches interact to facilitate the collection of delinquent debt.

The Head of the Settlement Department also negotiates restructuring of delinquent credits. Once he determines that a restructuring is satisfactory, he then moves for approval. There are delegations of authority to approve restructures as follows, based upon the total amount of debt outstanding:

Head of Settlement Department 1,000,000 IQD Head of Legal Division 1,000,000 IQD to 3,000,000 IQD Banking Expert 3,000,000 IQD to 4,000,000 IQD General Manager 4,000.000 IQD to 5,000,000 IQD Loan Committee Over 5,000,000 IQD

In spite of the many problems created by the recent conflict and the collateral damage to the economy, Rafidain has been able to continue its collection efforts. The following is a schedule showing actual collection and amounts of debt rescheduled since 2003:

Cash Collected (IQD) Debt Rescheduled (IQD) 2003 142,520,617 611,171,711 2004 1,284,103,701 976,664,514 2005 thru Sept. 1,710,736,970 939,759,470

Legal/Litigation Department If the efforts of the Settlement Department, and of the branch, to collect the delinquent debt are unsuccessful, the loan is forwarded to the Legal Department (a department of the Legal Division). This determination is made by the Head of the Settlement Department. The Legal Department is responsible for initiating the necessary litigation required to sell the collateral. During the recent conflict, the courts were not operating, and no loans were referred for legal action. Now, the courts are operating and the Legal Department is initiating litigation with delinquent borrowers. Currently, the legal department has active cases involving 2,891 loans, totaling IQD 11,415,574,635 in delinquent debt. The Legal Department employs 21 people.

There is little or no coordination between the Settlement Department, and the Legal Department. Debt restructures, placed with the Legal Department, are negotiated by the individual attorneys handling the credit, or at times by the Head of the Legal Department. There are delegations of authority to approve as follows based on the total amount of debt outstanding:

Head of Legal Department 1,000,000 IQD Head of Legal Division 1,000,000 IQD to 3,000,000 IQD Bank Expert 3,000,000 IQD to 4,000,000 IQD General Manager 4,000,000 IQD to 5,000,000 IQD Loan Committee Over 5,000,000 IQD

Process The system for handling delinquent credits at Rafidain is rigid, fragmented, and static. Although delinquencies have increased greatly since the end of the conflict in 2003, the Bank has not taken adequate measures to correct the situation. There is little communication or cooperation between the areas responsible for collection of delinquent debt. There is no single area of the Bank that controls or has information about either the delinquent loan portfolio, or individual delinquent loans. Although the Bank realizes there is a real problem with delinquent loans, it has not devised any plan for

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handling the problem. None of the areas assessed had a monitoring system to allow them to have at hand how many loans were under their control or the total value of these loans. Statistical information must be gathered from various sources, and there seems to be little communication between areas. Although the individuals were very cooperative, they were reticent ever to attempt to go beyond their prescribed functions in gathering information or getting payment for delinquent loans. Many managers noted deficiencies, but seemed unconcerned as long as they “did their prescribed job”.

Rafidain Bank Bad Debt and Delinquencies by Departments (as of October 31, 2005)

Department # Loans # Loans Past Due Principal Balance Principal Past Due

Settlement 3,482 ** 3,482 5,605,533,320 5,605,533,320

Legal 2,891 ** 2,891 11,415,574,635 11,415,574,635

Intl Branches 615 ** 276 79,285,626,627 71,672,516,487 2 *** 2 62,039,930,628 62,039,930,628 International* 27 ** 27 266,324,651 266,324,651 4,457 ** 1,045 44,035,896,774 1,270,488,729 Credit 23 *** 23 102,333,406,666 102,333,406,666

Total 11,497 7,746 304,982,293,301 254,603,775,116

Amounts used for the assessment were derived from individual departments of the Bank. For this reason the figures do not reconcile to other amount reported by the Bank.

Loans defined as loans and facilities.

All amounts converted to IQD equivalents (International Branch loans in local currency except Egypt, which is USD. International loans are in USD and Domestic loans are either IQD or USD).

For the information from the Credit, not all branches responded, however, the vast majority of the loans and facilities are included.

* This is a loan to the Ministry of Finance, which is set up to offset two loans from Rafidain to Gulf International Bank, Bahrain. The two loans to Gulf Bank are delinquent, therefore, the mirror loan to the Ministry of Finance is past due. There is no collection effort being made.

** Private Debt

*** Government Debt

Bad Debt and Delinquencies Results and Data Collection

As a part of the assessment of Delinquent Loans, a database was established in order to collect data on all individual delinquent loans. The concept was to develop a representative survey of loans on which accurate conclusions could be reached. Originally, the database was designed to take approximately 44 pieces of key information on each loan. In interviewing the Bank, it became apparent that these would not be fully obtainable. Therefore the information was reduced to 8 vital pieces of information. None of the areas that handle delinquencies had the information readily available, so each area was required to create as large a sample as possible. In reviewing the results, it was found that there were many errors in the data input. Whether this was caused because individual data was not available or because people doing the input simply did not furnish the information was not determined; in any

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case, this demonstrates the inability of the Bank to provide accurate information on their loan portfolio. The Settlement Department began the project of developing a database to automate their system in 2001. They should complete this project by the end of 2005 or early 2006, but their database was not compatible with the database developed for this assessment.

Not all branches responded to the requests sent for information. Many of the branches that did respond did not send the complete information as requested. In reviewing the inputted data, there were many obvious errors in the material. This indicates a lack of ability to accumulate and report accurate information on the delinquent loan portfolio. This of course impairs the ability to do an accurate analysis of the portfolio. Bank records indicate that there are currently approximately 7,746 delinquent loans (loans and facilities) at Rafidain Bank. 2,885 loans were loaded into the database. Of these, a sample of 950 was deemed to be accurate enough to be placed into a sampling. The only criteria for a loan being put into the sample was that it appeared to have complete information furnished and to have no obvious errors. Under this circumstance, no accurate conclusion can be expected. However certain observations of the included final data can be made.

When reviewing Delinquent Loans, it is important initially to review the quality of loan origination. Loans originated after the recent conflict appears that there are several delinquencies resulting from the Bank’s weak assessment and approval efforts. Additionally, most of the post-conflict delinquent loans appear to have been made with no payments being received. One would expect with well- intentioned borrowers that repayment performance would have taken place by this time. As such, it may be concluded that the Bank will continue to have a high percentage of delinquent loans.

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4.1.2.4 Operations, Automation, and Human Resources

Operations

A review of the Operating Units of the State-owned banks revealed similarities in the administration and control of their duties and responsibilities. An Assessment Questionnaire was supplied to six Department Heads of each State bank. These departments were: Accounting, Credit, Operations, Human Resources, Audit and IT. The purpose was to obtain a general perspective on the various important segments of each bank. The sample questionnaire is shown in Annex B, Sample Assessment Questionnaire with summary replies provided therein.

The general oversight of the Bank by the Board of Directors is fair as Bank employees fill many of the Board positions. Experience, skills and contacts that external Board members bring to the Bank are not realized. The ability of management to adapt has been limited due to political and economic constraints. Management needs to be trained in general management principles. Management should provide clarity and direction so that all elements of the Bank move in concert.

The Bank needs improvement in defining the Table of Organization, top to bottom. Other than department heads, most sub-units appear to lack formal clarity as to where they are positioned in the Bank structure. Bank Operations’ organizational design could better demonstrate the “chain of command” and help to clarify position responsibilities. However, until back office functions come on line with the impact of automation, any design structure would be only temporary. A massive “process flow and re-engineering” effort needs to be planned and implemented. This effort will help to sort out the redundancy or “not needed” positions, which in turn will facilitate reducing staff.

Policy and Procedure manuals should be standardized throughout the Bank in order to achieve better clarity and understanding. Policies and Procedures help ensure that all Bank staff members are in concert when performing their duties. Auditing currently provides oversight for Policy & Procedure compliance.

Job Descriptions detailing employee duties and responsibilities need structure and standardization. Frustration and lack of self-worth can be experienced by an employee who is not sure of what is expected of him in the performance of his duties. This need is greatest at the lower levels of the organization.

Compliance with existing internal controls and policies is adequate, but internal controls and systems are not up to date. Policies and procedures need to be modernized and documented.

All reports are scheduled for timely submission, the internal report by the 3rd of each month, and the report for the Central Bank by the 10th of each month. There is a need for automating the production of all reports. The reporting process currently is manual, and the work is frequently duplicated and usually delayed till end of following month due to manual consolidation and the physical delivery of reports from remote branches.

Internal as well as external auditors from the Supreme Audit Board, the Central Bank and the MoF regularly audit the bank. As a matter of Bank policy, all audit exceptions are resolved within 30 days.

Senior management is relatively well trained and experienced. However, middle management has had no formal training due to the past twenty-five years of political and economic difficulties. Managers are requesting management training.

Overall compensation has not been based on performance and is administered by the Ministry of Finance. Promotions are based on longevity, not performance.

Organization Structure A total of four senior department managers report directly to the General Manager. These include Legal, Audit, IT, and the International Department. The remainder of the departments report to

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“Experts”. This is a new reporting structure, as previously, all departments reported directly to the General Manager. This is a manageable span of control.

The individual’s reporting relationship, however, is not well defined. There are far too many layers of management. One key reporting relationship is the role and reporting line between the internal auditor and the Board of Directors. It would be more appropriate for the internal auditor to report to the Board of Directors, so as to avoid any conflict of interest and to maintain independence.

Operating Procedures The Banks has operating procedures documented, but these procedures have not been updated. Instead of having revisable, bound operating and accounting manuals available to all operating, accounting, counter staff and department heads, there is only a loose collection of CBI, MoF, and management circulars kept in various files and locations. There does not appear to be significant “information sharing” among the Operations Managers and their staff.

Process All processes for products such as current accounts, savings accounts, time deposits, and loans, are being performed manually and are often duplicated. There is a great need for streamlining and automating these processes. The process levels, i.e. the number of people utilized to finalize a process, range between 4 and 5. All processes should be handled and finalized by only two people and, in the case of tellers, by only one person (up to an authorized limit). Some branch operations staff members are moving in this direction. The objective is to avoid a “check the checker” scenario.

Banking Operations Statistics A sample of one-month of statistics of Transactions Processed for the total branches of each of the State-owned banks and the averages/cost per Transactions Processed is provided in Annex C, Transaction and Activity Statistics.

Forms Forms used for processes either do not facilitate easy processing or would not be useful in an automated environment. They need redesigning in preparation for automation. Currently, forms are completed manually, with carbon paper being used for generating duplicate copies.

Branch/Main Office Communications Current communications between main office and branches are by means of fax, messenger or phone (when available) using a code. This is time consuming and prone to error. There is an urgent need to establish an on-line “due to” and “due from” accounting and advising for better control and timely processing, and elimination of huge volumes of unreconciled accounts. (The issue of “connectivity” is addressed in the Automation portion of this Assessment)

The working conditions at the Bank are presently only fair, with conditions exacerbated by intermittent power outages during the workday. Workspace seems to be at a premium, due largely to over-staffing conditions. Most employees appear to be underutilized. Access and parking at the main branch office are extremely limited.

The Bank’s risk profile and security procedures are inadequate. For example, branches do not possess any sort of deterrent to discourage or capture a perpetrator. Specifically, neither dye packs, bait money, cameras or police hook-ups are being utilized. Cash appears to be poorly controlled, as it is openly and easily accessed. In several instances the cash was visible and unprotected. This money should be key controlled.

Records retention capability is negligible. Should a fire or flood impact a branch, records retrieval would be very difficult, if not impossible. The bank addresses its disaster recovery program by having an IT person take diskettes home. This poses a risk to the employee, as well as to the Bank, as these disks can be stolen or duplicated and ransomed. The Bank does not have a written disaster recovery program that describes, in detail, actions to be taken in the event of a disaster. The program should be formulated, implemented and tested periodically.

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Safety Deposit boxes are not available at all branches. Customers may not trust the Bank’s security. People still prefer to have physical control of their money.

All staff members interviewed appeared to have a positive attitude towards their job performance and were looking to change for the better

Automation

An Operational Questionnaire documents the fact that only very basic support is provided by IT to other Bank units (i.e. Human Resources, Credit, Operations, Audit and Accounting). Isolated attempts to automate some functions were made, but they were soon abandoned.

The Bank does not have a centralized database, for essential back office settlement and accounting processes. The operating system is FoxPro, which is completely obsolete.

The Bank lacks the capability to perform central processing, which would involve all financial transactions, customer data and other data flowing into the system, captured and passed to the central database for reporting and analysis.

The Bank does not have an application that would give it the ability to view a customer’s account in real-time. There is a need for the Bank to view the products, accounts and transactions that the customer operates within the application and to be able to generate reports expeditiously.

Typically, large banks, (such as Rafidain) need to install software with fully integrated modules that cover business needs. Applications are needed for Retail Banking, Lending, Transaction Processing, Treasury, General Ledger, MIS, Customer C.I.F., Accounting, Report Query and Report Generation. These applications entail the managing of the accounts: receipt of funds, the disbursement of funds, and the collection of payments into an automated General Ledger for balancing purposes. The need is particularly critical for Rafidain Bank, given the size of its customer base.

The Bank does not provide a Bank-wide Automated Transaction History file. It does provide this information, on a limited basis, at the activity branch. A Bank-wide capability would be necessary to document financial transactions on the system and to allow the Bank to maintain a complete record of all transactions across all accounts for customer service and problem resolution. The system should update the Transaction History file in real-time, as transactions are performed at any branch.

Bank-wide data is not made available immediately to business units or management offices. A real- time data requirement exists, so that, once an update takes place, the data are made available to users in response to inquiries.

No “Branch Bank” network exists, with terminals at all branches throughout the country, utilizing duplicate General Ledger Accounts. This “connectivity” would enable staff to enter remote transactions into the system for monitoring and reporting at a central location.

No capacity exists for monitoring “Branch Bank’s” Credit portfolio in order to capture, review and analyze Bank disbursements, collections, and delinquencies. No billing statements are mailed but rather, the customer is notified telephonically that his payment is due, which is inefficient and expensive.

The absence of automation precludes establishing a sophisticated security in the data processing area. The Bank’s IT is only password protected, and the IT area is under key control.

No “connectivity” exists between branches and home office. Telephone, fax and messenger are used to communicate data entries to General Ledger (weekly or semi-monthly), loan and savings histories.

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Computers are very few and often antiquated. In some instances, computers are allocated one to each department. They are loaded with Microsoft Word and Excel, but most are used as electric typewriters. Some desktops are used as stand-alone processors, whereby information is loaded on a disk and is manually transported from one site to another. Often, the computer is so underutilized as to be ornamental.

Computer skills of Bank staff range from “poor” to “adequate.”

Automation impacts all areas of the Bank, and as the Bank grows in customer base, more emphasis will be placed on this area to improve efficiencies and to meet the demands of both the customer and the employee.

Human Resources

Members of the Human Resources Unit of the Rafidain Bank undertake the responsibilities entrusted to them. Personnel Files are maintained under key control, and access is limited. The Human Resource Department maintains a checklist of the documents held in the file, and the list is used to keep control when documents are needed to be withdrawn from a file. While original Personnel Files are maintained at the head office, copies are distributed to branches, for servicing. Some retiring employees have boxes of records to be stored by Personnel, documenting the individuals’ long career at the Bank. The average tenure of Managers surveyed was approximately 20 years. There may be opportunities to bring modernized and innovative ideas to the work environment.

Management stresses confidentiality, and feels comfortable that confidentiality is maintained, as required.

A bank’s Human Resources Department is responsible for orchestration of basic management tools such as: Table of Organization design, writing of Job Descriptions, standardization of written Policies and Procedures, and a wage and salary administration program. At Rafidain Bank, these disciplines are not well defined or used. Also, there does not appear to be a formal training program for staff.

According to the Personnel Manager, the reporting relationship of some departments should be changed. For example, employee loans should be maintained and managed by the Personnel Department instead of the Credit Department. Another suggestion is that the Administration Department be separated from the Human Resources area. These ineffective relationships point out the need for dialogue and a vehicle to present these recommendations.

The Bank is overstaffed, due largely to government directed hiring, operational inefficiencies, and lack of automation. Of the approximate 6,500 employees working at Rafidain, it is estimated by Managers that it is overstaffed by 30% to 50%.

Official Hiring and Terminations are presented and reviewed by committees, with formal approvals reserved for the MoF. A manager can recommend the termination of an employee and notify the MoF, which in turn, notifies the employee that he or she is terminated. Termination is a rare occurrence. Currently, there is a “no hiring” policy, and as attrition impacts the staff complement, responsibilities are apportioned among the staff. Salaries and promotions are established by “law” and an employee may work many years just to have a newer employee equal or surpass the tenured employee in salary.

Some automation (offline, standalone Excel applications) is provided to Human Resources, and Managers realize that they need a more efficient system at the Bank. Attempts at automation were unsuccessful in the past, but some efforts are being made to at least reduce workload by increasing efficiency through simplification of manual procedures and implementation of some stand-alone, off line reports.

Staffing Numbers and Salary Distribution by Branch and by Home Office are set out in detail in a comparative chart for all six State-owned banks in Annex D, Staffing and Salary Distribution. The chart identifies areas noted for review and assessment. The two largest banks in Iraq are very similar

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in structure. Rafidain and Rasheed have almost the same number of Branches, have almost the same number of staff, and have a similar breakdown in number of staff in the branches and in the home office. Furthermore, salaries paid to staff in the head office and branches are almost identical.

The situation is similar with the smaller four State-owned banks. The average salary for employees from the head office and branch was almost the same (see also Annex D). This may suggest that salaries are set and applied universally by the MoF, rather than having a pay-for-performance program.

Management The general oversight of the Bank by the Board of Directors is fair as Bank employees fill many of the board positions. Experiences, skills and contacts that external Board members bring to the Bank, are not realized. Management should provide clarity and direction, for all elements of the Bank to move in concert.

Senior management is relatively well trained and experienced, but middle management has had little or no formal training, due to the past twenty-five years of political and economic difficulties. Functional Managers are requesting management training, and those interviewed have an average of 20+ years of experience on the job. While experienced, they may be expected to be set in their ways and not readily accepting of change.

The composition of the Board of Directors of Rafidain Bank is as follows:

RAFIDAIN BANK BOARD

Member Name Position Location 1 Dhia Habib Khayoon General Manager Rafidain Bank 2 Mahmood Jawad Alwash Deputy Member of Board Baghdad Chamber of Commerce 3 Said Abbas Merza General Director MoF 4 Zuhair Abdul Samad Al-Naib Expert Rafidain 5 Muhsin Abid Hassan Deputy General manager Rafidain 6 Yahya Mohamed Saleh Al-Ani Director of Legal Dept Rafidain 7 Riyadh Abdul Aziz Kenoona Admin. Manager Rafidain 8 Mohm. Jasim Al Sahan Senior Manager Rafidain 9 Mejeed Al-Dilaimi Rep. of Central Region Rafidain

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______

FINDINGS

RAFIDAIN BANK ______

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4.1.3 FINDINGS – RAFIDAIN BANK

4.1.3.1 Accounting and Reporting – Financial Condition

ƒ The Bank is not conforming to any generally accepted accounting principles (GAAP), including those of the Republic of Iraq, which has adopted versions of several International Accounting Standards (IAS). Accordingly, financial statements are lacking and deficient in data integrity, accuracy, and transparency, and in the representation of their fair value. ƒ The Bank does not follow the international accounting standard of accruing income and expenses in standard, universal method throughout the Bank, thus misstating the Bank’s results throughout the year and making reconciliations difficult if not impossible. ƒ The Bank’s accounting function is dysfunctional and decentralized throughout its entire 142 branch network and within the head office. It is also fragmented within the main office, as described in the foregoing report, between the International Division, the Foreign Branch Affairs Sector, and the Financial Division. Coordination between these areas is inadequate to allow reconciling data and accounts of Off Balance Sheet items and foreign branches. Reconciliation of accounts is mostly nonexistent, and where attempted, ineffective. ƒ There is a lack of analysis, comparison, verification, checking, and balancing of accounting transactions and records. Furthermore, the need for a Management Information System is largely unfulfilled. Essentially, the accounting function/system is nothing more than a manual “bookkeeping system”, lacking sufficient management attention and involvement. Divisions and sectors operate independently to the detriment of the Bank. ƒ Problems exist within the financial infrastructure, wherein the Central Bank of Iraq is evidently unable to provide sufficient regulatory oversight through offsite or onsite examinations or to exert adequate authority or penalties to force the Bank to comply. Similarly, the Supreme Audit Body appears unable to provide significant oversight or to bring about compliance through its audits. ƒ Management oversight appears to be lacking in the operations and accounting for the Foreign Office Branches. The records of these offices need to be reconstructed and reconciled with the main office. ƒ Decision-making is hampered by the lack of a proper, automated, timely, and reliable management information system to allow management to identify discrepancies, risks, trends, foreign currency exposure, asset quality, profitability, etc. ƒ The Bank has a concentration of deposits and risks centered with Government accounts and this has prevented diversification risks, has hindered broadening the resource base and has hindered the ability to press the Government client (its 100% shareholder) for repayments. ƒ The Bank’s branch network is comprised of many branches that are not generating sufficient loan income or deposits to justify their existence. Investing the capital locked up in branches in the financial markets would generate more revenue with no personnel, administration, or premises costs. ƒ Accounting, operations, and branch units are significantly overstaffed. Staff lack relevant technical experience, and require training and motivation.

4.1.3.2 Credit Management and Policies

ƒ Some improvements have been achieved in document design and the approval process with the cooperation and leadership of the Credit Department’s middle management, but much is still needed to develop the credit culture and bring the Bank up to international lending standards. ƒ Technical skills, professionalism, and training are lacking. A dual approach is needed, (1) to develop skills in credit initiation, credit analysis, credit administration at working levels; and (2) to provide training in credit policies, portfolio management, and risk management for senior management decision-making personnel.

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ƒ Though loan requests include more financial information, upper management still makes its lending decisions on the basis of quality of collateral and guarantees offered. ƒ Although staff members seem to understand the necessity to switch from collateral-based lending to cash flow lending, upper management has not yet taken any steps to change current procedures. Staff and management of this department demonstrated a keen interest in effecting these changes. ƒ The credit committee concept and approval limits are not effective, given market conditions. ƒ The Head Office Credit Department needs reorganization, automation, and modern filing systems. (Credit files are in poor condition) ƒ Loan classification showed that many loans considered as current in the department are in fact past due.

4.1.3.3 Bad and Doubtful Debts – Loan Recovery

ƒ Rafidain Bank suffers from large amounts of delinquent credits that are primarily a result of delinquent Iraqi Government Obligations. No attempt is being made by the Bank to address this problem. ƒ Delinquencies of Private Debt are at unacceptably high levels. Although this may be in part a result of the recent conflict, the problem still needs to be addressed. ƒ Although there is a large increase in delinquencies, the methods of collection, and the resources applied to the problem have remained static. ƒ Collection of delinquent credits is fragmented with portions of debt distributed over more than one banking area. One area does not represent or include another in the process. ƒ The management structure is rigidly departmentalized, with no overriding motivation to solve the Bank’s bad debt problems. Employees have only a narrow view of their specific tasks and responsibilities without regard to results. ƒ Solutions are not strategic, but instead are one-off and short-term. ƒ Although many individuals in the Bank were most cooperative, the work force is not motivated to do superior work and demonstrated a lack of interest in completing the tasks; information provided had many mistakes. Additionally, many branches did not respond to requests for information or often furnished incomplete or erroneous data in spite of clear direction from management. ƒ There seems to be genuine fear that delinquent borrowers might react violently to collection efforts of past due debt, hampering collection efforts. ƒ There is a prevailing attitude among borrowers that debts incurred under the prior regime do not require repayment. This was encouraged by the inactivity of banks following the recent conflict. ƒ Under current conditions, the Bank will not be able to resolve the problem of collecting delinquent debt. ƒ Accuracy of data collected is suspect because different sources have different information. This made validity of the task less certain. The assessment reveals that even though fully accurate data as was not available, the conclusions as to the major problems are still valid.

4.1.3.4 Operations, Automation, and Human Resources

ƒ All transaction processing, accounting, management reporting, and statuary reporting is done manually. There is much duplication of effort. Reports are delayed and unreliable. ƒ All department staff members are underutilized. The transaction/staff ratio is very low. ƒ There is no permanent operations manual for standardized procedural guidance for staff. ƒ Cash controls and branch security procedures are weak.

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ƒ Evaluation of final three bidders is suspended. The Bank needs guidance and decisions urgently. ƒ Lack of automation has led to the above-mentioned overstaffing, unreliable reporting, and poor customer service. ƒ The apparent inability of Banks to introduce various banking products and services (ATM, credit and debit cards, online banking) is due to lack of automation and telecommunications. ƒ The Human Resources area of the Bank needs assistance. There are far too many employees performing numerous manual tasks and record keeping. A Bank-wide plan to manage a significant downsizing of staff needs to be well thought out, planned, implemented and monitored. The dismissed staff should be made to feel that it was not anything they did that resulted in their release. ƒ Human Resources department needs to administer such areas as table of organization design, recruitment, wage and salary, benefits, employee loans, pay-for-performance program, job counseling, training, documentation and transfers, and terminations. ƒ A major impediment to the administration appears to be the involvement of the MoF office in the hiring and termination activities of Human Resources at the Banks. Staff members feel they have no say in certain personnel matters; this removes authority and management effectiveness. ƒ A program to design and develop an updated and automated Human Resources area is needed ƒ General oversight of the Bank by the Board of Directors is fair, as Bank employees fill many of the Board positions. However, 80 percent of the Board members are long-time bank employees, and with no outside directors, there has been a lack of various skills, backgrounds, and views to bring about innovation. ƒ Senior management is in fact well experienced in banking operations but requires training to be brought up to date with modern concepts and systems. ƒ Middle management has had no formal training, due to the past twenty-five years of political and economic difficulties. Therefore management requires training to upgrade skills. ƒ Functional Managers average 20+ years of experience on the job, but require training to upgrade their technical banking knowledge and skills. ƒ The Assessment questionnaire’s two most often cited needs were automation and training. ƒ The Bank’s senior management structure is male dominated, however, a majority of all Bank positions are held by women.

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______

ASSESSMENT

RASHEED BANK ______

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4.2 RASHEED BANK

4.2.1 EXECUTIVE SUMMARY – RASHEED BANK

Rasheed Bank is the second largest Bank in Iraq with 144 branches in Iraq servicing approximately 1.7 million accounts. All processing transactions, reporting, and customer services are completely manual, cumbersome, slow and inefficient. Furthermore, lack of automation appears to be a contributing factor to apparent excess staffing, estimated to be 30% to 50%. Rasheed Bank has a total staff of 6,500 employees with an estimated annual Payroll of IQD 19.2 Billion (approximately USD 13.2 million).

There is no connectivity between the head office and the branches. Attempts to automate the Bank were made throughout the last ten years via discussions with NCR and Citibank; however, political issues prevented the implementation of any automation. Rasheed is in the process of developing an RFP to automate the Bank, using a Citicorp model. It is the Bank’s intention to automate on a turnkey and fixed price basis. Rasheed advises that it has a commitment from the MoF for USD 4 million to purchase software and hardware.

Rasheed Bank Accounts Department does not prepare financial statements under IAS and GAAP principles. The accounting process is decentralized among its entire branch network of 144 branches and within the main office. It is also fragmented within the main office as described later in the report between the International Division, the IT Division, and the Financial Division regarding recordation of LOCs and proper revaluation. There is insufficient coordination between these areas to reconcile data and information regarding Off Balance items. Accrual accounting is practiced only on a limited basis, i.e., the accrual of Treasury bill income and savings interest expense at year-end and quarterly for loans at a limited number of core branches. Accordingly, financial statements are lacking and deficient in data integrity, accuracy, and transparency, and in the representation of their fair value.

After restating the 2004 accounts, the following is noted:

ƒ Based upon adjustments to December 31, 2004 financials, adjusted total capital and retained earnings as depicted in Exhibit I, Statement of Condition (unaudited), is a negative IQD 1.7 trillion, or USD 1.2 billion. This reflects balance sheet liabilities of IQD 5.6 trillion and assets of 3.9 trillion, consequently resulting in the insolvency of the Bank. ƒ Rasheed Bank’s non-earning assets as a percent of total year-end assets for 2003 and 2004 were at unprecedented levels of 64 percent and 89 percent respectively, exceedingly high. Ideally, the percentage should be in the range of 10-15 percent of total assets. The Bank has an inverse ratio of earning to non-earning assets, compared with international banking best practices. ƒ The Bank’s deposit liabilities consist of private sector deposits of approximately IQD 832 billion (USD 570 million), and of Government related deposits of IQD 1.3 trillion (USD 870 million). ƒ Foreign claims identified by Ernst & Young currently total USD 1 billion. Additional foreign liabilities on the Bank’s books under Past Due Long-term Debt, Past Due Interest Payable, Pending Litigation, and huge Off Balance Sheet (OBS) liabilities totaling almost IQD 1.2 trillion (USD 804 million) need to be investigated. ƒ The Bank made several adjustments and revaluations during 2005 to the 2004 financial statements to show a translation gain of IQD 395 billion (USD 271 million). ƒ In November 2005, the Bank adjusted 2004 financial statements to record a new earnings figure of IQD 14 billion (USD 9.6 million). Reliability of the financial statements is of concern. ƒ The Bank stills retains on its books a BCCI deposit and foreign deposits of IQD 227 billion (USD 155 million), frozen bank balances of IQD 265 billion (USD 181 million), war damage and looting losses of IQD 256 billion (USD 175 million), plus an amount of IQD 2.2 billion in old Iraqi and Swiss dinar notes still held in vaults (worthless since January 16, 2004). These should all be written off.

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ƒ The Bank’s IT Division provided a listing of 1,045 LOGs for a total amount of “old Dinars” of IQD 1,077,171,000. Only 229 of these are foreign LOGs while the remaining are purportedly domestic LOGs. Converting the IQD 1.1 billion to USD would result in an additional write off amount of IQD 5 trillion (USD 3.5 billion).

Detailed analyses and financial statements can be reviewed in the separate report, Rasheed Bank Financial Condition and Viability, attached hereto as Annex K.

The June 2005 half-yearly accounts reveal improvement following a year of recovery in 2004 and a return to more normal activities. Income improvement was due primarily to increased income from higher yielding T-Bills and from CBI’s newly instituted overnight facility where substantial investments of previously idle cash (especially USD 300 million of dollar notes in the vault) were placed at interest. However, the impact of this marginal increase in financial investment earnings (basically recirculated government deposits) does not contribute to any improvement in the Bank’s overall financial condition.

Rasheed Bank has the largest number of commercial loans and facilities of all the banks in Iraq. Rasheed’s current practices do not allow for proper credit assessment or loan monitoring. The portfolio of delinquent loans is very large, and little has been done to collect or resolve them. Rasheed’s credit process for analysis, approvals, and risk rating are weak throughout the Bank. Lending is based strictly on collateral rather than on creditworthiness or cash flow. Risk management is non-existent. Specific training and a change in credit culture are imperative Bank-wide. The portfolio of performing loans and facilities includes overdrafts to the Government Sector that have actually been past due for years. Many commercial loans, rated as current by the Bank, should also be reclassified delinquent and sent to the Settlement Department.

A recent instruction from the Central Bank of Iraq requires all banks to apply a rating system to loans and facilities according to International Standards. Completing this will help redefine the Bank’s portfolio. To date, however, the Bank’s Credit Management has taken no steps to comply.

The follow up, collection, administration, and prosecution efforts of Rasheed Bank’s delinquent borrowers, including Government entities, by the Bank’s Settlements and Legal units are informal and ineffective. There are no written procedures, and documentation of actions taken is inadequate. Very large potential losses are not being correctly recorded.

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4.2.2 ASSESSMENT OF RASHEED BANK

4.2.2.1 Accounting and Reporting – Financial Condition

Assets

Cash and Banks As at year-end 2004, the Bank showed the equivalent of IQD 860 billion (USD 589 million) cash in vaults plus non-interest bearing operating, clearing, and deposit balances in banks totaling IQD 2.3 trillion (USD 1.6 billion), for a total of IQD 2.3 trillion (USD 1.6 billion) in non-earning current assets – an exceedingly high 82 percent of total assets. After deducting fixed assets, this leaves earning assets at only 11 percent of total assets - a miniscule earnings base for a bank of this size. This situation finally changed somewhat after March 2005 when the CBI offered an overnight facility to banks at 3 percent and allowed the T-Bill rate to rise to as much as 10 percent, thus improving the Bank’s income stream during the current year, as illustrated in the following paragraph.

Investments At end 2004, nearly 99 percent of the Bank’s financial Investments, IQD 363 billion (USD 249 million) were placed in CBI 90-day T-bills at an average of 3 percent, one and two percent below the deposit rates. The balance of investments was local investments in companies and other banks. Financial Investments increased substantially in 2005 when Rasheed Bank shifted nearly all its surplus cash and foreign notes to the Central Bank for placement in Overnight and T-Bills, and as of June 30, 2005, the Bank’s financial investments (per CBI books) appeared as follows:

12-31-04 06-30-05 06-30-05 06-30-05 T-Bill T-Bill Overnight IQD Overnight USD

IQD 292 billion IQD 179 billion IQD 600 billion USD 135 million

Loans Rasheed showed total loans at year-end 2004 of IQD 197 billion (USD 135 million) after loan loss allowances established by the Bank. After adjustments for delinquencies and other items and increasing loan loss allowances, the net current loans balance becomes only IQD 51 billion (USD 35 million). The Bank’s loan to deposit ratio is only 6.1 percent of average loans and average deposits – an exceedingly low and unprofitable proportion. Details of these accounts may be seen in the separate report, Rasheed Bank Financial Condition and Viability, attached as Annex K.

Loan Charge-offs and Reserves for Loan Losses The Reserves for Loan Losses were reduced, on a net basis, by IQD 677,536,000 during 2004, indicating that loans may have been charged against the reserves or, possibly some recoveries were also applied to the reserves.

Loan delinquencies, as presented in Annex O, indicate that 95.3 percent of the Bank’s loan and facilities portfolio is delinquent as to the principal balance, and in terms of the number of loans, 54 percent or 9,670 loans are delinquent.

Additionally, data presented in the Financial Settlement sector Quarterly reports, indicate a steady increase in the number of loans in the settlement process, which is the final collection effort. From December 2002 through March 2005, the number of borrowers and their debt has increased, respectively from 1,433 to 1,948 borrowers, and from IQD 3.4 billion to 4.6 billion, a 35 percent increase in amount of principal and a 36 percent increase in number of borrowers.

Fixed Assets The Bank’s furniture, fixtures, buildings and land amounted to only IQD 11 billion after depreciation. On one hand, nearly all of these assets are old, worn, obsolete, or damaged and most should be written off. On the other hand, land and buildings may benefit from potential revaluation in view of the recent market increases in real estate following the recent war with a chance to move significantly

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higher if the security situation improves. This could, in the future, have a positive impact on the Bank’s net worth, but this was not speculated on in this report and restatement exercise.

Liabilities

Deposits The Bank’s deposit liabilities consist of private sector deposits of approximately IQD 832 billion (USD 570 million), and of Government related deposits of IQD 1.3 trillion (USD 870 million). These plus other deposits amounted to IQD 3.5 trillion (USD 2.4 billion) in total resources.

Borrowings and Foreign Debts The foreign obligations of Rasheed Bank constitute a serious threat to the survival of the Bank. After adjustments and considering all potential claims, the total foreign debts could, before Paris Club reduction, amount to the following:

Past due debt, Interest payable, and Other Liabilities USD 804 million Claims collected / reported by Ernst &Young under Paris Club 1 USD 1.1 billion Pending litigation (50 cases) against the Bank (IQD 527 million) USD 0.4 million

It is not clear at this point how much of this debt will be included in and reduced by Paris Club, but the amounts do not reconcile with the Bank’s books and in any case will represent a major deduction from capital. For detailed analysis, please also refer to Annex K, Rasheed Bank Financial Condition and Viability. Additionally Annex L, Rasheed Bank Total Foreign Debt, summarizes the foreign claims against the Bank (USD 1.1 billion) assembled by Ernst & Young through September 2005.

Earnings

The Bank’s earnings for 2003 are not accurate for several reasons. During 2003, the Government directly paid the salaries of Bank employees for a portion of the year and provided other assistance as a result of the military conflict. Confiscated deposit accounts were not written-off in 2003 and, as indicated previously, certain interest expense accruals have not been recorded. Also since 1990, significant trade finance losses have not been recognized, and the commensurate interest expense for these liabilities also has not been recognized in the Bank’s accounting operations.

A summary of the major income and expense (unadjusted) categories is as follows:

(000s) IQD 2004 2003

Interest Income 12,648,249 12,259,396

Investment Income 34,333,171 24,617,517

Total Interest Income 46,981,420 36,876,913

Less Interest Expense 24,374,157 21,288,360

Net Interest Income 22,607,263 15,648,553

Less Provision for Loan Losses -0- (318,132)

Non-interest Revenue 6,523,823 4,242,427

Total Operating Income 29,131,086 19,572,848

Less Gen. & Admin. Expenses 29,341,905 6,562,106

Net Income (loss) (210,819) 13,010,742

1 In 2004 Ernst & Young was engaged by the Minister of Finance to issue a global RFI inviting all holders of Iraqi debt to submit documented claims to Ernst & Young for review and record matching, and for submission to MoF for acceptance of the debts by GOI. The final claims cut off date was April 15, 2005 and Ernst &Young has collated the total foreign debt collected and are preparing a final report for the Paris Club.

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General and Administrative expenses increased 347 percent over 2003, and if adjusted for expenses from prior years it is 325 percent. In spite of these increases the Bank only expended IQD 8,347,000 on employee training for the entire year. This is the equivalent of less than USD 1 per year, per employee.

Off Balance Sheet (OBS)

The IT Division provided a listing of 6,426 outstanding Letters of Credit that totaled IQD 835 billion, or USD 572 million. Capital of the Bank was reduced by this amount to reflect the Bank’s liability.

The OBS statements reviewed indicate differing amounts for LOGs ranging from IQD 4.3 billion-5.4 billion for domestic LOG. The International Division provided a listing of 229 LOGs, denominated in “old Dinars” which amounts to IQD 56.5 million. The current liability should be recorded as IQD 264,654,621,659 or USD 181,270,288. The remaining domestic LOG liabilities valued at old Dinars IQD 1.1 billion, now equates to USD 3.5 billion, or IQD 5 trillion potential additional loss, which requires further investigation.

Capital

Capital was IQD 10.3 billion at the end of 2003, or only 0.51 percent of year-end assets. In 2004, capital increased by IQD 1.2 billion, to IQD 11.5 billion, or 0.30 percent of year-end assets. Based upon adjustments to December 31, 2004 financials, adjusted total capital and retained earnings as depicted in Exhibit I, Statement of Condition (unaudited), are a negative IQD 1.7 trillion, or USD 1.2 billion. This reflects balance sheet liabilities of IQD 5.6 trillion and assets of IQD 3.9 trillion, consequently resulting in the insolvency of the Bank. Annex K Exhibit VII, Adjusting Journal Entries, and further discussions in this report provide more details regarding these adjustments.

Financial Viability

As noted above in section, Capital, it can be seen that after adjustments the Bank is in a negative net worth condition. Increased earnings from short-term financial investments (T-bills and Overnight facility with CBI), effectively investing surplus Government deposits back with the Government, will not be adequate to compensate for the major ongoing overstaffing costs, the potential write down of loans, the unrecognized loss of confiscated correspondent bank accounts of IQD 265,598,555,000 (USD 182 million) plus LOC foreign margin deposits of IQD 177,859,941,000 (USD 122 million), the enormous unacccrued interest payable, amounts due on foreign loans, unreconciled interbranch accounts, and the potential loss from settlement of USD 1 billion in foreign debts. This situation leaves the Bank in an untenable present and future financial position. Remedial steps must be sought and implemented by the shareholder. Suggested alternatives and details may be found in Annex K and Exhibits attached to this report.

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4.2.2.2 Credit Management and Policies

Credit Department Organization Overview

The organization of the Credit Department of Rasheed Bank is a mirror image of the organizational structure of the other large State-owned bank, Rafidain Bank. Located on the fourth floor of the Bank’s building in a fairly small and crowded area, the department consists of four main areas and comprises ninety employees. The four main areas are: Loans, Facilities inside Baghdad, Facilities outside Baghdad, and the Information unit. In addition, there is a unit dealing with advances to employees and a unit for administration. This Department deals only with domestic clients, individual or corporate, and the Government sector. Foreign loans are assessed and booked separately by the International Division on a different floor.

Commercial loans encompass all kind of industries, with no specific orientation. Lending products are very limited. Facilities are mostly evergreen IQD overdrafts, while loans are now primarily medium-term in USD. The Information unit controls and checks information provided by branches.

Branches originate the loans and continue thereafter to maintain a global relationship with clients. After assessment of the request and the collateral, the files are sent to the head-office for review and approval (Annex M, Rasheed Bank Credit Approval Process).

Currently, Rasheed Bank is working under a series of policies, which follow the instructions of the Central Bank and the Ministry of Finance. These policies are very summary and do not comprehensively cover all lending issues. There is no bound, permanent and revisable Credit Policies and Procedures manual to guide lending in a standardized manner and that sets out basic requirements for collateral, types of lending, tenure of loans, and basic financial guidelines. Most of the policies are based on years of circulars handed down from the Board, the CBI or the MoF. In any event, most policies appear to be followed in a reasonably adherent fashion.

The entire lending process is done manually. There are no computers in the Credit Department. As a result of the slow, unreliable, and sporadic manual reporting, management information and risk management are very poor.

Credit Department Units

Domestic Loans This section deals exclusively with domestic loans in USD and IQD, usually with a term of over one year. Twelve employees, including the head of the unit, work in this section.

Facilities within Baghdad Facilities within Baghdad deal exclusively with short-term credit, such as overdrafts and discounted bills originating from the 49 branches located in Baghdad. This unit has 21 employees, including the Head of the unit.

Facilities outside Baghdad Facilities outside Baghdad deal with of short-term credit originating from branches located outside Baghdad. This unit has 20 employees, including the head of the section.

Credit Information Department This unit has eight employees and performs investigations of clients on behalf of Facilities units.

Advances to Employees This unit deals specifically with loans to employees of Rasheed bank. It comprises four employees. It is recommended that this unit does not belong to the Credit Department but to the HR unit.

Other Units In addition, there are two small units. One follows repayments of loans in USD granted before the war and the loans to the Socialist sector. The other one monitors the clients’ guarantees.

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Domestic Loans

Products Loans are made in USD and in IQD. The Bank’s policies do not stipulate a maximum or a minimum for Loans, as distinguished from short-term Facilities. Presently, the largest loan granted in IQD amounts to an equivalent of USD 200,000. The largest loan in USD amounts to USD 65,000. Terms are short-term up to one year or medium-term for two to three years.

Interest is due quarterly, while principal is usually payable in semi-annual installments. The rate of interest for loans in USD is a flat 9 percent. For loans in IQD, rates vary from 13 percent to 15 percent, according to the term of the loan (one, two, or three years).

Loans are granted to various types of clients: traders, tourist hotels, services, farmers, etc. Loans are made to individuals rather than to companies, in spite of the fact that the purpose is usually business related.

Lending to tourists hotels in Najaf and Karbala seems to be the new trend. These hotels cater to pilgrims traveling to holy shrines. The Bank does not keep track of the industry concentration, nor of its exposure to the various economic sectors.

According to the Bank, loans granted after the war are performing well, though some had to be rescheduled. Rating of the loans will determine the condition of the portfolio.

Process At Branch Level:

All loan applications originate at the branches of the Bank. The customer brings his request to a branch. The decision to proceed relies on the branch manager. He reviews the request and determines if it is worthy of consideration. If the manager decides to go ahead with the request, the potential borrower is required to fill out an application that details the potential borrower’s assets and liabilities. A request is then made to the Central Bank to verify if the applicant has outstanding obligations with other State owned institutions. The potential borrower must also provide proof of identity and of his business activities.

The manager then designates two committees within the branch for further analysis. One committee is made up of the manager, the assistant manager in charge of lending, a bank real estate expert, and an engineer from the Government land registry. It is responsible for valuing the borrower’s real estate holdings, including any properties to be used as collateral. In many cases, when a customer does not have enough real estate to pledge, he will obtain real estate collateral from a relative or business associate. The second committee includes the manager and other designates from the branch’s staff. Its purpose is to evaluate the applicant’s business. Additionally, members of this committee contact business associates of the potential borrower and other trusted bank customers to gain an insight into his business ability and character.

Little attention is paid to the financial situation of the customer, and financial statements are usually incomplete or non-existent. The purpose of the loan and the use of the funds is not specified, nor are the sources of repayment.

After the manager has fully reviewed the credit request, he will send it along with his recommendation and the information he has obtained to the Bank’s Credit Department. Unless questions arise, no other input is required of the manager.

There seems to be no attempt to match a borrower’s lending needs to the structure of the loan or facility. Loans are generally made for one year with full payment of principal at the end of that period. Facilities are usually based on borrowers’ desires and have no relationship to actual needs.

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In many instances, the amount of the request is reduced by the branch manager before going to the Head Office, with no specific reason other than the amount of the collateral or the suspicions that the amount requested has been inflated on purpose.

Loans are all priced at a set rate. No adjustment is made based on the perceived risk of the credit or the amount of compensating deposits kept at the Bank by the borrower or related parties.

At Head Office Level: Once received by the head office, the request is submitted to the Loan Department. The department verifies that all the required documentation is in the file. It then reviews the research of the Information Department. With this information the Department writes a recommendation to the Credit Committee. It communicates the request of the borrower along with the recommendation of the branch manager. Additionally, it makes its own recommendation to ensure the request is within the lending policies of the Bank. These recommendations contain the loan amount, rate of interest, term if appropriate, purpose, financial evaluation of the potential borrower, and basic information on collateral and guarantees. The information is very summary and brief.

The Bank relies totally on collateral to ensure that the credit will be repaid. When the advisor suggested that a borrower’s cash flow should be utilized as the primary source of repayment and that reliance on collateral should be the last resort for repayment, there seemed to be little understanding of the concept. The bankers feel assured that as long as the value of collateral is sufficient there could be no problem. They seem indifferent to changes that could take place in the market to affect collateral values.

Facilities

Products There are several types of Facilities, overdrafts (basically lines of credit offered to clients), discounted bills with recourse, and letters of credit. Facilities are always denominated in IQD and are usually evergreen. Once approved, the clients can use the facilities at will. There are no specific terms of repayment, nor is there a clean up period. There is no systematic review. Interest is payable quarterly.

Prospective borrowers must be clients of the Bank for at three months before qualifying for a facility.

Process At Branch Level: Application, analysis, and approval follow the same basic procedures as for loans, outlined above.

At Head Office Level: The branches submit requests to one of the Facilities units, the unit “Within Baghdad,” or the unit “Outside Baghdad”. Once distributed to the staff for review, the steps are the same as for processing loans as explained above.

Advances to Employees

Prior to the war, advances to employees were granted to all Government staff, and these advances are for the most past due in spite of the fact that the employees still have a job and a salary.

Presently, only the employees of Rasheed are eligible. Advances range from IQD 2,000,000 to IQD 4,000,000, depending on the level of salary. Payments of principal and interest are deducted from the salary and are current (principal installments and interest payments are all up to date).

Credit Information Unit

This unit is in charge of performing investigations of borrowers on behalf of the Facilities Units of the Credit Department. Occasionally, it may also intervene at the request of the Domestic Loans Section.

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The task of these employees is, first to review the form provided by the branch. They then investigate the borrowers and the guarantors, their character, assets, financial strength, and market reputation. They focus on the following issues:

ƒ Verification of identity ƒ Financial information ƒ Inventory ƒ Fixed assets ƒ Cross check value of real estate ƒ Checking commercial invoices ƒ Checking the books

Credit Portfolio

The total performing short-term and long-term loans and facilities portfolio amounts, as of May 30, 2005, in USD equivalent, to 104.46 million, of which USD 8.20 million is for loans and USD 96.26 million for facilities (Total IQD 156.7 billion). These amounts do not include advances to employees. (see Annex N, Rasheed Bank Loans and Facilities)

The quality of the portfolio has deteriorated since 2003 due to the political situation. Many people either could not repay their debt or took advantage of the situation to avoid or to delay payments. According to the management, loans granted after the war are of better quality, with fewer problems. During the last few months, the Bank has taken little action to recover past-due loans.

According to information provided, non-performing loans and facilities to private companies and individuals represent IQD 25.87 billions. These loans are secured by real estate. In reality, this amount is more important, as the facilities to the Government Sector, IQD 69.21 billions are, for the most part, past due and all interest due having been capitalized.

Credit Approval Authority

There are no individual authorities for loans and facilities. They all need to be approved by the Credit Committee. The Committee can approve loans and facilities up to IQD 150,000,000 or its USD equivalent when the General Manager is present and up to IQD 100,000,000 when he does not attend the Committee. Above IQD 150,000,000, the request is sent to the Board of Directors for approval.

Credit Committee Functioning and Procedure

The Credit Committee reviews and approves loans and facilities. It usually meets once a week, on Monday. A representative from the Credit Division presents each request and retrieves any additional information requested by the Committee from the credit file. The Committee reviews new credits, resubmissions of credit, and settlement proposals for troubled loans. The Committee has three alternatives - it approves, denies, or requests more information for the credit. If a potential borrower is dissatisfied with a decision of the Committee, in selective cases, he is allowed to make an appeal (resubmission) to the Committee in person. The Committee is made up of eight members: General Manager, Head of the Credit Division, Manager of Facilities inside Baghdad, Manager of Facilities outside Baghdad, Manager of Loans, Bank Advisor and two Banking Experts who are on the Bank’s Staff. There is no formal vote in the credit decision. However, the Committee reaches a consensus about the proposed credit. If the request is over IQD 150,000,000, it goes to the Executive Loan Committee. This Executive Loan Committee is made up of seven members of Rasheed Bank’s Board.

The Credit Committee relies totally on collateral to ensure that the credit will be repaid. Only summary analysis of the borrowers’ current financial condition is undertaken. An estimation of worth and a rough breakdown of assets and liabilities are presented with the loan request. The primary focus is on real assets that can be pledged against the loan. In most instances, the amount is arbitrarily

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reduced without consideration of the needs of the project. The branch and/or the credit department have usually already reduced the amount before sending the request to the Credit Committee. Given this expectation, many clients inflate the amount of their request.

An average of 60 loans and facilities are processed each month, including 50 renewals and 10 new requests.

Work Out/Delinquent Loans

Once a loan is past due, primary negotiations and contacts with delinquent borrowers are carried on exclusively through the branch that originated the loan. At times a borrower who is not pleased with the negotiations may try to circumvent the branch. However, in most cases the branch maintains the relationship. On a few occasions the relationship might be moved to a different branch if it appears the borrower and the branch manager have a personal conflict. If the loan becomes Past Due 90 days or more, and after efforts to collect are unsuccessful, the case is reported by the branch to the Credit Division (Facilities or Loan Department). Subsequently, if the borrower continues to be delinquent, the loan is supposed to be directed to the Settlement Department or the Legal Department for further action, though this is not consistently done.

The advances to government employees made before the war are all past due in spite of the fact that the beneficiaries retained their jobs and continued to receive their salaries. There was no explanation why salary deductions and loan repayments were suspended.

Little effort has been made in recent months to try efficiently to collect delinquent loans. One advisor will endeavor to assess the extent of the bad loans and to guide the Bank in enforcing the collection.

Risk Management

Risk Rating (Classification) Until recently loans and facilities were not rated according to International Standards. Nevertheless, a recent instruction from the Central Bank of Iraq has directed banks to perform the ratings. The advisor explained to the Bank how to proceed and coached the Bank in its effort to enforce this recommendation. A database has been designed and installed to accumulate and sort all loans, based on dictated criteria, into a range of risk ratings (classifications). This new Risk Management tool has been tested and samplings used for this Assessment, and classification of loans has been partly completed. It may take several months in view of the large number of loans but should become a routine credit management report.

Risk Diversification The Bank does not know its exposure to any one industry. Therefore, no assessment of risks associated with any business type can be measured. No information is available about concentration of debt to a single business type. There is some evidence that at some time in the past there may have been an attempt to gather this information, but no one appears to have expressed a need for it.

Loan Reviews The Credit Department maintains strict control of documentation and collateral. No disbursement of funds takes place until all prerequisites of the loan are completed. Unfortunately, after funding there is no follow up and control to ensure that loan funds are actually being used for the intended purpose.

Once a loan or facility is approved, there is no further attention paid to the credit unless it either becomes delinquent or the borrower makes a new request. Facilities secured by real estate may go five years without a review of the borrower. There are no periodic reviews of the portfolio to assess the ongoing quality of loans. Additionally, there is no requirement that the borrower provide financial information periodically which could be used to make an assessment of his current situation. This makes it impossible to measure risk factors in the portfolio. When asked about this situation, it was suggested that, with the amount of real estate collateral taken, there ultimately is no risk in the portfolio.

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4.2.2.3 Bad and Doubtful Debts – Loan Recovery

Delinquent Loan Collection Procedures of Rasheed Bank

Rasheed Bank has developed over time a method of administrating delinquent loans. It is based on the model created by its predecessor, Rafidain Bank, and has stayed very similar with only slight variations. These procedures are established by tradition and have never been put into a comprehensive written form. This means that there is no documentation to judge the performance of handling delinquent loans, and there is no ability to assign responsibility for specific actions. Also, procedures are changeable without notice or review. Annex O, Rasheed Bank Debt and Delinquencies, states outstanding loans by department. The Annex also differentiates between Government and Private Debt. A summary review of this annex demonstrates that overwhelmingly the major source of delinquencies is from the Iraqi Government. Since the decisions regarding handling this debt are political, no analysis was made of this portion. Also, review shows that a large percentage of the Private Debt is severely delinquent. Since the progress of the economy of Iraq in the future will be more dependent on private development, this issue is addressed more thoroughly.

Branches The branches of Rasheed are responsible for originating loans and facilities. Each debt is assigned to a lending specialist, who is supervised by the branch manager. Subsequently, if a loan becomes delinquent, the specialist assigned to the credit has the primary responsibility of collecting and resolving the debt. This responsibility remains with the branch. Purportedly, in some branches there are staff members whose primary responsibility is to contact delinquent borrowers and to persuade them to make payment on their debts. Collection activities at the branch level ceased during the recent hostilities, and branches have only recently restarted their collection efforts. There has also been an attitude among borrowers that debt incurred before the hostilities began would be forgiven by the new Government. These factors have led to a situation where loan delinquencies have greatly increased. The Bank has attempted to allow easy restructuring of debt when a borrower makes a request to settle. However, there has been only limited success to date in rescheduling or refinancing installments. The branches are responsible for negotiating restructures of loans and facilities. The approval is either endorsed by the General Manager of the Bank, or goes through the single loan committee process like any other credit request. There is no real delegation of authority through the Bank. With so many delinquencies, it appears this is not an efficient way to handle approvals.

International Department One foreign loan is carried in the International Department of Rasheed. This loan is in the amount of USD 12,795,393.56 (IQD 18,681,274,548) and was made to the Ministry of Finance. It was originated as a back-to-back loan undertaken by Rasheed Bank from the Gulf International Bank, Bahrain on behalf of the Ministry. The loan to the Ministry of Finance mirrors the terms of the Gulf Investment Bank loan. The loan was extended in 1990 with a maturity of 1993. The loan is 12 years overdue and is therefore severely delinquent. A corresponding claim by Gulf Investment Bank was located in the Paris Club claims of creditors. In this instance, it appears that the Ministry of Finance has assumed the liability of Rasheed Bank. If this is verified, this loan should no longer be carried on the books of the Bank, as it will have been resolved.

Credit Department The responsibility for current and performing loans lies with the Credit Department. It maintains the files, and assures that documentation for the client is maintained. When a loan or facility reaches a delinquency of 90 days, either in its final maturity, or in a scheduled payment, the Credit Department is supposed to turn over the file and all documentation to the Settlement Department. At that time, the Credit Department relinquishes all responsibility for the debt. This procedure is not strictly adhered to, and several loans exceeding the 90-day delinquency remain with the Credit Department.

Loans are only segregated when they become past due. There is no mechanism for reviewing the loan portfolio on a continuing basis to identify problem loans before they become delinquent. Also, the Bank does not require the ongoing collection of financial information on borrowers and guarantors, required to make any review effective. Recently, an advisor has started a rating system for loans

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based on the perceived quality of the credit. Currently, this is being attempted with the very limited information at hand. This could be a first step in quantifying risk in the loan portfolio.

Credits issued to Government ministries and to Government owned entities are not transferred when they become 90 days delinquent but are maintained in the Credit Department. The Bank awaits the issuance of orders regarding these credits from the Ministry of Finance, so there is no active collection activity ongoing for these debts.

The Credit Department, with 78 employees, maintains the records on 14,899 delinquent loans (90 days or more), totaling IQD 16,804,597,777 (USD 11.5 million).

Settlement Department The Settlement Department receives the borrower’s file when it is transferred from the Credit Department. The Settlement Department operates as a part of the Legal Division of the Bank. It is charged with maintaining the documentation files from the Credit Department, and it also sends out a series of letters to the delinquent borrowers, requesting repayment and threatening legal action. This Department also determines when a debt should be moved to the Legal Department for litigation.

A further responsibility of the Settlement Department of Rasheed Bank is to report all Past Due loan information to Rafidain Bank and to the Central Bank of Iraq. The report contains all borrowers and guarantors who have been reported by the Credit Department who have become delinquent (90 days) on their debt. The list is not sequenced alphabetically, and there are no identifying criteria, other than the debtor’s name. Since the Credit Department has not been strictly adhering to the 90 days past due criterion, not all credits falling delinquent by 90 days are reported.

Before any form of credit is extended, the branches check to ensure that the borrower is not delinquent on another loan. Over several months, literally thousands of loans are put in the monthly reports. Since there are many similar names in Iraq, sometimes the name is missed on review, and at other times a creditworthy borrower can experience problems in obtaining credit when his name is similar to that of a delinquent borrower. It is the borrower’s responsibility to prove that he is not the delinquent party. This creates a system that is cumbersome at best and unworkable at worst. In addition, when a borrower pays his outstanding delinquency, the Collection includes this in its monthly report.

When a loan is moved to the Settlement Department, and a borrower wants to negotiate a restructure, he must contact the Originating Branch, the Head of the Settlement Section, or the Head of the Legal Division. After a successful negotiation, a presentation will be prepared recommending the restructure, which will then be directed to the Director General of the Bank for approval. The Director General will either act on the request or will require that the request be sent to the Loan Committee for further review and action.

The Rasheed Settlement Department currently employs 19 people. It is responsible for approximately 1994 loans for a total amount of IQD 4,182,541,071 (USD 2.9 million). Over the last two years, the Settlement Department and the IT department have been developing a database to identify and track delinquent credits. Currently, the database is operating, and about 80% of the subject credits are loaded into the system.

The Settlement Department does not account for the whole amount outstanding on the delinquent credit. It does not maintain information on the amount of delinquent interest outstanding on the loans. It does not record the interest rate on the loans. When asked why this was not done, the response was that the branch was responsible for the interest, only the principal was the responsibility of the Settlement Department. There was no explanation as to how the Settlement Department and the branches interact to facilitate the collection of delinquent debt.

Legal/Litigation Department If the efforts of the Settlement Department and of the branch to collect the delinquent debt are unsuccessful, and there is collateral, the loan is forwarded to the Legal Department (a department of

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the Legal Division), which employs 28 people. In instances of loans made in the past, prior to 2003, where occasionally collateral was only a third party guarantee, such cases are not forwarded for litigation. The Legal Department is responsible for initiating the litigation required to sell the collateral. During the recent conflict, the courts were not operating, and no loans were referred for legal action. Now the courts are operating and the Legal Department is initiating litigation with delinquent borrowers. Currently, the Legal Department has active cases involving 948 delinquent loans, totaling IQD 1,745,307,723 (USD 1.2 million).

There are defined criteria for moving credits from the Settlement Department to the Legal Department. When a credit has been restructured, either by the Branch or by the Settlement Department, and the borrower defaults on the restructure by three payments, the credit is supposed to be automatically sent to the Legal department. Also, if the credit is secured by collateral, and the Settlement Department and Branch cannot establish contact with the borrower, the loan is transferred to the Legal Department. It was not determined how strictly these procedures are adhered.

The Legal Department then proceeds to begin litigation or foreclosure against the borrower’s collateral. If the borrower establishes contact with the Bank after this point, negotiations are handled either with the Head of the Legal Department or with the Head of the Legal Division. If an agreement is reached between the borrower and the Bank, a written presentation detailing the terms of restructure is prepared. The Director General of the Bank then reviews this and either approves or denies the request. If the DG desires, this presentation may be delivered to the Loan Committee for its input.

Rasheed Bank Debt and Delinquencies by Department (as of October 31, 2005)

Department # Loans # Loans Past Due Principal Balance Principal Past Due

Settlement 1,994 1,994 4,182,541,071 4,182,541,071 Legal 948 948 85,916,732,334 85,916,732,334 International* 1 *** 1 18,681,274,548 18,681,274,598 14,899** 6,715 34,273,121,442 16,804,597,777 Credit 12 *** 12 226,756,184,784 226,756,184,784

Total 17,845 9,670 369,809,854,179 352,341,330,564

Numbers for different areas of the Bank were collected from the various departments handling the debt. These figures do not reconcile with other reporting areas of the Bank.

Loans defined as loans and facilities.

All amounts converted to IQD equivalents.

* This loan mirrors the terms of a loan payable by Rasheed Bank to Gulf International Bank, Bahrain. The loan receivable is to the Ministry of Finance as the Bank made its loan from Gulf Bank on behalf of the Ministry. No efforts are being made to collect this debt by the Bank. Possibly, Rasheed’s original note payable has been assumed by the MoF.

** Private Debt *** Government Debt **** 111 out of 115 Branches

Bad Debt and Delinquencies Results and Data Collection

As a part of the assessment of Delinquent Loans, a database was established in order to collect data on all individual delinquent loans. The concept was to develop a representative survey of loans on which

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accurate conclusions could be reached. Originally, the database was designed to take approximately 44 pieces of key information on each loan. In interviewing the Bank, it became apparent that this would not be obtainable. Therefore, the information was cut down to 8 vital items. None of the areas that handle delinquencies had the information readily available, so each area was required to create as large a sample as possible. In reviewing the results, it was found that there were many errors in the input of this data. Whether this was caused because individual data was not available or because people doing the input simply did not furnish the information was not determined. In any case, this demonstrates the inability of the Bank to provide accurate information on their loan portfolio.

Not all branches responded to the requests sent for information. Many of the branches that did respond failed to complete information as requested. In reviewing the inputted data, there are many obvious errors in the material. This indicates a lack of ability to accumulate and report accurate information on the delinquent loan portfolio. This of course impairs the ability to make an accurate analysis of the portfolio. Records indicate that there are currently approximately 9,670 delinquent loans (loans and facilities) at Rasheed Bank. Of these, 2,181 loans were loaded into the database. A sample of 590 was deemed to be accurate enough to be placed into review. The only criteria for a loan being put into the sample were that it appear to have complete information furnished and to have no obvious errors. Under this circumstance, no accurate analysis can be expected. However, certain observations of the included final data can be made.

Whenever reviewing Delinquent Loans, it is important to review initially the quality of loan origination. When reviewing loans originated after the recent conflict, there did not seem to be a great number of delinquent loans. Upon direct inquiry at the Bank’s Credit Department, the analyst found that this was not the case. Approximately 20 percent of the loans and facilities made since the conflict were estimated to be delinquent. These loans, however, were not directly impacted by the conflict. If the Bank is experiencing this rate of delinquencies in its current lending program, it can be expected that loan delinquencies will be a major problem in the future.

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4.2.2.4 Operations, Automation, and Human Resources

Operations

A review of the Operating Units of the State-owned banks revealed similarities in the administration and control of their duties and responsibilities. An Sample Assessment Questionnaire was supplied to six Department Heads of each State bank. These departments were: Accounting, Credit, Operations, Human Resources, Audit and IT. The purpose was to obtain a general perspective on the various important segments of the Bank. The sample questionnaire is shown in Annex B and a summary of replies are provided therein.

The Board of Directors provides general oversight of the Bank. As 80% of Members are senior bank staff, this facilitates feedback to the operational areas. This arrangement, however, does not provide a variety of outside experience and views. The ability of management to adapt has been limited, due to political and economic constraints. Management needs to be trained in general management principles, so that it can provide clarity and direction for all elements of the Bank to work together.

The Bank could use some improvement in defining the Table of Organization, top to bottom. Other than Department Heads, most sub-units appear to lack formal clarity as to where they are positioned in the Bank structure. Bank Operations’ organizational design could better demonstrate the “chain of command” and help to clarify position responsibilities. However, until back office functions come on line with automation, any design structure at this time would be only temporary. A massive “process flow and re-engineering” effort needs to be planned and implemented. This effort will help to sort out redundant positions, a prerequisite for staff reduction.

Policy and Procedure manuals should be standardized through out the Bank, in order to improve understanding of job requirements. The Bank’s Internal Auditors currently review areas at least annually for compliance with existing Policy and Procedures.

Job Descriptions detailing employee duties and responsibilities need structure and standardization. Frustration and lack of self-worth can result when an employee does not understand what is expected of him in the performance of duties. This need is greatest at the lower levels of the organization.

Compliance with existing internal controls and policies is adequate, but those internal policies and procedures are not up to date, and are in need of modernization and documentation.

All reports are scheduled on a timely basis, the internal report by the 3rd of each month, and the report for the Central Bank by the 10th of each month. However, this process throughout the Bank is manual, causing the work to be duplicated and delayed till end of the following month. There is a need for automating the production of all reports at the Bank.

Internal as well as external auditors from the Supreme Audit Board, the Central Bank and MoF regularly audit the bank. As a matter of bank policy, all audit exceptions are resolved within 30 days.

Senior management, an older generation of bankers who at one time were relatively well trained and experienced, has had no training or exposure to modern banking techniques for 25 years. These managers are “good bankers” but are now out of touch with modern banking systems and techniques. Additionally, middle management has had no formal training due to the history of political and economic difficulties. Managers are aware of this gap and actively request management training.

Overall compensation has not been based on performance and is administered by the Ministry of Finance. Promotions are based on longevity, not on performance.

Organization Structure Two of the thirteen Department Heads report directly to the General Manager. The other eleven report to “Experts” or “Deputies”. This is an acceptable ratio so as not to unduly burden the General Manager.

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The individual’s reporting relationship is not well defined. There are far too many layers of management. Key is the role of the internal auditor and his reporting relationship with the Board of Directors. It would be more appropriate for the internal auditor to report directly to the Board of Directors to avoid any conflict of interest and maintain independence.

Operating Procedures The Bank has operating procedures documented, but these have not been updated. There does not appear to be significant “information sharing” among the Operations Managers and their staff.

Process All processes for products such as current accounts, savings accounts, time deposits, loans, etc. are being performed manually and are often duplicated. There is a great need for streamlining and automating these processes. The process levels, i.e. the number of people utilized to finalize a process, range between 4 and 5. All processes should be handled and finalized by only two people and, in the case of tellers, by only one person (up to an authorized limit). Some branch operations staff is moving in this direction. The objective is to avoid a “check the checker” scenario.

Forms Forms used for processes either do not facilitate easy processing or would not be useful in an automated environment. They need redesigning in preparation for automation. Currently, forms are completed manually with carbon paper being used for generating duplicate copies.

Branch/Main Office Communications Current communications between main office and branches are by means of fax, messenger or phone. These methods are time consuming and prone to errors. There is a need to establish on-line “due to” and “due from” accounting and advising for better control and timely processing.

The working conditions at the Bank are presently fair to poor. Difficult working conditions are exacerbated by the intermittent power outages during the workday. Workspace seems to be at a premium, perhaps due to over-staffing. Rasheed Bank has an open-office environment in the Credit area and has 35 employees crowded into one room. Most employees appear to be underutilized.

The risk profile is inadequate due to physical security. Branches do not possess any sort of deterrent to discourage or capture perpetrators. Specifically, dye packs, bait money, cameras and police hook- ups are not being utilized. Cash appears to not be well controlled, and it is easily accessed. In several instances cash was both visible and unprotected. Money should be key controlled.

Records retention capability is negligible. Should a fire or flood impact a branch, records retrieval would be very difficult, if not impossible. A typical disaster recovery program involves having an IT person take diskettes to his home. This poses risks to the employee, as well as to the Bank, of theft, duplication and ransoming. The Bank should have a written recovery program that describes, in detail, action to be taken in the event of a disaster, and the program should be tested periodically.

Safety deposit boxes are not available at branches. They are available at the home office, suggesting that customers do not trust the security status of the Bank and therefore have no need for such a service. People still prefer to have physical control of their money.

All staff members interviewed appeared to have a positive attitude towards their work and were looking to change for the better. Despite the difficulty of the past few years and oppressive bureaucratic environment, most staff maintains good moral.

Automation

An Operational Questionnaire documents the fact that some very basic support is provided by IT to various units of the Bank, including Human Resources, Credit, Operations, Audit and Accounting. Isolated attempts to automate some functions were made, but they were soon abandoned.

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The Bank does not have a centralized database, needed to support essential back office settlement and accounting processes.

The Bank lacks the capability to perform central processing, which would involve all financial transactions, customer data and other data flowing into the system, captured and passed to the central database for reporting and analysis.

The Bank does not have an application that would give it the ability to view a customer’s account in real-time. The need is for the Bank to view products, accounts and transactions, by customer, within the application to be able to generate reports expeditiously.

Typically, a large bank such as Rasheed needs to install software with fully integrated modules that cover business needs. Applications would be needed for Retail Banking, Lending, Transaction Processing, Treasury, General Ledger, MIS, Customer C.I.F., Accounting, Report Query and Report Generation. These applications entail the managing of the Bank’s accounts, including receipt of funds, disbursement of funds, and collection of payments into an automated General Ledger for balancing.

The Bank does not provide a Bank-wide Automated Transaction History file. It does provide, on a limited basis, this information at the activity branch. A Bank-wide capability would be necessary to document financial transactions on the system and to allow the Bank to maintain a complete record of all transactions across all accounts for customer service and problem resolution. The system should update the Transaction History file in real-time, as transactions are performed at any branch.

Access to data throughout the bank is not made available immediately to business units. Due to the real-time requirements, once an update takes place, the data should be made available to users.

No capability exists for a “Branch Bank” network, with terminals at all branches throughout the country, utilizing duplicate General Ledger Accounts. This “connectivity” would enable staff to enter remote transactions into the system for monitoring and reporting at a central location.

No capacity exists for monitoring “Branch Bank’s” Credit portfolio in order to capture, review and analyze Bank disbursements, collections and delinquency. For example, no billing statements are mailed, but rather, the customer is notified telephonically that his payment is due. This is expensive and labor intensive.

The absence of automation precludes establishing a sophisticated security level for the data processing area, with controlled access, including firewalls, and accompanying policies and procedures. Most IT is only password protected, with the IT area under key control.

No “connectivity” exists between the branches and the head office. Telephone, fax and messenger are used to communicate data entries to General Ledger (weekly or semi-monthly), loan and savings histories.

Computers are very few in number and often are antiquated. In some instances, computers are allocated one per department or as many as three to a branch. Most computers are installed with Microsoft Word and Excel, but these are used mostly as electric typewriters. Some desktops are used as stand-alone processors with information loaded onto a disk and manually transported from one site to another. Often, the computer is simply sitting on a desk with little use.

Computer skills of Bank staff range from “poor” to “adequate”.

Automation impacts all areas of the Bank, and as the Bank’s customer base grows, more emphasis will be placed on this area to improve efficiencies and meet the needs of both customer and employee.

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Human Resources

The Human Resources Unit of the State-owned banks exhibits control over its area of responsibilities. Personnel Files are maintained under key control, and only limited access is allowed. The Bank’s Human Resource Departments maintain a checklist of the documents held in the file, and the list is used to keep control when documents are needed to be withdrawn from a file. While original Personnel Files are maintained at the head office, copies are distributed to branches, for servicing. Some retiring employees have boxes of records to be stored by Personnel, documenting the individual’s long career at the Bank. The average tenure of Managers surveyed was over 20 years. There should be opportunities to bring new and innovative ideas to the work environment.

Management stresses confidentiality, and it comfortable that it is maintained, when required.

A typical Human Resources Department has responsibilities for basic management tools, including these: Table of Organization design, writing of Job Descriptions, standardization of written Policies and Procedures, and a wage and salary administration program. These disciplines are not well defined at the Bank. Also, formal training programs for staff do not exist at the Bank.

According to some Personnel Managers, the functions should be differently allocated among departments. For example, employee loans should be maintained and managed by the Personnel Department instead of by the Credit Department. Another suggestion is that the Administration Department be separated from the Human Resources area. These ineffective relationships point out a need for dialogue and a vehicle to present these recommendations.

The Bank is overstaffed, due largely to the lack of automation with 6500 employees in 144 branches. It is estimated by Managers that the Bank is overstaffed by nearly 50 percent.

Official Hiring and Terminations are presented and reviewed by committees. However formal approvals are made by the MoF. A manager can recommend the termination of an employee by notifying the MoF, which, in turn, notifies the employee that he or she is terminated. As advised, termination is a rare occurrence. At the present time, there is a “no hiring” policy and as attrition impacts the staff complement, responsibilities are spread among remaining staff. Previously, Bank vacancies were placed on bulletin boards or communicated within the community verbally. Salaries and Promotions are established by “law,” and an employee may work many years only to have a newer employee equal or surpass the tenured employee in salary.

Managers realize that they need a more efficient system to maintain and support the large number of employees. Attempts at automation were largely unsuccessful in the past and some effort is being made at least to reduce workload though computerization.

Staffing numbers and salary distribution by branch and by head office are set out in detail in Annex D. The chart identifies areas noted for review and assessment. It is interesting to note that the two largest banks in Iraq are very similar in structure. Rasheed and Rafidain have almost the same number of branches, have almost the same number of staff members, and have a similar breakdown of number of staff members (in branches and in head office).

Furthermore, salaries paid to staff in head office and Branches are almost identical. As pointed out by an employee of Rasheed Bank, “Rasheed and Rafidain do not compete, they imitate one another”. Average head office employee monthly salaries at the banks are almost the same. This could suggest that salaries are set and applied universally by the MoF, i.e., there is no pay-for-performance program. Salaries appear to be “imitated” rather than developed on the basis of market competition, which provides no incentive for employees to improve performance.

Management Oversight of the Bank by the Board of Directors is direct and effective, as 80 percent of members are senior Bank staff. Management should provide clarity and direction to senior staff so that all elements of the Bank move in concert.

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Furthermore, senior management is relatively well trained and experienced. However, middle management has had no formal training, due to the past twenty-five years of political and economic difficulties. Functional Managers are requesting management training, and those interviewed have an average of 20+ years of experience on the job. This constitutes a mature staff to build around, and skill levels should be high. However, those with 20+ years of experience tend to be set in their ways and tend not readily to accept change.

The composition of the Board of Directors of Rasheed Bank is as follows:

RASHEED BANK BOARD

Member Name Position Location 1 Abdul Hadi Sadiq Abdul Mehdi General Manager Rasheed 2 Fuad Kadhim Al Wakeel Expert Rasheed 3 Abdul Razaq Mohamed Araibi Expert Rasheed 4 Kadhim Mohamed Nashoor Expert Rasheed 5 Khaleel Murtaza Deputy General Manager MoF 6 Hussein Ali Qasim Deputy General Manager Industrial Bank 7 Suhair Fadhil Ahmed Head of Credit Rasheed

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______

FINDINGS

RASHEED BANK ______

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4.2.3 FINDINGS – RASHEED BANK

4.2.3.1 Accounting and Reporting – Financial Condition

ƒ The Bank does not conform to generally accepted accounting principles (IAS, GAAP), including those of the Republic of Iraq, which has adopted versions of several International Accounting Standards (IAS). Accordingly, financial statements are lacking and deficient in data integrity, accuracy, and transparency, and in the representation of their fair value. ƒ The Bank does not follow the international banking standard of accruing income and expenses in standard, universal method Bank-wide, thus understating the Bank’s results throughout the year and making reconciliations difficult if not impossible. ƒ The Bank’s accounting function is decentralized throughout its entire 144 branch network and in the head office as well. Reporting is fragmented and duplicated between the International Division, IT department, and the Financial Division. Coordination among different areas is lacking, preventing reconciliation of Off Balance Sheet accounts and interbranch accounts. ƒ There is a lack of analysis, comparison, verification, checking, and balancing of accounting transactions and records. Furthermore, the need for an automated, reliable, and timely Management Information System is largely unfulfilled. Essentially, the accounting function/system is nothing more than a manual “bookkeeping system”, absent sufficient management attention and involvement. Divisions and sectors operate independently, to the detriment of the Bank. ƒ Problems exist within the financial infrastructure, wherein the Central Bank of Iraq is evidently unable to provide sufficient regulatory oversight through offsite or onsite examinations or to exert adequate authority or penalties to force the Bank to comply. Similarly, the Supreme Audit Body apparently has no effective influence to bring about compliance through its audits. ƒ Management oversight appears to be lacking in the operations and accounting for the Foreign Office Branches. The records of these offices need to be reconstructed and reconciled with the main office. ƒ Decision-making is hampered by the lack of a proper, automated, timely, and reliable management information system to allow management to identify discrepancies, risks, trends, foreign currency exposure, asset quality, profitability, etc. ƒ The Bank has a concentration of deposits and risks centered with Government accounts, and this has prevented diversification, has impeded broadening the resource base, and has hindered the ability to press the Government client (Bank’s 100% shareholder) for repayments. ƒ The Bank’s branch network is comprised of many branches that are not generating sufficient loan income or deposits to justify their existence. Investing the capital amounts locked up in old unprofitable branches instead in the financial markets would generate more revenue with no personnel, administration, or premises costs. ƒ Accounting, operations, and branch units are significantly overstaffed. Staff lack relevant technical experience, and require training and motivation. ƒ The Bank is technically insolvent (see analysis above), and serious consideration is to be given to continue the support or additional capitalization (which will be imperative).

4.2.3.2 Credit Management and Policies

ƒ Rasheed Bank’s current lending program is based strictly on collateral lending. Little is done to encourage clients to provide detailed financial information. Under these conditions, availability of credit is limited to borrowers who have access to large amounts of real estate. ƒ Although staff members seem to understand the necessity of switching from collateral based lending to cash flow lending, management has not taken any steps to change current policies.

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ƒ Additionally, Rasheed’s current practices do not allow it to monitor risk in its loan portfolio, nor aggressively to collect delinquent loans. This introduces a basic risk to the stability of the Bank. ƒ Credit reports for management are one-off, non-standard and done manually on request, rather than standard, automated reports generated directly from the accounts. ƒ The existing loan policies and procedures for Rasheed are summary and incomplete and far from International Standards. They do not clearly identify the goals and objectives of the Bank in its lending function. ƒ The credit committee concept and approval limits are not effective for market conditions. ƒ Loan origination is centered with branch managers. Though they are generally seasoned bankers, in most cases they have no training in lending. The advisor found that no formal training curriculum exists to train lenders. ƒ Loan administration is poor. The Head Office Credit Department needs reorganization, automating, and modern filing systems. (Credit files, including loan security documents, are maintained in old paper folders, with contents in random order and poor condition). ƒ Technical skills, professionalism, and training are lacking. A dual approach is needed, (1) to develop skills in credit initiation, credit analysis, and credit administration at working levels; and (2) training in credit policies, portfolio management, and risk management for senior management decision-making personnel. ƒ Loan classification showed that many loans considered as current in the Department are in fact past due.

4.2.3.3 Bad and Doubtful Debts – Loan Recovery

ƒ Rasheed Bank suffers from large amounts of delinquent credits, which are primarily a result of delinquent Iraqi Government obligations. No attempt is being made by the Bank to address this problem. ƒ Delinquencies of Private Debt are at unacceptably high levels. Although this may be in part a result of the recent conflict, the problem still needs to be addressed. ƒ Although there is a large increase in delinquencies, the methods of collection, and the resources applied to the problem, have remained static. ƒ Collection of delinquent credits is fragmented, with portions of debt distributed among multiple banking areas. One area does not represent or include another in the process. ƒ The management structure is rigidly departmentalized, with no overriding motivation to solve the Bank’s bad debt problems. Employees have only a narrow view of their specific tasks and responsibilities, without regard to results. ƒ Solutions are not strategic, but instead are one-off and short-term. ƒ Although many individuals in the Bank were most cooperative, the work force is not motivated to do superior work. Throughout the process of gathering data, there was a lack of interest in completing the work; the information provided had many mistakes. Additionally, many branches did not respond to requests for information, or often furnished incomplete or erroneous data in spite of clear direction from management. ƒ There seems to be genuine fear that some delinquent borrowers would react violently to collection efforts of past due debt. This of course hampers collection efforts. ƒ There is a prevailing attitude among borrowers that debts incurred under the prior regime do not require repayment. This view is encouraged by the Bank’s period of inactivity following the recent conflict. ƒ Under current conditions the Bank will not be able to address or resolve the problem of collecting delinquent debt. ƒ Accuracy of data collected is suspect because different sources have different information. The utility of the data is therefore questionable. Although data was sparse and not completely

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accurate through the Assessment and portfolio reviews, the conclusions as to the major problems with a large percentage of delinquencies may still be considered valid.

4.2.3.4 Operations, Automation, and Human Resources

ƒ All transaction processing, accounting, management reporting, and statuary reporting are done manually. There is much duplication of effort. Reports are delayed and unreliable. ƒ All department staff members are underutilized, and there is a very low transaction/staff ratio. ƒ There is no permanent operations manual for standardized procedural guidance for staff. ƒ Cash controls and branch security procedures are weak. ƒ Issuance of an RFP should be suspended; the Bank needs guidance and decisions urgently. ƒ Lack of automation has led to the above-mentioned overstaffing, unreliable reporting, and poor customer service. ƒ The apparent inability of Banks to introduce various banking products and services (ATM, credit and debit cards, online banking) is due to lack of automation and telecommunications. ƒ The Human Resources area of the Bank needs assistance. There are far too many employees performing numerous manual tasks and record keeping. A Bank-wide plan to manage a significant downsizing of staff needs to be well thought out, planned, implemented and monitored. The dismissed staff should be made to understand that the changes are structural, and not a result of their actions. ƒ Human Resources department needs to administer such areas as table of organization design, recruitment, wage and salary, benefits, employee loans, pay-for-performance program, job counseling, training, documentation and transfers, and terminations. ƒ A major impediment to the administration appears to be the involvement of the MoF office in the hiring and termination activities of Human Resources at the Banks. Staff members feel they have no say in certain personnel matters; this removes authority and management effectiveness. ƒ A program to design and develop an updated and automated Human Resources area is needed. ƒ General oversight of the Bank by the Board of Directors is direct and effective as Bank employees fill many of the Board positions. However, 80 percent of Board members are bank employees. The lack of a variety of skills, backgrounds, and views has hampered innovation. ƒ Senior management is relatively well trained and experienced. ƒ Middle management has had no formal training, due to the past two decades of political and economic difficulties, and these people require management training to upgrade skills. ƒ Functional Managers average 20+ years of experience on the job, but require training to upgrade and update their technical banking knowledge and skills. ƒ The two most often requested needs stated in response to assessment questionnaires were automation and training. ƒ The Bank’s senior management structure is male dominated, however, a majority of all Bank positions are held by women.

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______

ANNEXES

______

______

ANNEX A

Rafidain Bank Financial Condition and Viability Report ______

Annex A

Rafidain Bank Financial Condition and Viability Report

Introduction

This report determines the financial condition and future viability of six (6) State-owned Banks, excluding the Trade Bank. The purpose is to obtain information and data and present it in a format to assist the Government of Iraq to determine the need for restructuring, including the prospect of liquidating all or some portion of the State-owned banks.

The scope of our work was based upon a review of available financial reports prepared by the Bank as of December 31, 2004. We gathered additional data where available or provided by Bank staff, and recorded adjustments to this information based upon “international best practices”. We applied International Accounting Standards (IAS) concepts where possible.

This report is not an audit of the financial statements of the Bank, or an evaluation of its systems of internal controls. Because of the Bank’s method of accounting, the integrity of all reported information should be viewed skeptically as to its proper accounting classification, amount recorded, the accounting period reported in, and accuracy.

Restated financial statements and other data are presented at the end of this report as the following Exhibits:

I. Consolidated Statement of Condition (unaudited), II. Foreign Branch Offices Consolidation (unaudited), III. Consolidated Statement of Income (unaudited), IV. Adjusted Consolidated Off Balance Sheet (unaudited), V. Comparative Balance Sheet (unaudited), VI. Comparative Income Statement (unaudited), VII. Consolidated Statement of Condition with Journal Entries (unaudited), VIII. Consolidated Income Statement with Journal Entries (unaudited), IX. Adjusting Journal Entries, X. Comparison of Branch Locations, XI. Branch Listing by Direct Net Income (Loss), XII. Branch Loan Balances in Descending Order, and XIII. Total Branch Deposits in Descending Order XIV. Pro forma Statement of Condition.

Background

In order to better comprehend and understand the nature of this report, it is necessary to understand the following characteristics of the Bank’s accounting function and system:

Accounting Principles

The Bank is not conforming to any generally accepted accounting principles (GAAP), including those of the Republic of Iraq, which has adopted versions of several International Accounting Standards (IAS). Accordingly, financial statements are lacking and deficient in data integrity, accuracy, and transparency, and in the representation of their fair value.

Accrual Accounting

Accrual accounting is an underlying assumption of financial statements, prepared under IAS and GAAP, of various countries. Rafidain Bank’s accrual accounting is on a limited basis, i.e., the accrual of Treasury bill income and savings interest expense at year-end. A few branches do accrue some loan interest, but it is minimal. Specific examples of major accrual problems are mentioned within the report.

Loan Overdraft Facilities granted by the Bank are reviewed each quarter, and interest is calculated for billing purposes, but not accrued in the proper accounting reporting period. Rather, it appears to be recorded on a cash basis, and if the customer does not pay the interest due, it is “capitalized”, that is, added to the customer’s OD Facilities Loan balance.

Systemic Weaknesses of the Accounting Function

The Bank’s accounting function is dysfunctional and decentralized throughout it entire branch network of 142 branches and within the head office. It is also fragmented within the main office as described later in the report, between the International Division, the Foreign Branch Affairs Sector, and the Financial Division. There is insufficient coordination among these areas to reconcile data and information regarding Off Balance Sheet items and the foreign branches. Reconciliation of accounts is mostly nonexistent, and where attempted, ineffective.

There is a lack of analysis, comparison, verification, checking, and balancing of accounting transactions and records. Furthermore, the need for a Management Information System is largely unfulfilled. Essentially, the accounting function/system is nothing more than a manual “bookkeeping system”, lacking sufficient management attention and involvement. Divisions and sectors operate independently to the detriment of the Bank. When the International Division submitted off balance sheet totals of IQD 11.5 trillion, which were incorrect and not revalued, the accounting staff and senior management were queried as to why this error wasn’t discovered and corrected. The response was that it is the responsibility and the job of the International Division, not the Financial Division.

Problems exist within the financial infrastructure, wherein the Central Bank of Iraq is evidently unable to provide sufficient regulatory oversight through offsite or onsite examinations of the Bank. Similarly, the Supreme Audit Body also appears unable to provide significant oversight and findings through its audit of the Bank.

ii

Findings

Assessment findings regarding the financial condition and future viability of the Rafidain Bank are presented below. Focus is initially on the negative capital position of the Bank, and then the information and details that contributed to this situation are provided.

Bank Capital

According to the Bank’s records as of December 31, 2004, the amount of capital was recorded as:

Paid in Capital 4,000,000,000

Capital Reserves 28,639,240,000

Reserves Research and Development 912,473,000

Social Reserves 716,999,000

Total 38,801,408,000 IQD

Based upon adjustments made as of December 31, 2004, adjusted total capital and retained earnings as depicted in Exhibit I, Consolidated Statement of Condition (unaudited), is a negative 66.4 trillion IQD, or $45.5 billion. This reflects balance sheet liabilities of 72.1 trillion IQD and assets of 5.7 trillion, thereby resulting in the insolvency of the Bank.

A brief description of the major adjustments that reduced capital is as follows:

1. Recognition of revalued Off Balance Sheet liability items which, are considered a legal obligation of the Bank, as there are no assets or contra parties to offset these liabilities. -45.3 trillion IQD

2. Revaluation of monetary assets and liabilities denominated in foreign currencies. (Many accounts were valued at 1 IQD = $3.21.) -10.4 trillion IQD

3. Accrual of past due interest for direct foreign loans and rescheduled agreements accumulated for approximately the past 25 years -9.9 trillion IQD

4. Reduction of confiscated and blocked accounts from 1991 and 2003 still recorded in the Bank’s records. - 900 million IQD

5. Increased capital by eliminating the Bank’s net overdraft to foreign banks, going back to 1991. +1 trillion IQD

Exhibit IX Adjusting Journal Entries and further discussions in this report provide more details regarding these adjustments. It was first necessary to revalue the Bank’s investment listed as 9,153 IQD, in its foreign branch offices. Then, through the consolidation process this amount was eliminated from the investment and capital accounts.

iii

Foreign Debt Liabilities

Since the 1980s, the Bank has borrowed significant sums of money, oftentimes with the Bank listed as the legal borrower with the CBI as guarantor of the loans. Most of these government directed borrowings were granted by foreign banks in the mid 1980s and have not been repaid, and the Bank has not accrued interest payable on these loans. The loans and agreements have been rescheduled on various occasions, but not repaid. Further exacerbating the economic environment was the 1991 embargo and the military conflict of 2003, which resulted in the confiscation of the Bank’s foreign correspondent bank accounts.

On Balance Sheet

The International Division has provided us the following information regarding foreign debt:

• Direct Loans Past Due – principal of 1,284,563,873,180 IQD and interest due of 967,730,868,120, and

• Rescheduled Agreements – principal of 7,791,331,045,269 and interest due of 8,945,181,545,120,

As depicted in Exhibit I, these amounts are recorded in the financial statements in account 2418, Past Due Long-term Loans for 9,075,919,502,000, and in account 26631, Accrued Interest Payable Foreign Loans and Rescheduled Agreements for 9,912,912,413,000. The above amounts are slightly off, due to rounding differences.

Off Balance Sheet (OBS)

Other past due foreign long-term debt is recorded Off Balance Sheet, Exhibit IV, but Bank senior management tells us they are a liability of the Bank.

• Overdue Promissory Notes – account 1943, principal of 2,521,132,816,249 and interest due of 501,261,705,768, and

• Overdue Loan Contracts – account 1945 or 1946, principal of 3,238,055,627 and interest due of 540,514,847,173.

The total of the above interest payable amounts to 5,280,309,934,419 and is less than the amount depicted in the OBS account 1942 as 5,748,890,763,000 (2,521,132,818 + 3,238,055,627). For the Overdue Loan Contracts, interest payable has not been calculated for some significant loan balances.

Revaluation of the above loans was tested, and numerous errors were found in the methodology used to calculate the revalued amounts. Therefore, these were redone at advisors’ request. It seems appropriate to consider recalculating the accumulated accrued interest payable amounts to ensure their accuracy.

During the course of the assessment, Bank staff provided several different versions of the OBS, with totals initially of 11.5 trillion IQD, and including the foreign branch offices amount, which was the amount reported in the Annual Report to the Minster of Finance. After questioning the validity of this amount, several additional versions were presented, ranging from 15 trillion to 27 trillion. The International Division staff said they did not revalue all the items denominated in foreign currencies and listed on the OBS, as the computer was unable to do the calculations!

Advisors have been working to obtain accurate data in this area since the last week of June 2005. Adjusted OBS total is 45.3 trillion IQD and does not include the 4.2 trillion IQD inventory of Unused Travelers Checks, which the Bank issues.

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Two (2) major adjustments accounted for the determination of the amount of 45.3 trillion IQD.

1. Accounts 1922/2922 represent the Bank’s obligations for Foreign Letters of Guarantee (LOG) and were initially listed as 5.2 billion IQD based upon the old Dinar rate of $3.21. The new revalued amount, including a small portion from the foreign branches, amounted to 24.3 trillion IQD. This amount was not included in the initial Bank-wide revaluation. Ninety-five pages of documentation were provided, listing data for approximately 4,000 foreign currency LOGs to support this adjustment.

2. Sometime in the past, the Bank made a policy decision to transfer Letters of Credits (LOC) indebtedness to various domestic branches of the Bank. Confusion exists within the Bank as to which Division should account for these items. It appears it is the branches’ responsibility, but it seems they are not properly accounting for these items, and neither the International nor Financial Divisions review this area. It appears these LOCs were not revalued or included in the Bank’s consolidated financial statements.

These LOCs are categorized as: a) public sector, which amounts to 9,293,475,654,640 IQD and b) private sector, which amounts to 626,016,230,400 IQD, a total of 9,919,491885,040 IQD. Information provided details the various terms of the LOCs, and there are nearly 33,000 outstanding items dating from 1981 though 2005. This information was presented as of August 31, 2005.

These two adjustments approximate 34.2 trillion IQD, or approximately $23.4 billion. Based upon the assurances of International Division senior management that the above items are liabilities of the Bank and are not included elsewhere in other accounting records, we have included all OBS items as adjusted, totaling 45,382,315,174,000 IQD or $31.1 billion, in the balance sheet as past due liabilities.

It is important to note that no accrued interest payable has been calculated for these items, and a determination must be made as to what extent the Bank will be liable for such interest. This amount should be calculated to determine the potential liability. In previous examples cited above, accrued interest has been greater than the principal amount.

Ernst & Young provided a listing of approximately 33,000 legal claims against the Bank. The various claims were converted and obtained a total amount of USD 21,270,497,455.

At advisors’ request, the Bank’s Legal Division provided a listing of pending litigation against the Bank as of June 2005. There are approximately 112 pending cases, with total claims for USD 17,672,964,068.

Overdrawn Due from Foreign Bank Accounts

Accounting records as of December 31, 2004 indicate the balance of this asset account 187 as overdrawn in the amount of 1,007,402,542,705 IQD. In 2003, this amount was approximately 1.8 trillion IQD, and the reduction is unexplained by Bank staff, notwithstanding a reduction of 14% due to exchange rates used.

According to the International Division, the composition of the overdraft is shown as:

Overdrafts per Bank records (824,922,169,959)

Debit Balance per Bank records 543,986,087,835

Balances set-off by correspondent bank (726,497,469,401)

Total (1,007,402,542,705)

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The Bank provided Ernst & Young with a listing of bank account balances prior to the embargo and as of the current date (which we are unable to ascertain from E&Y) this listing represents approximately 300 bank accounts with positive and with overdrawn balances. The Bank computed no totals for these accounts, as they are in various currencies.

According to International Division staff, some of the overdrafts were created by correspondent banks to offset some trade finance transactions which the Bank had not paid. Also, some of the accounts confiscated or blocked are a result of the bankruptcy of the Bank’s London Branch, and as a result of the 1991 embargo and the recent military conflict. The Bank has indicated that some of the accounts confiscated did not belong to the Bank but were accounts of various entities in Iraq maintained abroad such as airlines, ministry accounts, etc.

The Bank has not identified or offset any of its liabilities that were related to setoffs or overdrafts generated by the correspondent banks.

Therefore, to close the overdraft accounts, advisors debited this account and credited Retained Earnings on the assumption that this will offset the liabilities and be resolved at a later date with the Paris Club.

Summary of Foreign Debt

A summary of the foreign debt described above is listed below: (000s) IQD (000s) USD

1. Adjusted Balance Sheet Liabilities: Past Due Long-term Debt 9,075,919,502 Past Due Accrued Interest Payable 9,912,912,413 OBS Liabilities included in balance sheet 45,382,315,274 Unrecorded interest payable – unknown amount Total 64,371,147,189 44,089,826

2. Claims identified by Ernst & Young 31,054,926,284 21,270,497

3. Pending Litigation against the Bank 25,802,527,539 17,672,964

4. Overdraft Liabilities written-off (1,007,402,542) 690,001

As can be seen from the above, total foreign debt of the Bank is unreconcilable at this time. The amount depicted on the Bank’s balance sheet includes approximately 15 trillion IQD of interest, but Ernst and Young claims do not include past due interest, thus narrowing the gap between the two (2) amounts from approximately 33 trillion IQD to 18 trillion IQD. It is possible there is some unknown duplication between the amounts recorded as the Bank’s foreign debt in the attached financial statements, but it will require an in- depth audit of the Bank’s records. However, many of these records have been destroyed or burned.

The U.S. Treasury in Washington D.C. provided the following information regarding USA-domiciled accounts confiscated and paid to account of OFAC (Office of Foreign Asset Control):

• 2003 Period: $428,106,271.60 from Rafidain Bank, and

• 1991 Period: No details by individual bank, but OFAC reported a total of $1,261,426,606.57 for all confiscated/blocked deposits in USA of banks and Iraqi entities.

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Currently DFI (Development Fund of Iraq) is unable to provide us with a listing of amounts confiscated from Rafidain Bank’s accounts worldwide (outside USA). This makes it impossible to ascertain the accuracy of the remaining foreign debt of the Bank.

In all probability, the determination of the final amount of foreign debt will have to be resolved over time through negotiations with the Paris Club and other creditor groups.

Financial Statement Analysis

Analysis of the financial statements attached as exhibits to this report is presented below:

Loan Composition

According to the Bank’s chart of accounts and records, as of December 31, 2004, consolidated loans and facilities were as follows: (000s) IQD

• Short-term Loans 6,378,276 • Overdraft Facilities 119,165,256 • Long-term Loans 106,861,012 • Discounted Paper and Drafts 151,078,405 • Other Loans 754,067 • Past Due Obligations 99,823,278 • Rescheduled Loans 1,404,599

Total Gross Loans 485,465,343

Less Reserves for Loan Losses and Unpaid Interest (49,902,508)

Net Loans 435,562,835

It is understood that employee loans or advances IQD of 8.9 billion are not included in the above amounts, but rather are recorded in other assets, account 1671.

Included in the Discounted Commercial Paper and Draft account is the amount of 146,668,376,000 IQD which represents discounted checks drawn on branches of Rafidain Bank and other banks outside of the branch area which is discounting the check. This type of transaction should be viewed as a collection process rather than as a loan.

Several adjustments were made to the above amounts in order to more accurately present the loans and their valuation in the financial statements.

The Bank’s loan to deposit ratio is only 6.36 percent of average loans to average deposits, adjusted as described above.

Foreign Branch Offices

Included in the Long-term Loan category are two (2) loans made to Foreign Branch Offices:

1. Abu Dhabi in the amount of 34,790,578,578 IQD, or $23,829,163.00, which the branch records as a deposit. This represents three (3) loans that were made on 12/1/87 for $12,258,240.00, on 9/26/91 for $10,536,346.00, and on 6/3/92 for $680,642.00.

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2. Sanna Yemen Branch records a long-term loan in the amount of 425,322,000 IQD or $290,000.00, but according to the records of the International Division, the amount lent is $490,000.00. However, the Foreign Branch Affairs sector said this amount is incorrect and should be $290,000.00 or approximately 423,400,000 IQD.

These loans have been eliminated in the consolidated financial statements. No interest income or interest expense has been accrued by the main office or the foreign branches for these loans.

Foreign Bank Loans

The Bank has recorded a loan to U.B.A.F. (Union De Banques Arabes et Francaises) made in 1989, as a private investment. The Bank is also a shareholder in UBAC Curacao N V, which owns 100% of UBAC Nederland B.V., which in turn owns 25.40% of the stock of U.B.A.F.

According to the Bank’s records, the original loan was granted to U.B.A.F. for USD 10,168,724.00 on June 5, 1989, with two (2) equal payments of $5,084,382.00 to be paid on June 2, 2003, and June 4, 2004. The interest was LIBOR + 1%, to be paid every six (6) months. The last paid interest was on June 5, 1990. One comment by bank staff stated that this was originally actually two (2) loans for $8,172,742.00 and for $1,996,022 that total $10,168,764. No additional information was provided to us to clarify this comment.

According to Bank staff “From 6/5/1990 till 12/4/2000 interest matured of about $7,575,867.42 admitted by the UBAF itself and put it in Suspense Account in its ledger but never listed in our account”. It is unclear why a bank would put accrued interest payable due to another bank in a suspense account.

On June 17, 2003, U.B.A.F. requested to extend the maturity date of the loan for another four (4) years, with installment payments to be made on June 4, 2007 and June 4, 2008. Rafidain Bank granted the request.

The Bank has not accrued interest receivable for this loan since 1990. In fact, at the time of the above- mentioned renewal of the loan, interest earned but not collected by Rafidain Bank for the period of June 15, 1990 – December 4, 2000, amounted to $7,575,867.42. This amount was added to the existing principal, thus capitalizing the interest, and the new loan amount was $17,744,631.42. At our request, the additional interest due the Bank as of December 31, 2004 was calculated by Bank staff and amounts to $2,434,967.28. At the time the loan was renewed and the interest added to the loan, the Bank did not record the increase in the loan amount, and the International Division trial balance still depicts the original loan amount.

As a result of such lax banking practices, the Bank has not recorded interest income earned of $10,010,837 due from this loan for the past 15 years. Thus the Bank’s records were lacking in the recognition of income and in the proper valuation and classification of the loan and accrued interest amounts. The accrued interest receivable since the renewal date of the loan amounting to USD 2,434,967.28 has now been included increasing 2004 income by USD 425,760.87 or IQD 620,151,000.

On December 25, 1988, the Bank borrowed 62,039,930,000 IQD or USD 90,578,299 from the Gulf International Bank (GIB) and then loaned the funds to the Iraq government sector. Interest has occasionally been paid to GIB and paid by the Government sector when it is billed for the interest. At our request, the accrued interest receivable on these 2 loans amounts to IQD 58,805,351,000 or USD 40,277,637 and has not been reflected in the Bank’s past financial statements as to interest receivable or interest payable.

The above examples illustrate the issue regarding the integrity of data which is accounted for by Bank staff.

Loan Yields

Using year-end balances for loans, and excluding the 146.6 billion IQD of discounted checks, an average loan balance for 2004 of 350,572,270,000 was calculated. Total loan interest for 2004 was 13,635,709,000,

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resulting in a yield of 3.89% for the year, which is less than the yield of 5.8% the Bank received for its Treasury Bill investments.

Prevailing interest rates for customers during 2004 could range from 12-14%.

Past Due, Nonperforming Loans

This area is discussed in more detail in the Credit Assessment and the Loan Collection sections of this report.

Two attempts-were made to conduct a survey of all past due loans by each branch, and the Bank has been unable to have all the branches comply with the written instructions. The Bank has an account series, 1691 Past Due Obligations. As of December 31, 2003, these accounts totaled 36,116, 678,000 IQD, and as of December 31, 2004 the amount is 99,823,728,000, an increase of 63,707,050,000 IQD, which is attributable to the Abu Dhabi foreign branch office which increased its past due loans by 63,134,435,000.

Based on discussions with credit and accounting staff, past due loans are significantly understated in the financial records of the Bank. The Bank does not have any of its loans and facilities transactions automated. Also there is no automated database of loans prepared by the IT Division, using PCs, as is the case for deposits, as a source of backup data.

The Bank lacks a Management Information System (MIS) that would capture information needed to effectively manage such an important area of the Bank. At this time, the State-owned banks should be required to prepare specific reports regarding the credit function in order to ascertain and monitor the quality of their loan portfolios, and to provide sufficient data to enable management to establish the appropriate reserves for loan losses.

Loan Charge-offs and Reserves for Loan Losses

Rafidain Bank, in 2004, charged-off as cancelled debt, 47,309,181,000 IQD of which 36,449,327,000 IQD represented wedding loans or advances. Only 10,323,831,000 IQD of other loans were charged-off. The Bank did not record any recoveries of previously charged-off loans to account 4833, Recoveries of Written- off Loans.

Reserves for loan losses as of December 31, 2004, prior to advisors’ adjustments, were recorded in the following manner:

(000s) IQD

Foreign Consolidated Branches

• Reserves for Loan Losses 3,187,352 16,552,795 • Provision Foreign Branch Losses 3,368,418 3,368,522 • Reserve Letter of Credit Risk 64,800 • Provision for Cash Credit 911,585 • Reserves for Unpaid Interest 21,892,524 29,004,776

Totals 28,448,294 49,902,508

The foreign branch reserves of 28,448,294,000 represent 57 percent of the total Bank loan loss reserves. Out of a total foreign branches’ gross loans of 72,279,474,000, the Abu Dhabi branch loan reserves are 39.4 percent.

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In order to determine a reasonable level of reserves for loan losses the following steps were taken:

(000s) IQD

• Gross Loans and Advances 485,465,343

Plus Reclassification of U.B.A.F. 25,907,161 Less: Discounted Check amounts (146,668,376) Loans to Foreign Branch Offices (35,505,979)

Subtotal 329,198,149

Charge-off of all Past Due Obligations in A/C 1691 99,823,728

• Adjusted Gross Loans and Advances 229,374,421

The above-adjusted figures were then allocated by sectors or loan category, using a potential loan loss factor to calculate the required reserves as presented below:

(000) IQD

• Government 62,039,931 x -0- Full faith and Credit of GoI • Productive 76,796,057 x 75% 57,597,042 • Financial 33,005,280 x 10% 3,300,528 • Private 22,907,271 x 75% 17,180,453 • Foreign 2,150,026 x 75% 1,612,519 • Discount and Other 5,164,096 x 75% 3,873,072 • Rescheduled 1,404,599 x 75% 1.053,449

Total 229,374,421 84,617,063

Using 85 billion IQD as the desired amount of Loan Loss Reserves, and deducting existing reserves of approximately 50 billion IQD, another 35 billion IQD was added to the reserves and this amount was deducted from retained earnings.

Deposits

The composition of deposits as recorded by the Bank as of December 31, 2004 was:

IQD (000s) • Current Accounts 4,049,011,936 • OD Facilities as Deposits 595,977,278 • Savings Accounts 594,760,879 • Time Deposits 2,488,819,963 • Deposits of Foreign Banks and Organizations 326,849,832 • Other Deposits and Drafts Outstanding 180,344,317

Total 8,235,764,205

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Several adjustments were made regarding confiscated deposits, and the new total is 8,547,309,151. For some unknown reason the chart of accounts includes in Time Deposits, Times Deposits in Foreign Currency. These are not time-restricted, allowing customers to withdraw the funds with notice to the Bank. Thus IQD 2,231,420,900 of these Time Deposits was reclassified as Current Accounts. The amount of overdrawn Due from Banks account was added to Deposits in the amount of IQD 423,011,358.

The average balance for the year, based on the two (2) year-end balances, was 6,992,813,095. Interest expense was 38,037,963, resulting in an extremely low cost of funds of 0.54 percent.

The Bank’s unusually low cost of funds is primarily due to the placement of government deposits with the Bank, the majority of that is non-interest bearing. We estimate government funds – which include the Government, productive, financial and mixed sectors, to be 4,782,018,345,000 or 56% of total deposits. Since several deposit categories are not classified by sector, i.e., time deposits in foreign currency mentioned above, this is the best available data.

Where data was available, we have reduced the overall numbers for confiscated deposits, but they are still recorded in the Bank’s records.

In the beginning of this report, it was mentioned that the Bank was insolvent with total assets of 5.7 trillion IQD. Since total deposits are 8,547,309,151,000, the Bank is unable to pay all depositors and is deficient in the amount of 2,873,183,330,000 IQD deposits, assuming all assets could be utilized at their book or recorded value, which is unlikely, given the quality of the loan portfolio and other issues.

The Bank’s ability to continue to operate is solely dependent upon the source of low cost Government deposits.

Earnings

Income reported over the years has been inaccurate and overstated as a result of not adequately providing for loan losses, the limited amount of loans written-off, not recording all accrued income and expense, and the lack of recognition of losses for various assets such as confiscated or blocked accounts.

The primacy of earnings cannot be overemphasized in the assessment of any entity. Banks must be able to generate sustainable, quality earnings, in order to support capital requirements and continued growth.

Exhibit III Consolidated Statement of Income (unaudited) and Exhibit VI Comparative Consolidated Income Statements (unaudited) provide the details of the Bank’s recent losses. Understandably, the year 2003 was extraordinary, and throughout 2004, the Bank continued to experience difficulties. The mentioned Exhibits were based on revalued data for the years 2003, and 2004. The Bank did not revalue monetary assets or liabilities denominated in foreign currencies for 2002, but since income and expense items occurring throughout the fiscal year are of primary concern, the changes in exchange rates should be reflected in these transactions.

The Bank’s earning for 2003 are not accurate for several reasons. During 2003, the Government directly paid the salaries of Bank employees for a portion of the year and provided other assistance as a result of the military conflict. The Bank indicated its earning were 20,278,917,000, but the comparative data is based upon adjustments made for 2003, which included a 10 billion IQD provision for loan losses, and a write-off of 36,116,780,000/ for past due loans, a deduction of 33,997,811 for war damage and looted cash. Also, Government assistance was included as income. For comparative purposes either the Bank’s net earnings of 20,278,917 or other data will be used, as appropriate.

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A summary of the major income and expense categories is as follows:

(000s) IQD

2002 2003 2004

Interest Income 10,542,348 12 174,253 13,635,709

Investment Income 53,423,651 67,027,998 37,349,259

Total Interest Income 63,965,999 79,202,251 50,983,968

Less Interest Expense (29,407,833) (35,740,602) (38,037,963)

Noninterest Revenue 6,656,555 3,135,127 18,651,929

Total Operating Income 36,064,388 36,596,776 31,597,934

Less Gen. & Admin. Expenses (11,800,982) (19,902,372)* (36,823,023)

Net Income (loss) 24,263,406 16,694,404 (5,085,089)

*Previous write-off of past due loans 36,116,780 was reversed.

A review of several earnings ratios and changes are listed below:

• Calculation of the 2002 Return on Assets, using the year-end asset amount, which was not revalued, indicates a ROA of 1.57%, which is not realistic since assets were not revalued. Using the revalued year-end balance of 5.4 trillion, the 2003 ROA would be 0.31%. The Return on Equity for year-end 2002 would be 163.2%, which also is meaningless as the Bank is undercapitalized by international practices.

• The most significant reduction in 2004 earnings, was the reduction in Treasury Bill interest income, which was reduced by 28,464,518,000/ or 45.7%, as compared to 2003. This occurred as a result of the CBI change in the issuance of Treasury Bills, utilizing a new competitive auction method. This will have a continuous impact in the reduction of the Bank’s future earnings, as even at this reduced level, investment income represents 73.3% of total interest income.

• With the liberalization, in 2004, of interest rates that banks could charge, the Bank’s interest income increased by only a disappointing 12% from 2003.

• Noninterest revenue increased 495% compared with 2003, and 280% compared to 2002.

• General and Administrative expenses increased 85% from 2003 to 2004, and 68% from 2002 to 2003. From 2002 to 2004, these expenses increased 212%. The single largest increase was in salaries which were 5,345,149,000 in 2002, and in 2004 were 22,204,899000, a 314% increase. Recorded salaries for 2003 were 8,856,059,000, and do not include the amount paid by the government. The next largest item was depreciation expense of 6,367,000,000.

The banking industry uses a ratio referred to as an efficiency ratio. This can be calculated by determining the percentage of noninterest expense to total net operating income. This ratio measures the proportion of net operating revenues that are absorbed by overhead expenses. Therefore, the lower the percentage, the greater the efficiency.

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For Rafidain Bank this ratio is 116 % based on December 31, 2004 data. For the 25 largest bank companies in the United States, this ratio is approximately 57%.

In the next section one of the major reasons for the poor earnings of the Bank is discussed.

Nonearning Assets

Nonearning assets are those assets that are not directly used to generate revenue through the granting of credit, placements of funds or investments. Nonearning assets consist of cash, noninterest bearing deposits in other banks, reserves maintained at the Central Bank, nonperforming loans which are not accruing interest, fixed assets net of accumulated depreciation, and other assets. Rafidain Bank’s nonearning assets as a percentage of total average year-end assets were at an unprecedented level of 78.6%. The disproportionate amount of nonearning assets is exceedingly high. Ideally, the percentage should be in the range of 10-15% of total assets, which can vary according to the nature of a bank’s activities and the environment in which it operates. Rafidain Bank has an inverse ratio of earning to nonearning assets, compared with international banking best practices.

In 2004, the Bank had restrictions placed on the total amount of Treasury Bills it can purchase through auctions, and this will limit future income from this source. However, in 2005, CBI has instituted an overnight investment fund program for banks to invest idle funds and earn interest. The CBI offered the following rates for Dinars as of March 7, 2005:

• 5% for overnight deposits, • 6% for deposits for 14 days, and • 7% for deposits for 30 days.

The CBI also offers different rates for USD deposits, which vary from 3 percent for 30 days, to 3.25 percent for 90 days.

As of June 30, 2005, Rafidain reported Treasury Bill income as 10,015,172,603 IQD and 13,180,920,990 IQD from overnight investment of funds. The overnight funds should increase to some extent the amount of earning assets.

Assuming average assets of 5,542,814,806,000 IQD, and the attainment of a ROA of 1-1.5%, the Bank would earn 55.4-83.1 billion IQD. This ROA is more in line with the international best banking benchmark and should become the goal of the bank as it goes forward.

Net Interest Margin

In 2004, the Bank earned a yield of 5.08 percent from its Treasury Bill investments, and it earned a yield of only 3.89% on its total average loan portfolio. The cost of funds is inordinately low, at 0.54 percent. However, the net interest margin (net interest income/average assets) was only 0.23%, as compared to an international benchmark of 3.5 percent to 4.0 percent.

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Investments

We have reclassified Treasury Bills, 570,550,000 as Investments Held-to-Maturity, and the remaining investments as Available-for-Sale, 137,534,997,000. Bank staff provided the following information:

Foreign Bank Holdings

1. Arab Trade Financing Program $1,320,000 2. British Arab Commercial Bank 4,795,595 3. Arab Financial Services Co. 75,000 4. Arab African International Bank 1,000,000 5. U.B.A.F. 33,451,400

Subtotal $40,641,995 IQD 59,337,312,700

Domestic Holdings IQD

6. Iraqi Company for Banking Services 200,000,000 7. Al Oteifiya Fodder Production Company 100,000,000 8. United Bank for Investments 424,999,000 9. Babil Company for Cinema and TV Production 6,500,000 10. Baghdad Company for Drink (Pepsi) 1,250,000,000 11. Cinema Houses Company 20,000 12. Mosul Bank 500,000,000 13. Kilkamish Bank 150,000,000 14. Islamic Bank 300,000,000 15. Housing Bank of Jordan unknown 16. Jordan Phosphate Co. unknown 17. Arabic Medical Company unknown 18. Industrial Union Investment Bank 100,000,000

We were not able to obtain all the data in order to complete the total value of investments.

The Bank does not obtain financial statements on a timely basis, if at all, for the above entities and does not use financial information or any other techniques to determine the market or carrying value of the investment.

Foreign Branch Offices

The Bank has eight (8) foreign offices in seven (7) countries as listed below:

1. Main Office, Amman, Jordan 2. Amman Mountain, Amman Jordan 3. Aquaba, Jordan 4. Cairo, Egypt 5. Abu Dhabi, UAE 6. Bahrain 7. Beirut, Lebanon 8. Sanna, Yemen

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As depicted in Exhibit II, the foreign offices have total assets, as of December 31, 2004, of 289,615,251,000 IQD, plus 225,061,094,000 in Off Balance Sheet items, for a total of 514,676,345,000. The branches reported net income of 4,595,284,000 IQD as depicted in Exhibit VIII.

The accounting for these branches is poorly administered, and involves the individual offices, the Foreign Branch Affairs sector with the primary main office responsibility, the International Division, and finally the main office accounting department.

Many unusual situations were noted within the financial statements of the foreign offices, such as :

1. The International Division trial balance indicates it has 329,392,823,000/ IQD in the Foreign Branch Offices as a Due from Bank, whereas the total assets of these branches are only 289,615, 251,000.

2. International Division also indicates it has a liability to the foreign branches listed in account 2543, Deposits of External Foreign Offices, in the amount of 1,134,881,682/. However, this account states that the Sanna office has a debit balance of 519,707,133/ rather than a credit balance for a deposit. Furthermore, there are four (4) accounts for Ghunaim Co. which total 1,609,5135,40/ listed in this account as due to the foreign office. If this branch has transferred customer funds to Iraq, they should be properly recorded in Rafidain’s records.

3. The Aquaba office has an investment valuation reserve of 101,012,000/IQD, but has no investments.

4. The Amman office has reserves for loan losses and reserves for unpaid interest which total 3,362,660,000 IQD, and are greater than all total loans and advances which are 3,227,921,000, or a difference of 134,739,000/. The reserve for unpaid interest is 236,744,000, but accrued interest receivable is only 85,880,000 and should include the amount in reserve.

5. The Beirut office also shows a negative loan balance of (2,053,983,000) after deducting reserves for loan losses of 13,951,000, and reserves for unpaid interest of 2,335,094,000 which total 2,349,045,000. The outstanding loan balance is 295,062,000, and there is no accrued interest receivable to apply the reserve for unpaid interest.

6. As indicated earlier in this report, the International Division records indicate there are two (2) loans granted to the Yemen and the Abu Dhabi branches. The former has properly recorded the loan, but the Abu Dhabi branch shows it as a deposit from head office. Also, there is a $200,000 difference in the loan amounts recorded by the International Division and the branch. No explanation could be provided as to how an adjustment would be made and what accounts would be offset

7. Regulators in various countries require the foreign branch offices to increase their capital or to deposit funds in the foreign office to support capital. During 2005, the Bank will increase capital/deposits at the following offices:

• Abu Dhabi $10,000,000 • Amman $10,000,000 • Bahrain $3,000,000 • Beirut $2,500,000 • Sanna $9,000,000 $34,500,000

Existing capital and capital reserves for the foreign offices as of December 31, 2004 was recorded as 65,059,154,000 IQD. Converting the above infusion of funds into Dinars, and adding it to the existing capital provides 115,429,154,000/ IQD, which represents 39.8% of total foreign branch assets. If OBS items are added to total assets, then the new capital level would be 22.4% of total assets and OBS items.

xv

It is noteworthy that, for the same period, the Bank’s total capital prior to our adjustments was only 59,080,322,000/ IQD, or 1.04% of the total asset base of 5.7 trillion IQD.

8. Exhibit III depicts total deposits for the foreign offices as 241,406,920,000/ IQD. The branches provided a listing of confiscated/blocked deposits that were still recorded in their records, and the amount was IQD 103,281,439,055. Additionally, the branches recorded IQD 87,985,100,000 as accounts in other foreign branch offices. This includes deposits with the liquidated London office.

9. Total gross loans for these offices as of December 31, 2004 were 72,279,476,000/ IQD. This balance includes past due loans of 68,944,393,000/ or 95.4% of the total foreign offices’ loan portfolio. The adjusted net loans of the foreign branches are 15 % of the Bank’s adjusted total loans.

Management oversight appears to be lacking in the operations and accounting for the Foreign Office Branches. The records of these offices need to be reconstructed and reconciled with those of the main office.

Cash and Due from Bank Accounts

Rafidain Bank has not been able to reconcile its balances with the CBI and other banks. This seems to be the case for all the State-owned banks. Last year we were told that 65 branches had not reconciled their accounts with the CBI. When we have asked what the balance is with another bank, offers are made to call the correspondent and ask what balance they have recorded. Almost certainly large adjustments will be required for these accounts among all of the banks.

Rafidain Bank maintains an unusually large amount of cash denominated in foreign currency, the majority of which is in USD. The need for the Bank to maintain such a high level of a nonearning assets is questionable. Prior to restructuring the Bank, it seems appropriate to determine whether the CBI, rather than Rafidain Bank should be the custodian of such funds, since a large volume of cash apparently comes from the Ministries.

Interbranch Transactions

In 2004, after a diagnostic review was conducted, a work group was formed to resolve and reconcile the accounts163/263 Interbranch Transactions, which on a net basis was a credit balance of 305 billion IQD, and represented 80,000 outstanding debit and credit entries among the Bank’s own branches. The IT sector has developed a program to process and reconcile these items. The work group did an outstanding job of reducing this amount last year. But, this year the total is a debit balance of 1,070 trillion IQD.

This is a result of poor performance by the branches in not reconciling these items, and of the lack of any sense of urgency by the Settlement sector in the Financial Division and on the part of senior management. Although the Bank has netted this item against liabilities, it represents 18.8% of total assets. Bank management is usually optimistic that these items will reconcile. There is a possibility of a loss of some unknown amount in these accounts.

Domestic Branch Operations

As of December 31, 2004, the Bank had approximately 142 domestic branches throughout Iraq, excluding its former branches in the North, which are no longer accounted for in the Bank’s records. Some of the branch data provided to us will vary as to the number of branches, but that does not in our view distort the perspective or context of our presentation of the overall data. We have attached the following exhibits regarding the branches:

• Exhibit X, Comparison of Rafidain and Rasheed Bank’s Branch Location, • Exhibit XI, Branch Listing By Direct Income (Loss) in Descending Order,

xvi

• Exhibit XII, Branch Loan Balances in Descending Order, and • Exhibit XIII Total Branch Deposits in Descending Order (which includes staff levels).

Branches employ approximately 5,300 of the Bank’s total staff of approximately 6,500. Total Bank salaries and benefits represent 60.5% of total General and Administrative Expenses, 22.2 billion IQD to 36,7 billion IQD. The ratio for 2002 was 45.3%.

An analysis of the data depicted in the above exhibits, prepared at our request by the Bank’s IT Division is presented below.

Direct Net Income (Loss)

Exhibit XI presents the direct income, expense and resulting net income or loss for each of the branches in descending order of net income or (loss). The term “direct” indicates amounts that the branches have earned or incurred at the branch level, and excludes any allocations from the main office. The net amount is not an indication of the branches’ actual profitability. Neither overhead costs, nor any charge/credit has been applied for either an excess or for a deficiency in deposits. The exhibit shows income but no expenses for branch 369, Al Rawaateb Al Khasa, which was closed in 2005. This branch was still included, as it does not change the overall results of the number of unprofitable branches.

Clearly, the financial performance of the branches for the year ending December 31, 2004 is extremely poor, based upon a review of Exhibit XI, stratified as follows:

(000s) IQD

Range of Earnings Number Branches Direct Income (Loss)

Over 2 billion 1 23,886,652 1 – 2 billion 2 2,779,059 500 million – 999 million 2 1,720,392 100 – 499 million 4 1,129,449 1 – 99 million 4 135,749

Income 13 29,651,301 Losses

1 – 99 million 35 (1,818,150) 100 – 199 million 34 (4,934,925) 200 – 499 million 44 (12,964,267) 500 – 999 million 16 (10,821,132) 1 – 2 billion 3 (6,496,850) Over 2 billion 1 (2,220,583)

Loss 133 (38,985,907)

Net Loss 146 (9,604,607)

As presented above, only 13 branches out of 146, or 8.9 percent, have direct net income, totaling 29,651,301,000 IQD. The remaining 133 branches have a net loss of (38,985,907,000) IQD, which results in an overall loss of (9,604,607,000) for the entire branch network. The direct expenses of the 133 branches with losses are 55,008,625,248 IQD.

Such poor performance requires additional analysis as to the feasibility and desirability of the existent branch network. The first step is to determine the reliability of the above data.

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Branch Loans and Facilities

Exhibit XII represents the total loans of foreign and domestic branches. The IT Division prepared the exhibit, but was unable to allocate 50,488,176,402 of OD Facilities to branches. The total for OD facilities is the same as in the financial statements. However, the OD Facilities amount listed as deposits for 545,489,102,933 is different by the same amount not allocated, when compared to the financial statements.

The exhibit was used in order to obtain perspective on the loans distributed throughout the branches, recognizing there is a discrepancy, which more than likely has its origin in one of the larger branches.

(000s) IQD

Range No. Branches Amount

Over 18 billion 3 148,903,389

3 billion – 3.9 billion 3 10,193,621

1 billion –1.9 6 9,282,702

500 million – 999 million 9 5,937,449

200 million – 499 million 12 3,917,159

100 million –199 million 16 2,379,307

50 million – 99 million 13 907,429

25 million – 49 million 21 754,214

10 million – 24 million 20 311,981

Less than 10 million 27 83,182

Unknown distribution 50,488,176

Total 130 233,158,609

The International Division and 2 branches comprise the first category and represent over half of the total loans. Loans to the foreign branches and the U.B.A.F. loans were adjusted, which reduces the International Division amount shown in the exhibit by approximately 10,000,000 IQD.

The above data indicates the small volume of loans generated by the majority of branches.

xviii

Branch Deposits

Exhibit XI provides the details of domestic branch deposits by individual branch, and states the average deposits based on the number of employees per branch, and by total for the entire branch network, and by total number of Bank employees. The amounts provided by the IT Division do not agree with the financial statement amounts, but the data provides a useful perspective of the disparate distribution of deposits.

(000s) IQD

No. Total Average Per Total Deposit Range Branches Deposits Employee Employees

Over 1 Trillion 1 1,782,138,030 11,802,238 151 500 billion - 999 billion 3 1,931,263,622 14,412,415 134 100 billion - 499 billion 4 536,380,109 3,373,459 159 50 billion – 99 billion 9 619,058,279 1,384,917 447 25 billion – 49 billion 23 838,214,337 762,013 1,100 10 billion – 24 billion 19 297,867,669 350,020 851 1 billion – 10 billion 65 249,930,428 113,502 2,202 Less than 1 billion 16 7,172,584 31,185 230

Totals 140 6,262,025,100 1,187,339 5,274

The above stratification of deposits by range, average deposits by employee, and the total number of employees within each category indicates that the majority of branches are not generating sufficient amounts of deposits to justify the economic existence of the branch.

Total deposits for the two (2) ranges of 25-49 billion, and 1-10 billion are 1,088,144,765,000 IQD, and total employees in these categories are 3,102, which represent 17.4% of total Bank deposits and 58.8% of the total number of branch employees.

In the 25 - 49 billion category, the branch designated as number 351, Labor and Social Affairs, supports 28,446,913,737 in deposits with only 12 employees, with average deposits per employee of 2,370,576,145 which distorts the average deposits per employee in this range.

The branch network and entire service delivery philosophy of the Bank should be examined to create a more profitable branch network. The Bank advised that it uses only 95 distribution points for the payment of pensions on behalf of the Government, even though it has many more branches.

Comparison of Branch Locations

Exhibit XII presents a regional comparison of Rafidain and Rasheed Banks’ branches in Iraq. Only someone intimately familiar with the various geographical regions can make a precise comparison. IT Division staff have tried to compare the branches as well as possible. At first glance it appears there is significant overlap or duplication of branches in the various regions.

Based upon the minimal amount of deposits and loans other than from Government and the lack of profitability of branches, it will be difficult to justify keeping branches open and operating, The Bank should do a detailed analysis, similar to the exhibits present in this report, of each of its branches.

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Future Viability of Rafidain Bank

The Ministry of Finance is faced with a difficult decision as to the future status of the State-owned banks (i.e. should they be liquidated, merged, privatized and sold, joined with a strategic investor or continue to “run as is”).

It is clear that the Bank is insolvent and would be illiquid if all depositors were to withdraw their funds. The Bank cannot adopt International Accounting Standards and publish its report, as it would depict the insolvency and could create a banking crisis. Survival of the Bank is dependent upon the Government’s immediate assumption of all foreign debt, amounting to approximately 64,371,147,089,000, plus any additional foreign debt interest expense, and continuing to provide non-interest bearing funds to Rafidain Bank.

The Assessment task was to include a determination of the future viability of the Bank. In the Advisors’ view the Bank is not viable under the current circumstances.

In the following section, we explore several scenarios whereby the Ministry of Finance could liquidate or restructure the Bank.

Scenario Number I – Financial Resolution

This assumes the MOF desires to retain the Bank in full, and provide 8% capital, which is the international benchmark.

In this case, the MOF would be required to:

1. Accept all foreign debt and interest of the Bank: a) past due interest of IQD 9,912,912,413,000, b) past due long-term loans of IQD 9,075,919,502,000, and c) all OBS liabilities of IQD 45,382,315,174,000, which totals IQD 64,371,147,089,000 . 2. Add the difference between deposits and other liabilities which exceed the total assets of the bank. This was calculated using total deposits of IQD 8,547,309,151,000, less a debit balance in other liabilities of IQD 840,724,716,000, resulting in total liabilities and capital of IQD 7,744,668,842. Deducting existing assets of IQD 5,674,125,821,000 results in a deficiency and requires an additional infusion of funds of IQQD 2,070,054,543,021.

3. At this point, the Bank would have total assets and liabilities of IQD 7,744,668,842. Capital of 8% should be infused and would require an additional IQD 632,053,370,000. The total assets of the Bank would then be IQD 8,376,722,212,000, with capital of IQD 670,137,777,696, as depicted in Exhibit XIV.

4. The amount of the deficiency between assets and liabilities, and the additional amount for capital of IQD 632,054,370,000 is a total of IQD 2,702,596,391,000.

5. The total amount of the debt resolution and additional infusion of needed funds is IQD 67,073,743,480,000 or USD 45,940,920,191.

The debt resolution of IQD 64.4 trillion would be a non-cash transaction. Also, it may be possible to provide the Bank with a Government bond or obligation of some type that would represent IQD 2,702 trillion of new assets.

xx

Scenario Number II - Liquidation

In this scenario, the Government would still be required to resolve the foreign debt, as this is a sovereign issue, as opposed to an individual bank problem.

1. Accept all foreign debt and interest of the Bank: a) past due interest of IQD 9,912,912,413,000 b) past due long-term loans of IQD 9,075,919,502,000, and c) all OBS liabilities of IQD 5,382,315,174,000, which total IQD 64,371,147,089,000.

2. Pay off all nongovernmental deposits of IQD 3,762,268,073,000, and other liabilities of IQD 192,610,487,000, for a total of IQD 3,954,769,560.

3. Remaining assets would be IQD 1,719,356,261,000, and liabilities would be IQD 3,789,899,282,000 (7,744,668,842,000 less 3,954,768,560). This would leave a deficiency of assets of IQD 2,070,543,021,000. Although all loans and investments may not be collected at their book value, the market value of real estate property may be significantly higher than its carrying value. Also, some branches could be sold to existing private banks to further reduce the Government’s loss. Finally, it unknown to what extent the 1,070 trillion in Interbranch transactions, slightly over 50 percent of the deficiency, could minimize the loss.

4. This scenario would assume that Rasheed Bank would remain open in order to continue to provide a physical network for the national payment system and the direct deposit program.

Scenario III Rehabilitation and Restructuring

To accomplish this scenario would first require the implementation of the resolution scenario. The financial condition of the Bank would be satisfactory at this point, but in its current condition relative to its mode of operations, given the efficacy of its branch network, and considering the burden of its foreign branch offices and its excess staff levels, it is unlikely the price a buyer would pay would significantly reduce the Government’s loss.

If no buyer were to come forward with an adequate offer and the Bank were allowed to operate “as is” without major management changes, it would certainly be only a matter of months before the Bank would be facing the same financial and operational problems and resume its need for additional MOF capital. Inexperienced and uncompetitive management, excess staff, poor quality loan portfolio, lack of an automated, efficient, and reliable accounting and reporting system mean no advance or change in the Bank’s future.

1. Management-driven weaknesses have played a significant role in the deterioration of the Bank’s financial and operational condition. There is an overall lack of management diversity and experience, especially in international best practices.

2. Poor loan asset quality is the result of lax banking practices, inadequate training of lending staff, asset based lending with undue reliance on collateral as opposed to the borrowers’ cash flow, poor loan administration, lack of aggressive loan collection policies, lack of a management information system and the like. Left as is, lending personnel will continue with past practices, resulting in further loan losses.

3. Overall, the Bank lacks adequate policies, systems and controls to monitor its operations.

4. The decision-making process lacks a proper management information system to identify trends, problems, profitability, asset quality, etc.

xxi

5. Risk management is not formalized within the Bank in areas such as asset/liability management, funds management, interest rate risk, foreign currency exposure, sovereign risk, credit risk, etc.

6. There are inadequate controls and systems to ensure compliance with policies, and the Internal Audit Department does not appear to be effective.

7. The Bank is significantly over staffed, staff lack relevant experience, are poorly supervised, lack a strong work ethics, and need significant training, and motivation. At our request, the Human Resources sector provided us with staff turnover rates for 2004. Out of a total of approximately 6,500 employees, in 2004, approximately 45 employees quit or retired.

8. Lack of automation, which the Bank is addressing, results in the manual processing of nearly all work within the Bank, and with all customer transactions. The Bank has received a $10 million budget from the MOF to purchase a new computer system. However, we were told the Bank has not developed a budget as to how this amount will be expended. Since Bank staff does not have experience in this area, a detailed implementation plan and budget must be developed to determine the actual cost of the program and whether additional funds will be required and over what time frame.

9. The branch network is comprised of many branches which are not providing sufficient loans or deposits to justify their economic existence. Closing half of the branches would generate annual savings of approximately 36 billion IQD, based upon the Bank provided data in Exhibit XI.

10. The Bank has not significantly penetrated the private market in terms of gathering deposits and granting loans. Rather its major customer base is the Government.

Given the above, the rehabilitation and restructuring of the Bank will require significant additional funding to prepare the Bank for eventual sale. We are not able at this time to determine the additional cost.

xxii

______

ANNEX B

Sample Assessment Questionnaire ______

Annex B

BANKING QUESTIONNAIRE SUMMARY - IRAQI STATE-OWNED BANKS

1. Do you have a table of organization for your department?

Comments: Most of those that replied (88%) to this question felt that they had a clear understanding of their particular position in the Bank’s Table of Organization.

2. Do you have written a Policy and Procedure Manual? (need figures)

Comments: Again, most of those surveyed (92%), believed they had sufficient manuals to perform their duties. Most agreed that the manuals need updating.

3. Are Job Descriptions written for each position? (need figures)

Comments: A large number of respondents (92%) felt that job descriptions were well written for themselves, however, those of their subordinates need to be established.

4. Are duties centralized or de-centralized? (need figures)

Comments: The large majority of those responding (88%) reported that duties are centralized. This centralization could be a result of the lack of Automation. Without Automation, functions are better performed, controlled and managed in a centralized environment

5. Is there any automation support provided by I.T.?

Comments: In answering this question, the Banks’ response was 70% felt IT provided support. Some qualified the question by answering, “limited”.

6. Does Audit perform regular audits of the department?

Comments: A high response of 88% was received from those surveyed that agreed that regular audits are performed. This Audit process ensures that the Policies and Procedures are being followed, even if they need revision.

7. Are Audits addressed in a timely manner? (i.e. within 30 days)

Comments: Again, almost a majority of those responding (92%) believe Audits are taken seriously. This represents an excellent compliance attitude.

1

8. What is the average tenure of the management team?

Comments: The responding manager has an average of 20+ years of experience on the job. This establishes a mature staff to build around and skill levels should be high. However, one must be alert to the fact that those that have 20+ years of experience might be set in their ways and will not readily accept change.

9. What is the name and purpose of reports regularly produced?

Comments: General reports are produced at all levels for numerous reasons. However, their usefulness and accuracy need to be individually analyzed.

10. If you could make one change, what would that be?

Comments: This question was answered with Automation as the most requested change in the daily activities of the bank. With Automation, staff is able to perform tasks more easily and efficiently while providing superior customer service. A productive employee will have a more positive feeling towards their job and portray this attitude to the customer.

The second most important change requested is Training. Respondents see a great need for skills, customer relations and management training so that they may be brought up to date on banking techniques. They felt more emphasis needed to be placed on this discipline.

NOTE:

Of the 36 individuals, responding to 10 questions (for a total of 360 responses, a small hand-full chose not to answer certain questions. Yet ALL surveys were returned. The survey did not appear to be negatively received.

One Personnel Manager suggested that the survey be given to all employees.

2

______

ANNEX C

Transaction and Activity Statistics ______

Annex C

Banking Operations – Transaction and Activity Statistics

RAFIDAIN RASHEED AGRICULTURAL INDUSTRIAL REAL ESTATE IRAQ TRANSACTION PROCESSING (1-month sample) NUMBER OF BRANCHES 142 144 40 5 16 5 NUMBER OF DEPOSITS 188,918 125,534 9,968 1,911 2,261 1,388 NUMFBER OF WITHDRAWAL 337,946 547,610 10,487 1,958 2,171 419

NUMBER OF LOAN PAYMENTS 2,400 7,722 2,515 83 1,518 269

NUMBER OF ADMINISTRATIVE 27,944 11,1169 989 144 207 84 TRANSACTIONS

TOTAL MONTHLY 557,208 692,035 23,959 4,096 6,157 2,160 TRANSACTIOINS BY BANK IQD IQD IQD IQD IQD IQD BRANCH ACTIVITY

(monthly) AVERAGE NUMBER OF 4,888 4,806 599 819 385 432 TRANSACTIONS BY BRANCH AVERAGE NUMBER OF 105 133 34 37 9 16 TRANSACTIONS PER EMP.

AVG. TOTAL COST OF 2,476 1,850 6,856 6,695 25,637 14,328 TRANSACTION PER EMPLOYEE

AVERAGE TOTAL COST OF 92,234 67,006 122,543 149,970 1,094,376 381,125 TRANSACTION BY BRANCH

______

ANNEX D

Staffing and Salary Distribution ______

Annex D

Staffing and Salary Distribution

(Two Largest State-owned Banks) (Four Specialty State-owned Banks) RAFIDAIN RASHEED AGRICULTURAL INDUSTRIAL REAL ESTATE IRAQ

NUMBER BRANCHES 142 144 40 5 16 5

BRANCH STAFF 5,289 5,216 715 112 683 133

HOME OFFICE STAFF 1,255 1,283 133 169 189 114

TOTAL STAFF 6,544 6,499 848 281 872 247

IQD IQD IQD IQD IQD IQD TOTAL BRANCH 16.6 BILLION 15.4 BILLION 2.0 BILLION. 0.3 BILLION 1.9 BILLION 0.4 BILLION. ANNUAL SALARY

TOTAL HOME OFFICE 4.0BILLION 3.8 BILLION 0.5 BILLION 0.6 BILLION 0.6 BILLION. 0.8 BILLION ANNUAL SALARY

TOTAL BANK ANNUAL 20.6 BILLION 19.2 BILLION 2.5 BILLION 0.9 BILLION 2.5 BILLION 1.1 BILLION SALARY

AVERAGE BRANCH 260,887 245,432 229,724 244,848 231,108 232,695 EMPLOYEE MONTHLY

SALARY

AVERAGE HOME OFFICE 271,033 248,885 312,333 281,107 249,688 566,274 EMPLOYEE MONTHLY SALARY

______

ANNEX E

Rafidain Bank Total Foreign Debt ______

Annex E

RAFIDAIN BANK TOTAL FOREIGN DEBT - SUMMARY (CLAIMS RECEIVED BY ERNST AND YOUNG)

RATE USD EQUIV

BILLS Amount Due O/S Principal O/S Interest ATS 0 CHF 0 0.77676 0 EUR 6,415,477 6,415,477 1.20360 7,721,668 GBP 2,871,005 2,871,005 1.75670 5,043,494 JPY 412,500,000 412,500,000 0.008748 3,608,550 USD 172,511,926 172,511,926 1.00000 172,511,926 188,885,639

BI-LATERAL Amount Due O/S Principal O/S Interest ATS 0 CHF 309,586,364 126,572,343 183,014,021 0.77676 240,474,304 DKK 28,729,380 - 28,729,380 0.16128 4,633,474 EUR 1,633,579,095 630,173,063 1,003,406,032 1.20360 1,966,175,799 GBP 56,117,247 24,427,325 31,689,922 1.75670 98,581,168 JPY 328,817,240,907 246,204,377,362 82,612,863,545 0.008748 2,876,493,223 NOK 266 266 0.15376 41 SEK 454,635,210 369,346,412 85,288,798 0.12776 58,084,194 USD 4,101,642,335 2,069,275,233 2,032,367,102 1.00000 4,101,642,335 9,346,084,539

GUARANTEES Amount Due O/S Principal O/S Interest ATS 0 CHF 7,312,398 7,312,398 - 0.77676 5,679,978 EUR 1,224,481,545 1,183,342,003 41,139,542 1.20360 1,473,785,988 GBP 8,503,749 8,503,749 - 1.75670 14,938,536 JPY 40,933,219,937 37,638,602,707 3,294,617,230 0.008748 358,083,808 USD 528,775,554 439,424,128 89,351,426 1.00000 528,775,554 2,381,263,864

LETTERS OF CREDIT Amount Due O/S Principal O/S Interest ATS 0 0 CAD 1,272,261 1,272,261 - 0.84574 1,076,002 CHF 161,527 161,527 - 0.77676 125,468 DKK 91,968,304 91,968,304 - 0.16128 14,832,648 EUR 150,473,338 149,811,908 661,430 1.20360 181,109,710 GBP 33,533,926 33,533,926 - 1.75670 58,909,048 JPY 1,077,574,851 1,077,574,851 - 0.008748 9,426,625 KWD 243,360 243,360 - 3.42571 833,681 NOK 17,608,038 17,608,038 - 0.15376 2,707,412 SEK 104,613,928 102,828,338 1,785,590 0.12776 13,365,475 USD 4,490,354,411 4,272,170,707 218,183,704 1.00000 4,490,354,411 4,772,740,479

OTHER Amount Due O/S Principal O/S Interest ATS 0 CHF 0 0.77676 0 DKK 12,480,625 12,480,625 - 0.16128 2,012,875 EUR 5,335,694 5,335,694 - 1.20360 6,422,041 GBP 0 1.75670 0 JPY 0 0.008748 0 SEK 22,013,541 22,013,541 - 0.12776 2,812,450 USD 68,384,443 68,384,443 - 1.00000 68,384,443 79,631,809

PROMISSARY NOTES Amount Due O/S Principal O/S Interest ATS 0 CHF 2,541,445 2,397,077 144,368 0.77676 1,974,093 EUR 408,125,358 299,055,185 109,070,173 1.20360 491,219,681 GBP 0 1.75670 0 JPY 121,235,576 116,015,014 5,220,562 0.008748 1,060,569 KWD 1,326,515 1,280,000 46,515 3.42571 4,544,256 USD 1,380,795,425 1,305,227,771 75,567,654 1.00000 1,380,795,425 1,879,594,023

SYNDICATED LOANS Amount Due O/S Principal O/S Interest ATS 0 CHF 0 0.77676 0 EUR 0 1.20360 0 GBP 451,630,612 372,869,342 78,761,270 1.75670 793,379,496 JPY 0 0.008748 0 USD 1,212,663,959 666,428,581 546,235,378 1.00000 1,212,663,959 2,006,043,455

UNKNOWN Amount Due O/S Principal O/S Interest ATS 0 CHF 18,232,395 18,232,395 - 0.77676 14,162,195 DKK 22,480,867 22,480,867 - 0.16128 3,625,714 EUR 243,769,237 243,574,704 194,533 1.20360 293,400,654 GBP 23,366,397 23,366,397 - 1.75670 41,047,750 JPY 368,419,805 368,419,805 - 0.008748 3,222,936 KWD 92,275 92,275 - 3.42571 316,107 NOK 4,201,178 4,201,178 - 0.15376 645,973 SEK 36,374,007 36,374,007 - 0.12776 4,647,143 USD 255,185,174 255,072,022 113,152 1.00000 255,185,174 616,253,647

Total by Currency ATS 0 0 0 - CAD 1,272,261 1,272,261 0 0.84574 1,076,002 CHF 337,834,129 154,675,740 183,158,389 0.77676 262,416,038 DKK 155,659,176 126,929,796 28,729,380 0.16128 25,104,712 EUR 3,672,179,744 2,517,708,034 1,154,471,710 1.20360 4,419,835,540 GBP 576,022,936 465,571,744 110,451,192 1.75670 1,011,899,492 JPY 371,730,191,076 285,817,489,739 85,912,701,337 0.008748 3,251,895,712 KWD 1,662,150 1,615,635 46,515 3.42571 5,694,044 NOK 21,809,482 21,809,482 0 0.15376 3,353,426 SEK 617,636,686 530,562,298 87,074,388 0.12776 78,909,263 USD 12,210,313,227 9,248,494,811 2,961,818,416 1.00000 12,210,313,227

Total Claims in USD 21,270,497,455

______

ANNEX F

Rafidain Bank Loans and Facilities ______

Annex F

Rafidain Bank Loans and Facilities (As of August 2005)

Number of Type of Loans or Facilities1 Outstanding Amount Loans

Total Domestic Loans IQD 6252 30,283,794,196 Facilities within Baghdad in IQD • Individuals Total 624 - Overdrafts 3,427,086,790 - Discounted bills 1,236,213,970 - L/Cs - Other • State Sector Total - Overdrafts 21 69,203,158,445 - L/Cs - Other • Mixed Sector Total - Overdrafts 1 0 • Real Estate bank - Overdraft 1 31,609,838,608

Facilities outside Baghdad in IQD • Individuals Total 3813 - Overdrafts 4,244,417,345 - Discounted bills 4,469,340,000 - L/Cs

Total Loans in IQD Equivalent 625 30,283,794,196 Total Facilities in IQD 4460 114,190,055,158

1 This table does not include advances to the employees of Rafidain Bank, which amounts to IQD 7,854,157,167,000.

2 Includes 148 loans in IQD and 477 in USD.

______

ANNEX G

Rafidain Bank Lending Authorities ______

Annex G

Lending Authority for Facilities

Deputy Southern, Central Head of Section Branch Type of Facility General Manager General Manager Northern Region Type of Collateral Department Manager Manager (The expert) Delegates

15,000,000 10,000,000 5,000,000 7,500,000 3,500,000 250,000 With Personal Guarantee Overdraft 25,000,000 20,000,000 10,000,000 15,000,000 7,500,000 1,000,000 With Real estate Collateral 30,000,000 20,000,000 10,000,000 15,000,000 7,500,000 500,000 With Personal Guarantee Discount 50,000,000 40,000,000 20,000,000 30,000,000 10,000,000 2,000,000 With Real estate Collateral 150,000,000 60,000,000 30,000,000 50,000,000 25,000,000 3,000,000 With or without Collateral 150,000,000 80,000,000 50,000,000 70,000,000 25,000,000 5,000,000 With Real estate Collateral Letters of 50,000,000 30,000,000 10,000,000 20,000,000 15,000,000 3,000,000 For those who have no facilities Guarantee with guarantee 100,000,000 75,000,000 30,000,000 50,000,000 25,000,000 6,000,000 With Real estate Collateral With no amount specified 150,000,000 75,000,000 100,000,000 50,000,000 7,500,000 Social Sector 25,000,000 15,000,000 5,000,000 10,000,000 1,500,000 Private Sector Domestic Drafts 5,000,000 40,000,000 Socialist Sector & State Institutions Purchase 30,000,000 25,000,000 Mixed Sector

Other Various Real estate Collateral or Personal 75,000,000 50,000,000 15,000,000 25,000,000 10,000,000 Loans Guarantee Cancellation of No specified amount As above As above As above As above Facilities

Suspension of No specified amount As above As above As above As above Facilities

Reactivation of No specified amount As above As above As above As above None Facilities

Reopening Closed None Current Accounts

Note - All amounts are in IQD.

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ANNEX H

Rafidain Bank Credit Approval Process ______

Annex H

Rafidain Bank Credit Approval Process

• Receives loan application from client • Collects necessary documents • Checks documents received • Checks eligibility of request Branch • Assesses request • Checks collateral and has it appraised and registered • Writes recommendation • Sends recommendation to head office Credit Department for review, comments and approval

• Receives loan request from branch • Checks the file and review documents Credit • Coordinates with loan information unit when necessary Department • Makes sure collateral has been properly appraised • Makes recommendations and asks for more information to branch if necessary • Transmits to Credit Committee with short presentation memo

• Head of Credit Department presents the request • Members discuss request • Returns files to Credit Department for further information if necessary Credit • Approves or declines the request Committee • Sends back to the Credit Department, which will inform the Branch and the client of the decision • Above US$100,000 request is send to Executive Committee • Above US$200,000 request is sent to the Board of directors

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ANNEX I

Loan Classification Report for Rafidain and Rasheed Banks ______

Annex I

Loans Classification Report for Rafidain and Rasheed Banks

At the request of both the Central Bank of Iraq and the USAID Contractor, the State-owned Banks started late August 2005, to classify their loans according to International Rating Standards and Basel II principles.

This process, which is entirely new for the Iraqi Banks, proved to be an excellent tool and test to show the real quality of the performing loans portfolio and the risk presented. It also verified that pre war loans are generally of a lesser quality than post war loans.

It is likely that many clients take advantage of the war and the present situation to stop or delay the repayments of their borrowings. It is also true that collateralization of the loans and facilities are largely sufficient to cover cash flow shortfall, as long as a proper action is taken to foreclose on delinquent loans. It seems that this is not the case at the present time.

The following tables indicate a partial loan classification (Not including the facilities), but they are sufficient to formulate a first opinion on the condition of the “performing” loans.

Meaning of Ratings:

Ratings Classification Considerations Provisions A Standard Good repayment sources. Loan repaid on time 2% to 5% B Watch Loan less than 90 days passed due. Needs follow- 10% up C Sub Standard Loan is Past due more than 90 days and less than 25% 180 D Doubtful Loan is Past due more than 180 days. Risk of loss 50% E Loss Loan is Past over one year. Considered un- 100% collectible

State-owned Banks Risk Considerations:

1. Rafidain Bank:

a. Rating of Post-war USD Loans – 84 percent of the number of loans is in category A and B while the 87 percent in amount is in the same categories. There are no loans in the loss category. This is mitigated by the fact that many loans in category A are not yet due. This classification does not include some recently approved loans of the Socialist Sector, which have not yet been disbursed and will be in category A (IQD 110 billions and USD 111 millions).

b. Rating of Post-war Loans in IQD – Close to 100 percent of Post-war loans in IQD are in category A and B. many are new loans not due yet.

2. Rasheed Bank:

a. Rating of Post-war USD Loans – 77 percent of the number of loans is in category A and B while 78 percent in amount is in the same category. Two percent in number and in amount is in the loss category. It shows a certain consistence in the average amount of the loans. b. Rating of Pre-war USD Loans – The situation is reversed for the pre-war loans. There are no loans in the standard category. More that half the loans are in the categories over 90 days past due.

Annex I

RAFIDAIN BANK

Ratings of Performing Loans Extended in USD

Rating Number of Loans Outstanding Amount

Pre war Post war Pre war Post war

A 222 6,930,530

B 128 4,708,818

C 53 1,343,227

D 13 399,687

E 0 0

Total 416 13,382,262

Grand 416 USD 13,382,262 Total

Breakdown in percentage of loans classification in USD post war

Rating Number % Amount % A 53 52 B 31 35 C 13 10 D 3 3 E 0 0 Total 100 100

Annex I

Ratings of Performing Loans Extended in IQD

Rating Number of Loans Outstanding Amount

Pre war Post war Pre war Post war

A 68 1,621,110,000

B 8 268,000,000

C 2 21,777,775

D 1 70,000,000

E 0 0

79 1,980,887,775 Total

Grand 79 IQD 1,980,887,775 Total

Breakdown in percentage of loans classification in IQD post war

Rating Number % Amount % A 86 82 B 10.20 13.40 C 2.55 1.10 D 1.25 3.50 E 0 0 Total 100 100

Annex I

RASHEED BANK

Ratings of Performing Loans Extended in USD

Rating Number of Loans Outstanding Amount

Pre war Post war Pre war Post war

A 0 133 0 2,155,000

B 7 12 189,200 161,500

C 3 29 88,500 459,373

D 4 10 79,630 152,000

E 11 4 169,350 67,800

Total 25 188 526,680 2,995,673

Grand 213 USD 3,522,353 Total

Breakdown in percentage of loans in USD post war

Ratings Number % Amount % A 70 73 B 7 5 C 16 15 D 5 5 E 2 2 Total 100 100

Breakdown in percentage of loans in USD pre war

Ratings Number % Amount % A 0 0 B 28 36 C 12 17 D 16 15 E 44 32 Total 100 100

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ANNEX J

Rafidain Bank Debt and Delinquencies ______

Annex J

Rafidain Bank Debt and Delinquencies

Department # Loans # Loans Past Due Principal Balance Principal Past Due

Settlement 3,482 ** 3,482 5,605,533,320 5,605,533,320

Legal 2,891 ** 2,891 11,415,574,635 11,415,574,635

Int'l Branches 615 ** 276 79,285,626,627 71,672,516,487

2 *** 2 62,039,930,628 62,039,930,628 International* 27 ** 27 266,324,651 266,324,651

4,457 ** 1,045 44,035,896,774 1,270,488,729 Credit 23 *** 23 102,333,406,666 102,333,406,666

Total 11,497 7,746 304,982,293,301 254,603,775,116

Amounts used for the assessment were derived from individual departments of the bank. For this reason the figures do not reconcile to other amount reported by the bank.

Loans defined as loans and facilities.

All amounts converted to IQD equivalents (International Branches loans in local currency except Egypt which are in USD, International loans are in USD, and Domestic loans are in either IQD, or USD).

For the information from the Credit not all branches responded, however the vast majority of the loans and facilities are included.

* This is a loan to the Ministry of Finance, which is set up to offset a 2 loans to Rafidain to Gulf International Bank, Bahrain. The two loans to Gulf Bank are delinquent, therefore the mirror loan to the Ministry of Finance is past due. There is no collection effort being made.

** Private Debt.

*** Government Debt.

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ANNEX K

Rasheed Bank Financial Condition and Viability Report ______

Annex K

Rasheed Bank Financial Condition and Viability Report

Introduction

The report determines the financial condition and future viability of the six State-owned Banks, excluding the Trade Bank. The purpose of the report is to obtain information and data and present it in a format to assist the Government of Iraq determine the need for restructuring or liquidating all or some portion of the State-owned Banks.

The scope of the work was based upon a review of available financial reports prepared by the Bank as of December 31, 2004. Additional data was gathered where available or provided by Bank staff, and recorded adjustments to this information based upon “international best practices”. International Accounting Standards (IAS) concepts were applied where possible.

This report is not an audit of the financial statements of the Bank, nor is it an evaluation of its systems of internal controls. Because of the Bank’s method of accounting, the integrity of all reported information should be viewed in a skeptical manner as to its proper accounting classification, amount recorded, the accounting period reported in and accuracy.

Restated financial statements and other data are presented at the end of this report as the following Exhibits:

I. Statement of Condition (unaudited), II. Statement of Income (unaudited), III. Off Balance Sheet (unaudited), IV. Comparative Balance Sheet (unaudited), V. Comparative Income Statement (unaudited), VI. Statement of Condition with Journal Entries (unaudited), VII. Adjusting Journal Entries, VIII. Comparison of Branch Locations, IX. Branch Listing by Direct Net Income (Loss), X. Branch Loan Balances in Descending Order, XI. Combined Statements of Condition (unaudited) Rasheed and Rafidain Banks

i

Background

In order to better understand the nature of this report, it is necessary to understand the following characteristics of the Bank’s accounting function and system.

Accounting Principles

Rasheed Bank, as well as the other State-owned banks is not conforming to any generally accepted accounting principles (GAAP), including those of the Republic of Iraq, which has adopted versions of several International Accounting Standards (IAS). Accordingly, financial statements are lacking and deficient in data integrity, accuracy, and transparency, and in the representation of their fair value.

Accrual Accounting

Accrual accounting is an underlying assumption of financial statements prepared under IAS and GAAP of various countries. Rasheed Bank’s accrual accounting is on a limited basis, i.e., the accrual of Treasury bill income and savings interest expense at year-end. However, the IT Division has developed a processing system for 35 of the Bank’s major branches, and another 25 branches that operate in the geographic proximity of the major branches. Some loans and facilities are accrued for quarterly by these branches. Specific examples of accrual problems are mentioned within the report.

What is lacking is a system, manual or automated, to calculate monthly accruals for all interest bearing deposits and liabilities, and for all interest earning assets. Management needs an information system in order to determine the profitability of the Bank, for budgeting and control, financial statements, etc.

Systemic Weaknesses of the Accounting Function

The Bank’s accounting function is dysfunctional and decentralized among its entire branch network of 144 branches and within the main office. It is also fragmented within the main office as described later in the report between the International Division, the IT Division and the Financial Division regarding recordation of LOC and the proper revaluation. There is insufficient coordination among these areas to reconcile data and information regarding Off Balance Sheet items such as over 6,000 Letters of Credit (LOC), which are the responsibility of selected branches. In fact, the 2003 Annual Report was being adjusted in mid 2005 and will not be approved as complete and accurate until the Supreme Audit Body approves the adjustments.

In August the Bank provided a copy of the 2004 Annual Report to the Ministry of Finance (MOF) and a trial balance of the general ledger. It was subsequently significantly adjusted and revised, and adjusted again in late October.

The Accounting Division Manager was unable to actively participate in the assessment. Assisting the advisor was a new supervisor of the Accounting Balance Sector. She recently transferred from the Bank’s main branch, where she worked in accounting sector.

While working with the International Division, we became aware of the above-mentioned 6,000 plus, LOCs, which have been given to selected branches. They were not revalued, however, during the financial statements preparation cycle. Also not revalued were the Foreign Letters of Guarantee (LOG). The financial implications of these trade finance type of transactions has a significant impact on the Bank’s financial condition.

ii

Findings

Findings regarding the financial condition and future viability of the Rasheed Bank are presented below. Focus first on the negative capital position of the Bank, and then on information and details that contributed to this situation.

Bank Capital

According to the Bank’s records as of December 31, 2004, the amount of capital is recorded as:

(000s) IQD

• Paid in Capital 2,000,000 • Capital Reserves 4,796,300 • General Reserves 3,274,498 • Reserve for Research and Development 1,157,879 • Social Reserves 292,908

Total 11,521,585

Capital was 10.3 billion at the end of 2003, only 0.51 percent of year-end assets. In 2004, capital increased by 1.2 billion, to 11.5 billion, or 0.30 percent of year-end assets. International standards require a bank to have at a minimum an 8 percent ratio of capital to assets. Then, based upon Basle Accord risk rating requirements, the required amount of capital increases based upon the level of risk facing a bank. Clearly, the Bank has continuously under capitalized.

Based upon adjustments to December 31, 2004 financials, adjusted total capital and retained earnings as depicted in Exhibit I, Statement of Condition (unaudited), is a negative 1.7 trillion IQD, or USD 1.2 billion. This reflects balance sheet liabilities of 5.6 trillion IQD and assets of 5.7 trillion, consequently resulting in the insolvency of the Bank.

A brief description of the major adjustments that affected capital is as follows:

1. Revaluation of monetary assets and liabilities denominated in +395 million IQD foreign currencies (most foreign denominated monetary assets or liabilities were historically valued at 1 IQD = USD 3.21).

2. Recognition of revalued Off Balance Sheet (OBS) items, which are considered a legal liability of the Bank as there are no assets or contra parties to offset these liabilities:

Foreign LOCs (835) billion Foreign LOGs (266) billion

3. Write-off of confiscated and blocked deposits and accounts dating back to the 1990s. (671) billion

4. Damage from military conflict and looting (256) billion

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When the Bank is audited under International Standards of Auditing, additional unrecorded liabilities are expected to be detected.

Exhibit VII Adjusting Journal Entries and further discussions in this report provide more details regarding these adjustments.

Foreign Debt Liabilities

On Balance Sheet

In April 1990, the Bank was granted a USD 60 million, medium-term loan to mature on February 1, 1993, by the Gulf International Bank (GIB). The loan was discounted and the Bank received USD 59,893,399.20. The MOF was the beneficiary of the loan. Scheduled interest payments were not regularly paid by the Bank, and on July 31, 1992, GIB exercised their “right of set-off” against Rasheed Bank’s accounts with GIB. The loan was reduced by USD 47.4 million and a new loan amount was granted for USD 12.7 million. Interest of USD 333,726.08, for the period of July 31,1992 through February 1, 1993, was included in the new loan. Since the restructuring of the loan and capitalization of the interest, Rasheed Bank failed to remit funds for interest payments and principal reduction.

The loan interest rate is the LIBOR six-month rate, plus 0.75 percent, plus 1.0 percent penalty. Using an annual interest, rate, based on the monthly average 6 month LIBOR rate, the calculation for the approximate amount of the Bank’s interest expense liability from 1993 - 2004 is USD 13 million, or IQD 19.1 billion. The interest due is now greater than the restructured loan balance of USD 12.7 million. No interest expense has been accrued for the above loan in Rasheed Bank’s records, or an accrued interest payable liability included in the balance sheet for the past 12 year period. The average of over USD 1 million per year of interest expense and liability has been excluded from the Bank’s financial statements.

According to in-house legal counsel, GIB filed a lawsuit against the Bank in 1994, seeking USD 37 million, and is listed as a claim against the Bank.

Noteworthy is the fact that the amount of past due interest was in excess of the Bank’s total capital at the end of 2004. Retained Earnings was charged for the above interest due and a liability established in the attached financial statements.

Another long-term liability which is past due involves four banks from Turkey and documentary credits dating from 1991-1992. The Bank agreed to a rescheduling for repayment to be made after the lifting of sanctions. The principal amount due is IQD 54,4 billion. Interest for these debts have not been accrued as a liability or expensed in the Bank’s restated financial statements.

Off Balance Sheet (OBS)

LOC

Exhibit III, Off Balance Sheet was presented although the Bank’s general ledger has more active accounts and differing amounts. International Division does not record or maintain the records for LOC, but rather they are located in various branch offices. The IT Division provided us with a listing of 6,426 LOCs that totaled IQD 835 billion, or USD 572 million. Capital of the Bank was reduced by this amount to reflect the Bank’s liability.

LOG

The OBS statements reviewed indicate differing amounts for LOGs ranging from IQD 4.3 billion-5.4 billion for domestic LOG. The International Division provided a listing of 229 LOGs, denominated in “old Dinars”

iv

which amounts to 56.5 million IQD. The current liability should be recorded as IQD 264,654,621,659 or USD 181,270,288.

The IT Division provided a listing of LOGs, numbering 1,045, for a total amount of “old Dinars” of 1,077,171,000 IQD. According to Bank staff, only 229 of these are foreign LOGs. The remaining are purportedly domestic LOGs and converting the 1.1 billion IQD to USD would result in an additional amount of USD 3.5 billion, or 5 trillion IQD.

Apparently these domestic LOGS were issued primarily to Government related beneficiaries during the1990s. After the UN embargo in 1991, the Bank extended the tenor of the guarantees at the instructions of the beneficiaries (the Government) to “pay or extend”. This was apparently done and the LOGs are still outstanding. Consequently, the Bank still records the LOGs as both contingent asset and contingent liability, on the basis that foreign correspondent banks should honor their obligations in order to allow payments to the beneficiary. The foreign counter-guarantees backing the Bank’s LOGs have all been cancelled under the UN resolutions.

The Bank and the MOF should resolve the final accounting for this issue, and one of the parties should recognize the “accounting loss” in its financial records.

Confiscated Accounts

The 1990 and 2003 UNSEC Resolution resulted in the confiscation of numerous foreign accounts of the Bank. The Bank, however, still includes these foreign accounts in its accounting records as deposits in the financial statements. The restated financial statements reflect the recognition of the following losses:

1. Based upon a listing from the International Division of confiscated accounts with approximately 35 foreign banks, a write-off of 265,598,555,000 IQD was taken.

2. LOC deposits, of IQD 177,859,941,000, maintained as “LOC Cover” in account 15386 were charged to retained earnings to offset the recognition of the Bank’s LOC liability.

3. Similarly, account 1692, Debtors for Foreign LOC Expense, a receivable for IQD 908,727,000, was offset to retained earnings.

4. Deposit liabilities for LOC, in accounts 2252 and 2553 for 1,482,249,000 IQD were credited to retained earnings to offset the recognition of the Bank’s total LOC liabilities.

Other Foreign Liabilities

During the summer of 2004, the Bank provided Ernst & Young, the international accounting firm, a list of approximately 125 foreign bank accounts which the Bank maintained from the early 1990s to the current date. This is in contrast to the smaller list of 35 banks mentioned in the above item.

The Bank should review its accounts in detail to perform two specific functions: 1) identify and write-off all confiscated accounts and deposits, 2) where an account has been confiscated, the Bank should ensure that any of its liabilities related to the account on the Bank’s records be set-off.

Ernst & Young provided a listing of approximately 5,500 legal claims against the Bank. The foreign currencies of the various claims were all converted and a total amount of potential liability of USD 1.0 billion obtained.

The Bank’s Legal Division provided a listing of pending litigation against the Bank, as of September 2005. There are approximately 25 pending foreign originated cases, with total claims for 590 billion IQD or USD 404 million.

v

Pending are approximately 50 local lawsuits against the Bank, for claims of 527 million IQD. We contacted the U.S. Treasury in Washington D.C. and were provided the following information regarding confiscated accounts through OFAC (Office of Foreign Asset Control):

• 2003 Period: USD 358,595,578.77 from Rasheed Bank, and

• 1991 Period: No details by individual bank, but OFAC reported a total of USD 1,261,426,606.57 confiscated/blocked deposits for all banks and Iraq entities.

Currently DFI (Development Fund of Iraq) is unable to provide us with a listing of amounts confiscated from Rasheed Bank’s accounts worldwide. This complicates and negates our ability to ascertain the accuracy of the remaining foreign accounts and debt of the Bank.

Determination of the final amount of foreign debt will have to be resolved over time through negotiations with the Paris Club and other creditor groups.

Financial Statement Analysis

Analysis of the financial statements, attached as exhibits to this report, is presented below:

Loans and Facilities

Loan Composition

According to the Bank’s chart of accounts and records, as of December 31, 2004, loans and facilities were as follows:

(000s) IQD

• Short-term Loans 41,994,208

• Overdraft Facilities 58,081,508 • Long-term Loans 3,298,398 • Discounted Paper and Drafts 68,828,775

• Other Loans 5,134,364

• Past Due Obligations 25,033,685 • Rescheduled Loans 1,734,359

Total Gross Loans 204,105,297

Less Reserves for Loan Losses and Unpaid Interest 7,117,009

Net Loans 196,988,288

Included in the Discounted Commercial Paper and Draft account is the amount of IQD 65.3 billion that represents discounted checks drawn on branches of Rasheed Bank and other banks outside of the branch area which is discounting the check. For discussion purposes, these amounts are excluded from the loan balances used for the calculation of ratios and loan loss reserves. This type of transaction is a collection process rather than a loan.

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Several adjustments to the above amounts were made in order to more accurately present the loans and their valuation in the financial statements.

The Bank’s loan to deposit ratio is only 6.1 percent of average loans and average deposits. Year-end loan and deposit balances for 2003 and 2004 were used to derive an average balance. The average balance for discounted checks was deducted from these amounts. The averages are 1) loans – 138 billion, and 2) deposits – 2.3 trillion IQD. A bank should strive, depending on its specific circumstances and market area, to have a loan to deposit ratio in the range of 75-85 percent. Money market banks generally exceed this ratio as a result of utilizing debt as a funding source.

Using the same average loan balances, interest income for all credits, which was 12.6 billion IQD, generating a yield of 9.1 percent. Such a high yield, compared to some of its peer banks, seems unusual given the degree of nonperforming loans. Interest rates range from 12-14 percent for loans granted in Dinars and 9 percent for loans in Dollars. It is possible that some significant income was received, but not previously accrued.

Loan Charge-offs and Reserves for Loan Losses

Reserves for loan losses as of December 31, 2004, prior to our adjustments, were recorded in the following manner: (000s) IQD

2004 2003 • Reserves for Loan Losses 3,027,263 3,027,263 • Reserve for Losses Personal Advances 2,467,070 2,450,527 • Reserve for Cash Credit 1,257,933 2,031,780 • Reserves for Unpaid Interest 364,743 284,975

Totals 7,117,009 7,794,545

In order to determine a reasonable level of reserves for loan losses, we reviewed the amount of cancelled debt and recoveries for the years of 2003 and 2004. We also utilized the delinquency data presented in the Debt and Delinquencies section of this report.

• During 2004, the Bank’s accounting records depicts only Dinars 190,000 as cancelled debt, and none for 2003, but there was a provision for loan losses of IQD 318,132,000 in 2003.

• The Reserves for Loan Losses were reduced, on a net basis, by IQD 677,536,000 during 2004, indicating that loans may have been charged against the reserves, or possibly some recoveries were also applied to the reserves.

• The account 4833 Loan Recoveries reflects only IQD 3,000 collected in 2004, and nothing for 2003.

• Loan delinquencies, as presented in Annex O, indicates that 95.3 percent of the Bank’s loan and facilities portfolio is delinquent as to the principal balance, and in terms of the number of loans, 54 percent, or 9,670 loans are delinquent.

• Data presented in the Financial Settlement sector Quarterly Report, indicates a constant trend of increasing number of loans in the settlement process, which is the final collection effort. From December 2002 through March 2005, the number of borrowers and their debt has increased respectively from 1,433 to 1,948 borrowers and 3.4 billion to 4.6 billion IQD. This is a 35 percent increase in the amount of principal and a 36 percent increase in the number of borrowers.

vii

• The Property Subdivision of the Bank has stated that the Bank has not “confiscated” any real estate property during the period of 2002 – October 2005.

For the restated financial statements the Loss Reserves were increased from 7 billion to 63 billion IQD. Applying a percentage factor of zero for government loans, 10 percent for financial sector loans, and 75 percent for all remaining loans derived this.

Deposits

The composition of restated deposit as of December 31, 2004 is:

(000s) IQD

• Current Accounts 1,639,848,315 • OD in Due from Bank Account 565,798,804 • Savings Accounts 417,856,275 • Time Deposits 44,372,934 • Deposits of Foreign Banks and Organizations 782,387,594 • Other Deposits and Drafts Outstanding 76,463,930

Total 3,526,727,852

An amount of IQD 113,600,440 was reclassified from Time Deposits, Current Accounts in Foreign Currency to the actual Current Accounts category. Also, the amount of overdrawn Due from Banks account in the amount of IQD 565,798,804 was added to Deposits.

Average deposits for 2004 were 2,3 trillion IQD, and interest expense for deposits was 24.3 billion, resulting in an extremely low cost of funds of 1.7 percent. The Bank’s unusually low cost of funds is primarily due to the placement of government noninterest bearing deposits with the Bank. Government funds, which include the government, productive, financial and mixed sectors, are IQD 1,156,319,605 or 32.8 percent of total deposits. Since several deposit categories are not classified by sector, i.e., savings accounts, time deposits in foreign currency mentioned above, this is the best available data.

The Bank as stated earlier is insolvent with total assets of 3.9 trillion IQD and liabilities of 5.6 trillion IQD. The Bank would be unable to pay all depositors and creditors if the need should arise, and is deficient in the amount of 1.7 trillion IQD. This deficiency assumes all assets could be realized at their book or recorded value, which is unlikely relative to the quality of the loan portfolio and other issues.

The Bank’s ability to continue to operate is largely dependent upon its reliance on the source of low cost government deposits.

viii

Earnings

Income reported over the years has been inaccurate and overstated as a result of not providing for adequate provisions for loan losses, the limited amount of loans written-off, not recording all accrued income and expense and the lack of recognition of losses for various assets such as confiscated or blocked deposit accounts.

The primacy of earnings cannot be overemphasized in the assessment of any entity. Banks must be able to generate sustainable, quality earnings, in order to support capital requirements and continued growth.

Exhibit II Statement of Income (unaudited) and Exhibit V Comparative Income Statements (unaudited) provide the details of the Bank’s recent losses. Understandably the year 2003 was extraordinary, and throughout 2004, the Bank continued to experience difficulties. The mentioned Exhibits were based on revalued data for the year 2004. The Bank did not revalue data monetary assets or liabilities denominated in foreign currencies for 2003, but since income and expense transactions occur throughout the fiscal year, the changes in exchange rates would be reflected in these transactions.

The Bank’s earning for 2003 are not accurate for several reasons, i.e., during 2003, the Government directly paid the salaries of Bank employees for a portion of the year and provided other assistance as a result of the military conflict. Confiscated deposit accounts were not written-off in 2003 and, as indicated previously, certain interest expense accruals have not been recorded. Also since 1990, significant trade finance losses have not been recognized, and the commensurate interest expense for these liabilities also has not been recognized in the Bank’s accounting operations.

A summary of the major income and expense categories is as follows:

(000s) IQD

2004 2003

Interest Income 12,648,249 12,259,396

Investment Income 34,333,171 24,617,517

Total Interest Income 46,981,420 36,876,913

Less Interest Expense 24,374,157 21,288,360

Net Interest Income 22,607,263 15,648,553

Less Provision for Loan Losses -0- (318,132)

Noninterest Revenue 6,523,823 4,242,427

Total Operating Income 29,131,086 19,572,848

Less General and Administrative Expenses 29,341,905 6,562,106

Net Income (loss) (210,819) 13,010,742

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A review of the Income Statements for 2004 indicates some positive as well negative performance during 2004. Some examples are as follows:

• Calculation of a Return on Assets ratio is meaningless since the Bank sustained a small loss for the year. The ratio for 2003 would be 0.33 percent, but is not useful, given the unusual operating conditions.

• Total interest income from lending increased only 3 percent from 2003, which as mentioned was an unusual year.

• Investment income significantly increased by 39 percent, as a result of a 26 percent increase in Treasury Bill income, and by IQD 3,240,364,000 from interest on foreign currency in foreign countries.

• Total interest income increased 27 percent while interest expense increased 15 percent as deposits were higher by IQD 38 billion at year-end, which overall resulted in a 44 percent increase in net interest income.

• Noninterest revenue, primarily from fees and commissions grew 54 percent, but if adjusted for items which the bank describes every year as Nonrecurring and Prior Year’ Items, the increase would be 22 percent.

• General and Administrative expenses increase 347 percent over 2003, and if adjusted for expenses from prior years, it is 325 percent.

• Salaries and benefits increased IQD 18.9 billion, or 1,429 percent. As stated earlier, the Government paid employees salaries on behalf of the Bank for most of 2003. However, employees received a significant increase in salaries following the 2003 Conflict and this will require management’s attention to control and reduce this expense which now represents 68 percent of the total noninterest expense of the Bank.

• Maintenance and repairs increased 394 percent, and business travel costs increased from IQD 60,565,000 to 223,834,000 or 270 percent.

Of note, is that the Bank only expended IQD 8,347,000 on employee training for the entire year. This is the equivalent of less than USD 1 per year, per employee.

The banking industry uses a ratio referred to as an “efficiency ratio” which is noninterest expense as a percent of net interest income plus noninterest income. This ratio measures the proportion of net operating revenues that are absorbed by overhead expenses, so that the lower the percentage, the greater the efficiency.

For Rasheed Bank, this ratio is 101 percent based on December 31, 2004 data. For the 25 largest bank companies in the United States, this ratio is approximately 57 percent.

Non-earning Assets

Non-earning assets are those assets that are not directly used to generate revenue through the granting of credit, placements of funds or investments. Nonearning assets consist of cash, noninterest bearing deposits in other banks, reserves maintained at the Central Bank, nonperforming loans which are not accruing interest, fixed assets net of accumulated depreciation, and other similar assets.

Rasheed Bank’s nonearning assets as a percent of total year-end assets for 2003 and 2004 were at unprecedented levels of 64 percent and 89 percent, respectively. The disproportionate amount of nonearning assets is exceedingly high. Ideally, the percentage should be in the range of 10-15 percent of total assets,

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which can vary according to the nature of a bank’s activities and the environment in which it operates. The Bank has an inverse ratio of earning to nonearning assets, compared with international banking best practices.

In 2004, the Bank had restrictions placed on the total amount of Treasury bills it can purchase through auctions, and this will limit them as to future income from this source. However, in 2005, CBI has instituted an overnight investment fund program for banks to invest idle funds and earn interest. The CBI offered the following rates for funds in Dinars as of March 7, 2005:

• 5 percent for overnight deposits, • 6 percent for deposits for 14 days, and • 7 percent for deposits for 30 days.

The CBI also offers different rates for USD deposits which vary from 3 percent for 30 days, to 3.25 percent for 90 days.

Net Interest Margin

In 2004, the Bank earned a yield of 9.1 percent on its total average loan portfolio, and its cost of funds is inordinately low at 1.7 percent. The net interest margin, net interest income expressed as percent of average earning assets, was 3.62 percent, similar to the international benchmark of 3.5 percent-4 percent. This benchmark was achieved because the Bank has a small base of earning assets and a low cost of funds.

Investments

Exhibit I depicts Treasury Bills of IQD 360,960,000,000 classified as investments Held-to-Maturity, and the remaining investments as Available-for-Sale.

The remaining 3 billion IQD includes 2 billion in the Arab Trade Finance Program. The remaining 1 billion is invested in several bank stocks, a poultry feed company and a cash transportation company, and their market value needs to be ascertained for valuation purposes.

Domestic Branch Operations

As of December 31, 2004, the Bank listed 144 branches throughout Iraq, excluding its former branches in the North that are no longer accounted for in the Bank’s records. Some of the branch data provided to us will vary as to the number of branches, but does not in our view, distort the perspective or context of our presentation of the overall data.

The following exhibits are attached regarding branches:

• Exhibit VIII, Comparison of Rafidain and Rasheed Bank’s Branch Location, • Exhibit IX, Branch Listing By Direct Income (Loss) in Descending Order, and • Exhibit X, Branch Loan Balances in Descending Order.

An analysis of the data depicted in the above exhibits is presented below.

Direct Net Income (Loss)

Exhibit IX, presents the direct income, expense and resulting net income or loss for each of the branches in descending order of net income or (loss). The term “direct” is used to indicate these are amounts, which the branches have earned or incurred at the branch level, and exclude any allocations from the main office. The net amount is not an indication of the branches’ actual profitability, since there has been no recording of

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overhead costs, or of a credit given to the branch for excess funds provided, or of charges to branches to obtain deposits from the main office to fund their loan portfolio.

Clearly, the financial performance of the branches for the year ending December 31, 2004 is extremely poor based upon a review of Exhibit IX, stratified as follows:

(000s) IQD

Range of Earnings Number Branches Direct Income (Loss)

Over 1 billion 4 8,823,741 500 million – 999 million 2 1,573,387 100 – 499 million 2 314,790 1 – 99 million 3 37,520

Total Income 11 10,749,438

Losses

1 – 99 million 41 (1,977,915)

100 – 199 million 31 (4,363,871) 200 – 499 million 42 (12,835,233) 500 – 999 million 17 (11,333,735) Over 1billion 1 (2,195,017)

Loss 132 (32,705,771)

Net Loss 143 (21,956,333)

As presented above, only 11 branches (International Division is included as a branch) out of 144, or 7.7 percent, have direct net income, and the remaining 133 branches incurred a loss. The direct expenses of the 132 branches with losses are IQD 38,723,514.

Branch Loans and Facilities

Exhibit X provides a perspective of loans by the government and private sector, and the number of customers distributed throughout the branches.

(000s) IQD Range No. Branches Amount

Over 10 billion 4 88,313,055 5 - 9 billion 2 14,868,894 2.5 – 4.9 billion 5 18,497,201 1 – 2.4 billion 18 25,687,338 500 – 999 million 24 16,445,001 250 - 499 million 31 11,152,244 100 – 249 million 20 3,510,918 50 – 99 million 7 509,144 0 –49 million 36 355,602

Total 147 179,339,397

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The above data indicates the small volume of loans generated by the majority of branches, 17 of which had no loans listed.

Comparison of Branch Locations

Exhibit VIII presents a regional comparison of Rasheed and Rafidain Banks’ branches in Iraq. There appears to be a significant duplication or overlapping or branch locations between the banks.

Future Viability of Rasheed Bank

In the Rafidain Bank section of this report, several scenarios regarding viability of the Bank were discussed. These are not repeated here. Exhibit 1 of Rasheed Bank financials depicts the restated balance sheet as at December 31, 2004 and possible outcomes to Rasheed are presented below.

Scenario I Financial Resolution of Rasheed Bank

This assumes the MOF will retain the Bank and provide a capital infusion equal to 8 percent of assets. Using data from Exhibit I, additional funding required is presented as follows:

Funding Required

MOF Accepts Foreign Debt 1,173,682,790 Replenish Deficiency 534,782,106 Capital Infusion 383,381,298 Total 2,091,846,194

Assets Liabilities/Capital IQD (000) IQD (000) December 31, 2004 3,874,102,827 5,582,567,723 11,521,585 (1,173,682,790) 4,420,406,518

Capital Infusion 371,859,713 Government Bond 918,163,404

Total 4,792,266,231 4,792,266,231

Scenario II Liquidation of Rasheed Bank

Essentially the negative capital of IQD 1,708,464,896,000 would be the incurred cost, along with professional fees, employee severance pay, etc.

A large number of depositors, but not creditors, could be repaid in this scenario, depending on the amounts received for various assets in comparison to their book value. At year-end, deposits were IQD 3.5 trillion, and total cash was IQD 859,761,423,000, and Due from Banks was IQD 2,237,095,220,000, for a total of IQD 3,186,856,643,000.

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Scenario III Rehabilitation and Restructuring of Rasheed Bank

Essentially similar requirements as Scenario I, which would resolve the foreign debt issue and provide adequate capital for the current period.

Additional funds and significant effort will be required in order to strengthen and enhance the overall institutional and individual capacities of employees.

It is unlikely a foreign buyer or strategic investor will be willing to invest significant sums for the Bank in its current condition and state of operations. The branch network is large, inefficient, costly, and probably not profitable. A new investor will be faced with significant issues such as staff reductions, staff training requirements, need for automation, and similar issues. Possibly the most critical issue will be to what extent the Government of Iraq agree to maintain non-interest bearing deposits with the new owners of the Bank, since this is the Bank’s single competitive advantage over private banks within the country.

Exhibit XI is Combined Statement of Condition for Rasheed and Rafidain Banks and is presented in order to visualize the size and composition of the assets and liabilities of the two banks if they were to be combined or merged.

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ANNEX L

Rasheed Bank Total Foreign Debt

Annex L

RASHEED BANK TOTAL FOREIGN DEBT - SUMMARY (CLAIMS RECEIVED BY ERNST AND YOUNG)

RATE USD EQUIV

BILLS Amount Due O/S Principal O/S Interest

CHF 0 0.77676 0 EUR 0 1.20360 0 GBP 0 1.75670 0 JPY 0 0.008748 0 USD 19,363,858 18,809,758 554,100 1.00000 19,363,858

MULTI-LATERAL Amount Due O/S Principal O/S Interest

CHF 0 0.77676 0 DKK 0 0.16128 0 EUR 2,945,041 2,945,041 1.20360 3,544,652 GBP 0 1.75670 0 JPY 0 0.008748 0 NOK 0 0.15376 0 SEK 0 0.12776 0 USD 36,764,133 36,764,133 1.00000 36,764,133

GUARANTEES Amount Due O/S Principal O/S Interest

CHF 0 0.77676 0 EUR 0 1.20360 0 GBP 0 1.75670 0 JPY 0 0.008748 0 USD 0 1.00000 0

LETTERS OF CREDIT Amount Due O/S Principal O/S Interest 0 CAD 11,936 11,936 0.84574 10,095 CHF 10,578,060 10,578,060 0.77676 8,216,614 DKK 4,637,985 4,637,985 0.16128 748,014 EUR 28,781,119 28,457,106 324,013 1.20360 34,640,955 GBP 9,283,806 9,283,806 1.75670 16,308,862 JPY 3,987,910,738 3,960,912,825 26,997,913 0.008748 34,886,243 KWD 0 3.42571 0 NOK 0 0.15376 0 SEK 18,222,776 18,222,776 0.12776 2,328,142 USD 473,427,588 472,457,544 970,044 1.00000 473,427,588 ZZZ 780,492 780,492 1.00000 780,492

OTHER Amount Due O/S Principal O/S Interest

CHF 110,697,449 110,697,449 - 0.77676 85,985,350 DKK 0 0.16128 0 EUR 0 1.20360 0 GBP 0 1.75670 0 JPY 0 0.008748 0 SEK 0 0.12776 0 USD 431,392,647 426,448,080 4,944,567.40 1.00000 431,392,647

PROMISSARY NOTES Amount Due O/S Principal O/S Interest

CHF 0 0.77676 0 EUR 0 1.20360 0 GBP 0 1.75670 0 JPY 0 0.008748 0 KWD 0 3.42571 0 USD 0 1.00000 0

SYNDICATED LOANS Amount Due O/S Principal O/S Interest

CHF 0 0.77676 0 EUR 0 1.20360 0 GBP 0 1.75670 0 JPY 0 0.008748 0 USD 0 1.00000 0

UNKNOWN Amount Due O/S Principal O/S Interest

CHF 0 0.77676 0 DKK 0 0.16128 0 EUR 0 1.20360 0 GBP 0 1.75670 0 JPY 0 0.008748 0 KWD 0 3.42571 0 NOK 0 0.15376 0 SEK 0 0.12776 0 USD 0 1.00000 0

Total by Currency - CAD 11,936 11,936 0 0.84574 10,095 CHF 121,275,509 121,275,509 0 0.77676 94,201,964 DKK 4,637,985 4,637,985 0 0.16128 748,014 EUR 31,726,160 31,402,147 324,013 1.20360 38,185,606 GBP 9,283,806 9,283,806 0 1.75670 16,308,862 JPY 3,987,910,738 3,960,912,825 26,997,913 0.008748 34,886,243 KWD 0 0 0 3.42571 0 NOK 0 0 0 0.15376 0 SEK 18,222,776 18,222,776 0 0.12776 2,328,142 USD 960,948,226 954,479,515 6,468,711 1.00000 960,948,226

Total Claims in USD 1,147,617,153

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ANNEX M

Rasheed Bank Credit Approval Process ______

Annex M

Rasheed Bank Credit Approval Process

Receives loan application from client Collects necessary documents Checks documents received Checks eligibility of request Branch Assesses request Checks collateral and has it appraised and registered Writes recommendation Sends recommendation to head office Credit Department for review and comments

Receives loan request from branch Checks the file and review documents Credit Coordinates with loan information unit when necessary Department Makes sure collateral has been properly appraised Makes recommendations and asks for more information to branch if necessary Transmits to Credit Committee with short presentation memo

Head of Credit Department presents the request Members discuss request Returns files to Credit Department for further information if necessary Credit Approves or declines the request Committee Sends back to the Credit Department, which will inform the Branch and the client of the decision Above IQD 150,000,000 (USD 100,000) file is send to Executive Committee or Board of directors

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ANNEX N

Rasheed Bank Loans and Facilities ______

Annex N

Rasheed Bank Loans and Facilities (As of May 2005)

Number of Type of loans Outstanding Amount Loans

Domestic loans in USD 212 USD 3,996,138

Domestic loans in IQD 1,393 IQD 6,313,393,000

Facilities within Baghdad in IQD • Individuals Total 2,404 - Overdrafts 6,259,967,500 - Discounted bills 9,016,977,000 - Guarantees. L/Cs 7,287,141,000

• State Sector Total* - Overdrafts 1 35,000,000,000

• Real Estate Bank 1 24,374,000,000

• Socialist Sector Total - Overdrafts 12 37,400,720,412

Facilities outside Baghdad in IQD • Individuals Total 7,933 8,328,026,086 - Overdrafts 13,566,398,500 - Discounted bills 3,160,135,000 - Guarantees L/Cs

Personal Advances in IQD

Total Loans in IQD equivalent * 12,307,600,000 Total Facilities 144,393,365,498

* Of which, Loans in USD represent IQD 5,994,207,000.

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ANNEX O

Rasheed Bank Debt and Delinquencies ______

Annex O

Rasheed Bank Debt and Delinquencies

Department # Loans # Loans Past Due Principal Balance Principal Past Due

Settlement 1,994 1,994 4,182,541,071 4,182,541,071

Legal 948 948 85,916,732,334 85,916,732,334

International* 1 *** 1 18,681,274,548 18,681,274,598

14,899** 6,715 34,273,121,442 16,804,597,777 Credit 12 *** 12 226,756,184,784 226,756,184,784

Total 17,845 9,670 369,809,854,179 352,341,330,564

Numbers for different areas of the bank were collected from the various department handling the debt. These figures do not reconcile with other reporting areas of the bank.

Loans defined as loans and facilities.

All amounts converted to IQD equivalents.

Date of data is 10/31/2005.

*This loan mirrors the terms of a loan payable by Rasheed Bank to Gulf International Bank, Bahrain. The loan receivable is to the Ministry of Finance as the bank made its loan from Gulf Bank on behalf of the Ministry. No efforts are being made to collect this debt by the bank. Possibly the original note payable of Rasheed has been assumed by MoF.

** Private Debt.

*** Government Debt

**** 111 out of 115 Branches Reporting.