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CAMELS Rating System
What is the ‘CAMELS Rating System’
The CAMELS rating system is a recognized international rating system that bank supervisory authorities use in order to rate financial institutions according to six factors represented by the acronym “CAMELS.” Supervisory authorities assign each bank a score on a scale, and a rating of one is considered the best and the rating of five is considered the worst for each factor.CAMELS is a rating system developed in the US that is used by supervisory authorities to rate banks and other financial institutions. It applies to every bank in the U.S and is also used by various financial institutions outside the U.S. This rating system was adopted by National Credit Union Administration in 1987. In 1988, the Basel Committee on Banking Supervision of the Bank of International Settlements (BIS) proposed the CAMELS framework for assessing financial institutions.
The ratings are assigned based on the financial statements of the bank or financial institution. This system helps the supervisory authorities to identify banks that need maximum amount of regulatory concern. It is used to measure risk and financial stability of a bank. It determines the banks overall conditions in the areas of financial, managerial and operational aspects.
The rating system consists of a score from one to five with score one considered as best and score five considered as the worst for each factor. Banks which obtain the score of one are considered most stable, banks with a score of 2 or 3 are considered average and those with 4 or 5 considered as below average and are subjected to supervisory scrutiny.
Factors for giving scores:
CAMELS is an acronym of the following factors on which ratings are given by supervisory authorities.
BREAKING DOWN ‘CAMELS Rating System’
Banks that are given an average score of less than two are considered to be high-quality institutions. Banks with scores greater than three are considered to be less-than-satisfactory institutions.
The acronym CAMELS stand for the following factors that examiners use to rate bank institutions:
Examiners assess institutions’ capital adequacy through capital trend analysis. Examiners also check if institutions comply with regulations pertaining to risk-based net worth requirement. To get a high capital adequacy rating, institutions must also comply with interest and dividend rules and practices. Other factors involved in rating and assessing an institution’s capital adequacy are its growth plans, economic environment, ability to control risk, and loan and investment concentrations.
Asset quality covers an institutional loan’s quality which reflects the earnings of the institution. Assessing asset quality involves rating investment risk factors that the company may face and comparing them to the company’s capital earnings. This shows the stability of the company when faced with particular risks. Examiners also check how companies are affected by fair market value of investments when mirrored with the company’s book value of investments. Lastly, asset quality is reflected by the efficiency of an institution’s investment policies and practices.
Management assessment determines whether an institution is able to properly react to financial stress. This component rating is reflected by the management’s capability to point out, measure, look after, and control risks of the institution’s daily activities. It covers the management’s ability to ensure the safe operation of the institution as they comply with the necessary and applicable internal and external regulations.
An institution’s ability to create appropriate returns to be able to expand, retain competitiveness, and add capital is a key factor in rating its continued viability. Examiners determine this by assessing the company’s growth, stability, valuation allowances, net interest margin, net worth level and the quality of the company’s existing assets.
To assess a company’s liquidity, examiners look at interest rate risk sensitivity, availability of assets which can easily be converted to cash, dependence on short-term volatile financial resources and ALM technical competence.
Sensitivity covers how particular risk exposures can affect institutions. Examiners assess an institution’s sensitivity to market risk by monitoring the management of credit concentrations. In this way, examiners are able to see how lending to specific industries affect an institution. These loans include agricultural lending, medical lending, credit card lending, and energy sector lending. Exposure to foreign exchange, commodities, equities and derivatives are also included in rating the sensitivity of a company to market risk.
Camels composite rating:
The CAMELS system is also based on composite ratings on a scale of one to five based on ascending order of supervisory concern. Each factor is assigned a weight as follows:
- Capital adequacy 20 %
- Asset quality 20%
- Management 25%
- Earnings 15%
- Liquidity 10%
- Sensitivity 10%
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