The CAMEL Ratings System

Bachir El Nakib Founder Compliance Alert

Friday July 26, 2024

CI Ratings vs CAMELS Rating System?

CAMELS is a recognized international rating system that bank supervisory authorities use in order to rate financial institutions according to six factors represented by its acronym: 

Capital Adequacy

Asset Quality, 

Management, 

Earnings, 

Liquidity, and 

Sensitivity.

Supervisory authorities assign each bank a score on a scale for each factor. A rating of 1 is considered the best, and a rating of 5 is considered the worst.

 

KEY TAKEAWAYS

CAMELS is an international rating system used by regulatory banking authorities to rate financial institutions.

The CAMELS system rates six factors: capital adequacy, asset quality, management, earnings, liquidity, and sensitivity.

A rating of 1 is considered the best, and a rating of 5 is considered the worst.

Capital adequacy is a measure of a bank's ability to continue operations in the event its debtors do not repay their loans.

Asset quality is an assessment of a bank's risk based on its investment and loan portfolios and other assets.

 

How the CAMELS Rating System Works

Composite and component CAMELS ratings are assigned from 1 to 5, with 1 indicating the strongest performance and 5 indicating the weakest.

The system can be used to more easily identify banks that are weak and pose a risk so that those banks can resolve their issues. So, banks that are given an average score of less than 2 are considered to be higher-quality institutions, and those with scores greater than 3 are considered to be less-than-satisfactory institutions. If a bank has a higher score, it is more likely to be subject to more examinations.

Components of the Rating System

Capital Adequacy

Examiners assess institutions' capital adequacy through capital trend analysis. Examiners also check if institutions comply with regulations pertaining to risk-based net worth requirements.

 

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

Asset quality covers an institutional loan's quality, which reflects the earnings of the institution. Assessing asset quality involves rating investment risk factors the bank may face and balancing those factors against the bank's capital earnings.

This shows the stability of the bank when faced with particular risks. Examiners also check how companies are affected by the fair market value of investments when compared with the bank's book value of investments. Lastly, asset quality is reflected by the efficiency of an institution's investment policies and practices.

Management

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 in the institution's daily activities. It covers management's ability to ensure the safe operation of the institution as they comply with the necessary and applicable internal and external regulations.

Earnings

A bank's ability to produce earnings to be able to sustain its activities, expand, and remain competitive is a key factor in rating its continued viability.

Examiners determine this by assessing the bank's earnings, earnings growth, stability, valuation allowances, net margins, net worth level, and the quality of the bank's existing assets. A bank earns money both through interest-earning assets like loans and non-interest sources like fees.

 

Liquidity

To assess a bank's liquidity, examiners look at interest rate risk sensitivity, availability of assets that can easily be converted to cash, dependence on short-term volatile financial resources, and asset and liability management technical competence.

Sensitivity

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 affects an institution.

 

These loans include agricultural lending, medical lending, credit card lending, and energy sector lending. Exposure to foreign exchange, commodities, equities, and derivatives is also included in rating the sensitivity of a company to market risk.