What Is the 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. Learn more about how the CAMELS rating system works.
- 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.
CAMELS Rating System
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.
The acronym CAMELS stands for the following factors that examiners use to rate financial institutions: capital adequacy, asset quality, management, earnings, liquidity, and sensitivity. Let's look at each factor in more detail.
Components of the CAMELS Rating System
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 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 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.
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.
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 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.
Do CAMELS Ratings Apply to Credit Unions?
CAMELS ratings apply to financial institutions, which include credit unions as well as banks. The National Credit Union Administration (NCUA) supports the CAMELS rating system and provides training to staff on evaluating the six components.
Why Does CAMELS Ratings Include Earnings?
A bank's earnings, which are a result of income from interest-earning assets like loans and other non-interest income sources like fees, help a bank or financial institution build capital and maintain operations. Earnings also allow banks to pay dividends to shareholders.
What Happens if a Bank Is Not Liquid?
If a bank does not have enough liquidity, it may not be able to meet the demand for loans and liabilities at the same time. Banks need to have enough assets on hand that can be easily converted into cash to maintain sufficient liquidity. In some cases, a bank that does not have enough liquidity could experience defaults and even bankruptcy.
The Bottom Line
The CAMELS rating system is a useful system for rating banks that is used internationally. It's based on six factors: capital adequacy, asset quality, management, earnings, liquidity, and sensitivity. This system helps identify banks that are weaker and potentially problematic.