CAMELS rating system
The CAMELS rating is a supervisory rating system originally developed in the U.S. to classify a bank's overall condition. It is applied to every bank and credit union in the U.S. and is also implemented outside the U.S. by various banking supervisory regulators.
The ratings are assigned based on a ratio analysis of the financial statements, combined with on-site examinations made by a designated supervisory regulator. In the U.S. these supervisory regulators include the Federal Reserve, the Office of the Comptroller of the Currency, the National Credit Union Administration, the Farm Credit Administration, and the Federal Deposit Insurance Corporation.
Ratings are not released to the public but only to the top management to prevent a possible bank run on an institution which receives a CAMELS rating downgrade. Institutions with deteriorating situations and declining CAMELS ratings are subject to ever increasing supervisory scrutiny. Failed institutions are eventually resolved via a formal resolution process designed to protect retail depositors.
The components of a bank's condition that are assessed:
In India, for supervision of banks, an extended framework is used which is named - C A M E L S C where the letters C A M E L stand for what has been mentioned above but 'S'- means- 'Systems' and 'C' means- 'Compliance' - to various rules, regulations, Acts. etc.
Development
In 1979, the Uniform Financial Institutions Rating System was implemented in U.S. banking institutions, and later globally, following a recommendation by the U.S. Federal Reserve. The system became internationally known with the abbreviation CAMEL, reflecting five assessment areas: capital, asset quality, management, earnings and liquidity. In 1995 the Federal Reserve and the OCC replaced CAMEL with CAMELS, adding the "S" which stands for to Market Risk.Composite ratings
The rating system is designed to take into account and reflect all significant financial and operational factors examiners assess in their evaluation of an institutions performance. Institutions are rated using a combination of specific financial ratios and examiner qualitative judgments.The following describes some details of the CAMEL system in the context of examining a credit union.
Rating 1
Indicates strong performance and risk management practices that consistently provide for safe and sound operations. Management clearly identifies all risks and employs compensating factors mitigating concerns. The historical trend and projections for key performance measures are consistently positive. Banks and credit unions in this group resist external economic and financial disturbances and withstand the unexpected actions of business conditions more ably than banks and credit unions with a lower composite rating. Any weaknesses are minor and can be handled in a routine manner by the board of directors and management. These banks and credit unions are in substantial compliance with laws and regulations. Such institutions give no cause for supervisory concern.Rating 2
Reflects satisfactory performance and risk management practices that consistently provide for safe and sound operations. Management identifies most risks and compensates accordingly. Both historical and projected key performance measures should generally be positive with any exceptions being those that do not directly affect safe and sound operations. Banks and credit unions in this group are stable and able to withstand business fluctuations quite well; however, minor areas of weakness may be present which could develop into conditions of greater concern. These weaknesses are well within the board of directors' and management's capabilities and willingness to correct. These banks and credit unions are in substantial compliance with laws and regulations. The supervisory response is limited to the extent that minor adjustments are resolved in the normal course of business and that operations continue to be satisfactory.Rating 3
Represents performance that is flawed to some degree and is of supervisory concern. Risk management practices may be less than satisfactory relative to the bank's or credit union's size, complexity, and risk profile. Management may not identify nor provide mitigation of significant risks. Both historical and projected key performance measures may generally be flat or negative to the extent that safe and sound operations may be adversely affected. Banks and credit unions in this group are only nominally resistant to the onset of adverse business conditions and could easily deteriorate if concerted action is not effective in correcting certain identifiable areas of weakness. Overall strength and financial capacity is present, thus making failure a remote probability. These banks and credit unions may be in significant noncompliance with laws and regulations. Management may lack the ability or willingness to effectively address weaknesses within appropriate time frames. Such banks and credit unions require more than normal supervisory attention to address deficiencies.Rating 4
Refers to poor performance that is of serious supervisory concern. Risk management practices are generally unacceptable relative to the bank's or credit union's size, complexity, and risk profile. Key performance measures are likely to be negative. If left unchecked, such performance would likely lead to conditions that could threaten the viability of the bank or credit union. There may be significant noncompliance with laws and regulations. The board of directors and management are not satisfactorily resolving the weaknesses and problems. A high potential for failure is present but is not yet imminent or pronounced. Banks and credit unions in this group require close supervisory attention.Rating 5
Considered unsatisfactory performance that is critically deficient and in need of immediate remedial attention. Such performance, by itself or in combination with other weaknesses, directly threatens the viability of the bank or credit union. The volume and severity of problems are beyond management's ability or willingness to control or correct. Banks and credit unions in this group have a high probability of failure and will likely require liquidation and the payoff of shareholders, or some other form of emergency assistance, merger, or acquisition.Capital adequacy (CA)
Part 702 of the NCUA Rules and Regulations sets forth the statutory net worth categories, and risk-based net worth requirements for federally insured credit unions. References are made in this Letter to the five net worth categories which are: "well capitalized", "adequately capitalized", "undercapitalized", "significantly undercapitalized", and "critically undercapitalized".Credit unions that are less than "adequately capitalized" must operate under an approved net worth restoration plan. Examiners evaluate capital adequacy by assessing progress toward goals set forth in the plan.
Determining the adequacy of a credit union's capital begins with a qualitative evaluation of critical variables that directly bear on the institution's overall financial condition. Included in the assessment of capital is the examiners opinion of the strength of the credit union's capital position over the next year or several years based on the credit union's plan and underlying assumptions. Capital is a critical element in the credit union's risk management program. The examiner assesses the degree to which credit, interest rate, liquidity, transaction, compliance, strategic, and reputation risks may impact on the credit union's current and future capital position. The examiner also considers the interrelationships with the other areas:
- Capital level and trend analysis;
- Compliance with risk-based net worth requirements;
- Composition of capital;
- Interest and dividend policies and practices;
- Adequacy of the Allowance for Loan and Lease Losses account;
- Quality, type, liquidity and diversification of assets, with particular reference to classified assets;
- Loan and investment concentrations;
- Growth plans;
- Volume and risk characteristics of new business initiatives;
- Ability of management to control and monitor risk, including credit and interest rate risk;
- Earnings. Good historical and current earnings performance enables a credit union to fund its growth, remain competitive, and maintain a strong capital position;
- Liquidity and funds management;
- Extent of contingent liabilities and existence of pending litigation;
- Field of membership; and
- Economic environment.
Ratings
A capital adequacy rating of 2 is accorded to a credit union that also maintains a level of capital fully commensurate with its risk profile both now and in the future and can absorb any present or anticipated losses. However, its capital position will not be as strong overall as those of 1 rated credit unions. Also, there should be no significant asset quality problems, earnings deficiencies, or exposure to interest-rate risk that could affect the credit union's ability to maintain capital levels at least at the "adequately capitalized" net worth category. Credit unions in this category should meet their risk-based net worth requirements.
A capital adequacy rating of 3 reflects a level of capital that is at least at the "undercapitalized" net worth category. Such credit unions normally exhibit more than ordinary levels of risk in some significant segments of their operation. There may be asset quality problems, earnings deficiencies, or exposure to credit or interest-rate risk that could affect the credit union's ability to maintain the minimum capital levels. Credit unions in this category may fail to meet their risk-based net worth requirements.
A capital adequacy rating of 4 is appropriate if the credit union is "significantly undercapitalized" but asset quality, earnings, credit or interest-rate problems will not cause the credit union to become critically undercapitalized in the next 12 months. A 4 rating may be appropriate for a credit union that does not have sufficient capital based on its capital level compared with the risks present in its operations.
A 5 rating is given to a credit union if it is critically undercapitalized, or has significant asset quality problems, negative earnings trends, or high credit or interest-rate risk exposure is expected to cause the credit union to become "critically undercapitalized" in the next 12 months. Such credit unions are exposed to levels of risk sufficient to jeopardize their solvency.