CAMELS RATINGS

By:-Shraddha Dharmadhikari

MBA-II

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INTRODUCTIONIn 1995, RBI had set up a working group under

the chairmanship of Shri S. Padmanabhan to review the banking supervision system. The Committee certain recommendations and based on such suggetions a rating system for domestic and foreign banks based on the international CAMELS model combining financial management and systems and control elements was introduced for the inspection cycle commencing from July 1998. CAMELS evaluates banks on the following six parameters

key components of CAMELS ratings

Capital adequacyAsset qualityManagementEarningsLiquiditySensitivity to market

Purpose of CAMELS ratingsThe purpose of CAMELS ratings is to

determine a bank’s overall condition and to identify its strengths and weaknesses:

FinancialOperationalManagerial

Rating Provisions Each element is assigned a numerical rating based on five key

components:

1 Strong performance, sound management, no cause for supervisory concern

2 Fundamentally sound, compliance with regulations, stable, limited supervisory needs

3 Weaknesses in one or more components, unsatisfactory practices, weak performance but limited concern for failure

4 Serious financial and managerial deficiencies and unsound practices. Need close supervision and remedial action

5 Extremely unsafe practices and conditions, deficiencies beyond management control. Failure is highly probable and outside financial assistance needed

SCORINGBank supervisory authorities assign each

bank a score on a scale of 1 (best) to 5 (worst) for each factor.

If a bank has an average score less than 2 it is considered to be a high-quality institution while banks with scores greater than 3 are considered to be less-than-satisfactory establishments.

The system helps the supervisory authority identify banks that are in need of attention.

Capital AdequacyCapital adequacy is measured by the ratio of capital to risk-weighted assets . A sound capital base strengthens confidence of depositors

Capital is rated based on the following considerationsNature and volume of assets in relation to total

capital and adequacy other reservesBalance sheet structure including off balance sheet

items, market and concentration riskNature of business activities and risks to the bankAsset and capital growth experience and prospectsEarnings performance and distribution of dividendsCapital requirements and compliance with

regulatory requirementsAccess to capital markets and sources of capital

ASSET QUALITYOne of the indicators for asset quality is the

ratio of non-performing loans to total loans (GNPA). The gross non-performing loans to gross advances ratio is more indicative of the quality of credit decisions made by bankers. Higher GNPA is indicative of poor credit decision-making.

Asset represents all the assets of the bank, current and fixed, loan portfolio, investments and real estate owned as well as off balance sheet transactions

Rating factorsAsset quality is based on the following considerations:

Volume of problem of all assets Volume of overdue or rescheduled loansAbility of management to administer all the assets of the

bank and to collect problem loansLarge concentrations of loans and insiders loans,

diversification of investmentsLoan portfolio management, written policies, procedures

internal control, Management Information SystemLoan Loss Reserves in relation to problem credits and other

assetsGrowth of loans volume in relation to the bank’s capacity

ManagementManagement includes all key managers

and the Board of Directors

Rating factorsManagement is the most important element for a successful

operation of a bank. Rating is based on the following factors:

Quality of the monitoring and support of the activities by the board and management and their ability to understand and respond to the risks associated with these activities in the present environment and to plan for the future

Development and implementation of written policies, procedures, MIS, risk monitoring system, reporting, safeguarding of documents, contingency plan and compliance with laws and regulations controlled by a compliance officer

Availability of internal and external audit functionConcentration or delegation of authorityCompensations policies, job descriptionsOverall performance of the bank and its risk profile

EarningsAll income from operations, non-

traditional sources, extraordinary itemsIt can be measured as the the return

on asset ratio

Rating factorsEarnings are rated according to the following factors:

Sufficient earnings to cover potential losses, provide adequate capital and pay reasonable dividends

Composition of net income. Level of expenses in relation to operationsReliance on extraordinary items, securities transactions, high risk

activitiesNon traditional or operational sourcesAdequacy of budgeting, forecasting, control MIS of income and

expensesAdequacy of provisionsEarnings exposure to market risks, such as interest rate

variations, foreign exchange fluctuations and price risk

LiquidityCash maintained by the banks and

balances with central bank, to total asset ratio is an indicator of bank's liquidity.

In general, banks with a larger volume of liquid assets are perceived safe, since these assets would allow banks to meet unexpected withdrawals.

Rating factorsLiquidity is rated based on the following factors:

Sources and volume of liquid funds available to meet short term obligations

Volatility of deposits and loan demandInterest rates and maturities of assets and liabilitiesAccess to money market and other sources of fundsDiversification of funding sourcesReliance on inter-bank market for short term fundingManagement ability to plan, control and measure liquidity

process. Contingency plan

Sensitivity to Market RisksSensitivity to market risks is not taken

into consideration by CBI.

Rating factorsMarket risk is based primarily on the

following evaluation factors:

Sensitivity to adverse changes in interest rates, foreign exchange rates, commodity prices, fixed assetsNature of the operations of the bankTrends in the foreign currencies exposureChanges in the value of the fixed assets of the bankImportance of real estate assets resulting from

loans write off

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