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The CAMELS ratings or Camels rating is a US supervisory rating of the bank's overall condition
used to classify the nations fewer than 8,000 banks. This rating is based on financial statements
of the bank and on-site examination by regulators like the Federal Reserve, the Office of the
Comptroller of the Currency and Federal Deposit Insurance Corporation. The scale is from 1 to 5
with 1 being strongest and 5 being weakest. These ratings are not released to the public but only
to the top management of the banking company to prevent a bank run on a bank which has a bad
CAMELS rating.[1]
It is being used by the United States government in response to the global financial crisis of 2008
to help it decide which banks to provide special help for and which to not as part of its
capitalization program authorized by the Emergency Economic Stabilization Act of 2008.
The CAMEL rating system is a method of evaluating the health of credit unions by the National
Credit Union Administration. The rating is based upon five critical elements of a credit union'soperations: capital adequacy, asset quality, management, earnings and liquidity. This rating
system is designed to take into account and reflect all significant financial and operational factors
examiners assess in their evaluation of a credit union's performance. Credit unions are rated
using a combination of financial ratios and examiner judgment.
The components of a bank's condition that are assessed:
* (C) Capital adequacy,
* (A) Asset quality,
* (M) Management,
* (E) Earnings,
* (L) Liquidity and
* (S) Sensitivity to market risk
Based these features Credit rating agencies rate instruments proposed to issue by the respective
company.
See also another three component, those are-
* Market discipline
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* Bank condition
* Basel II
Market discipline
Buyers and sellers in a market are said to be constrained by market discipline in setting prices
because they have strong incentives to generate revenues and avoid bankruptcy. This means, in
order to meet economic necessity, buyers must avoid prices that will drive them into bankruptcy
and sellers must find prices that will generate revenue (or suffer the same fate).
Market discipline is a topic of particular concern because of banking deposit insurance laws.Most governments offer deposit insurance for people making deposits with banks. Normally,
bank managers have strong incentives to avoid risky loans and other investments. However,
mandated deposit insurance eliminates much of the risk to bankers. This constitutes a loss of
market discipline. In order to counteract this loss of market discipline, governments introduce
regulations aimed at preventing bank managers from taking excessive risk. Today market
discipline is introduced into the Basel II Capital Accord as a pillar of prudential banking
regulation.
The efficacy of regulations aimed at introducing market discipline is questionable. Financial
bailouts provide implicit insurance schemes like too-big-to-fail, where regulators in central
agencies feel obliged to rescue a troubled bank with fear of financial contagion. It can be argued
that depositors would not bother to monitor bank activities under these favorable circumstances.
Numerous academic studies on this subject. The findings at first had mixed and somewhat
discouraging results where market discipline did not appear to be an essential feature in banking.
Later studies, though, when including some of the previously missing key aspects into the
empirical analysis, supported the existence and significance of such a natural control mechanism
unambiguously. Accordingly, depositors 'discipline' bank activities to some extent depending on
the well functioning of financial markets and institutions.
Bank condition:
Bank condition is a random variable used to represent the probability of failure of a bank. The
true probability of failure is unknown to depositors as well as regulators. Even the bank
managers themselves who manage the risky asset portfolio of the bank might not have an
accurate information about the probability of failure.
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Notice that the estimation of the bank managers are the closest to the true probability of failure,
then comes the evaluation of bank regulators and finally that of the investors.
CAMELS ratings in U.S. are intended to reflect the evaluation of regulators and supervisors
about bank condition. These evaluations are not publicly released but only given to the bank
managers.
Basel II:
Basel II is a banking supervision accord in its final version as of 2006. It describes and
recommends the necessary minimum capital requirements necessary to keep the bank safe and
sound. It consists of three pillars to this aim:
1. Minimum (risk weighted) capital requirements
2. Supervisory review process
3. Disclosure requirements
The third pillar requires the bank activities to be transparent to the general public. For this, the
bank is supposed to release relevant financial data (financial statements etc.) in a timely fashionto the public, for example, through its webpage. This might enable depositors to better evaluate
bank condition (i.e. bank probability of failure) and diversify their portfolio accordingly. As such
this pillar by itself is believed will enhance the role of market discipline in financial markets.