Camels Report

What is the CAMELS Rating System?
The CAMELS Rating System was developed in the United States as a supervisory rating
system to assess a bank’s overall condition. CAMELS is an acronym that represents the six
factors that are considered for the rating. Unlike other regulatory ratios or ratings, the
CAMELS rating is not released to the public. It is only used by top management to
understand and regulate possible risks.
Supervisory authorities use scores on a scale of 1 to 5 to rate each bank. The strength of the
CAMEL lies in its ability to identify financial institutions that will survive and those that will
fail. The concept was initially adopted in 1979 by the Federal Financial Institutions
Examination Council (FFIEC) under the name Uniform Financial Institutions Rating System
(UFIRS). CAMELS was later modified to add a sixth component – sensitivity – to the acronym.
What does CAMELS stand for?
The components of CAMELS are:

(C)apital adequacy
(A)ssets
(M)anagement capability
(E)arnings
(L)iquidity
(S)ensitivity
Capital Adequacy
Capital adequacy assesses an institution’s compliance with regulations on the
minimum capital reserve amount. Regulators establish the rating by assessing
the financial institution’s capital position currently and over several years.
Future capital position is predicted based on the institution’s plans for the
future, such as whether they are planning to give out dividends or acquire
another company. The CAMELS examiner would also look at trend analysis, the
composition of capital, and liquidity of the capital.
Assets
This category assesses the quality of a bank’s assets. Asset quality is important,
as the value of assets can decrease rapidly if they are high risk. For example,
loans are a type of asset that can become impaired if money is lent to a high-
risk individual.
The examiner looks at the bank’s investment policies and loan practices, along
with credit risks such as interest rate risk and liquidity risk. The quality and
trends of major assets are considered. If a financial institution has a trend of
major assets losing value due to credit risk, then they would receive a lower
rating.
Management Capability
Management capability measures the ability of an institution’s management
team to identify and then react to financial stress. The category depends on the
quality of a bank’s business strategy, financial performance, and internal
controls. In the business strategy and financial performance area, the CAMELS
examiner looks at the institution’s plans for the next few years. It includes the
capital accumulation rate, growth rate, and identification of the major risks.
For internal controls, the exam tests the institution’s ability to track and
identify potential risks. Areas within internal controls include information
systems, audit programs, and recordkeeping. Information systems ensure the
integrity of computer systems to protect customer’s personal information.
Audit programs check if the company’s policies are being followed. Lastly,
record keeping should follow sound accounting principles and include
documentation for ease of audits.
Earnings
Earnings help to evaluate an institution’s long term viability. A bank needs an
appropriate return to be able to grow its operations and maintain its
competitiveness. The examiner specifically looks at the stability of earnings,
return on assets (ROA), net interest margin (NIM), and future earning prospects
under harsh economic conditions. While assessing earnings, the core earnings
are the most important. The core earnings are the long term and stable
earnings of an institution that is affected by the expense of one-time items.
Liquidity
For banks, liquidity is especially important, as the lack of liquid capital can lead
to a bank run. This category of CAMELS examines the interest rate risk and
liquidity risk. Interest rates affect the earnings from a bank’s capital markets
business segment. If the exposure to interest rate risk is large, then the
institution’s investment and loan portfolio value will be volatile. Liquidity risk is
defined as the risk of not being able to meet present or future cash flow needs
without affecting day-to-day operations.
Sensitivity
Sensitivity is the last category and measures an institution’s sensitivity to
market risks. For example, assessment can be made on energy sector lending,
medical lending, and agricultural lending. Sensitivity reflects the degree to
which earnings are affected by interest rates, exchange rates, and commodity
prices, all of which can be expressed by Beta.
How does the CAMELS Rating System Work?
For each category, a score is given from one to five. One is the best score and
indicates strong performance and risk management practices within the
institution. On the other hand, five is the poorest rating. It indicates a high
probability of bank failure and the need for immediate action to ratify the
situation. If an institution’s current financial condition falls between 1 and 5, it
is called a composite rating.
A scale of 1 implies that a bank exhibits a robust performance, is sound, and

complies with risk management practices.
A scale of 2 means that an institution is financially sound with moderate
weaknesses present.
A scale of 3 suggests that the institution shows a supervisory concern in several
dimensions.
A scale of 4 indicates that an institution has unsound practices, thus is unsafe
due to serious financial problems.
A rating of 5 shows that an institution is fundamentally unsound with
inadequate risk management practices.
A higher number rating will impede a bank’s ability to expand through

investment, mergers, or adding more branches. Also, the institution with a
poor rating will be required to pay more in insurance premiums.

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What is the CAMELS Rating System?

The components of CAMELS are:

A scale of 1 implies that a bank exhibits a robust performance, is sound, and

A higher number rating will impede a bank’s ability to expand through

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