CAMELS Rating Model

Definition

CAMELS Rating Model is the informal name for a supervisory rating system developed by U.S. Financial Regulators to classify a bank's overall solvency condition. The formal name is Uniform Financial Rating System.

The model was introduced in the US in 1979 and it is applied to every bank and credit union in the U.S. (approximately 8,000 institutions) and is also implemented outside the U.S. by various banking supervisory regulators. It is an internal supervisory tool for evaluating the soundness of financial institutions on a uniform basis and for identifying those institutions requiring special supervisory attention. CAMELS ratings are normally assessed every year as every banking institution in the United States is generally examined once a year. In the case of problem banks (those with a CAMELS rating of 4 or 5), the ratings may be assessed more frequently, as these banks are subject to more frequent on-site examination.

Methodology

The model follows the traditional structure of Credit Scoring. Many aspects of the model (especially quantitative weights) are not public, hence it is not possible to prescribe a formula for the calculation. The following information is available

Composite Risk Rating

Composite ratings are based on the evaluation by the supervisor of an institution’s managerial, operational, financial, and compliance performance.

Risk Factors

The six key components used to assess an institution’s financial condition and operations are

• Capital Adequacy
• Asset Quality
• Management Capability
• Earnings Quantity and Quality
• Adequacy of Liquidity
• Sensitivity to Market Risk

Rating Scale

The composite rating derives from the rating of the underlying risk factors. The composite rating scale ranges from 1 to 5, with a rating of 1 indicating the strongest performance and risk-management practices, relative to the institution’s size, complexity, and risk profile, and the level of least supervisory concern. A rating of 5 indicates the most critically deficient level of performance; inadequate risk management practices relative to the institution’s size, complexity, and risk profile; and the level of greatest supervisory concern.

Rating Scale Definitions

• The scale definitions are provided in the form of narratives, with indication of relationships with underlying risk factors in the form rating caps.
• The assessment is generally on a relative rather than absolute basis (in relation with the firms size, complexity and risk profile)

Composite Score of 1

Financial institutions with a composite 1 rating are sound in every respect and generally have components rated 1 or 2. Any identified weaknesses are minor and can be handled routinely by the board of directors and management. These financial institutions are the most capable of withstanding fluctuating business conditions and are resistant to outside influences, such as economic instability in their trade area. These institutions are in substantial compliance with laws and regulations. As a result, they exhibit the strongest performance and risk-management practices relative to their size, complexity, and risk profile, and give no cause for supervisory concern.

Composite Score of 2

Financial institutions with a composite 2 rating are fundamentally sound. For a financial institution to receive this rating, generally none of its component ratings should be more severe than 3. Only moderate weaknesses are present, and the board of directors and management are capable of and willing to correct them. These financial institutions are stable, can withstand business fluctuations, and are in substantial compliance with laws and regulations. Overall risk-management practices are satisfactory relative to the institution’s size, complexity, and risk profile. There are no material supervisory concerns and, as a result, the supervisory response is informal and limited.

Composite Score of 3

Financial institutions with a composite 3 rating exhibit some degree of supervisory concern in one or more of the component areas. These institutions have a combination of moderate to severe weaknesses; however, the magnitude of the deficiencies generally will not cause a component to be rated more severely than 4. Management may lack the ability or willingness to effectively address weaknesses within appropriate time frames. Financial institutions in this group generally are less capable of withstanding business fluctuations and are more vulnerable to outside influences than those institutions rated a composite 1 or 2. Additionally, these financial institutions may be in significant non-compliance with laws and regulations. Risk-management practices may be less than satisfactory relative to the institution’s size, complexity, and risk profile. These financial institutions require more than normal supervision, which may include formal or informal enforcement actions. Failure of the institution appears unlikely, however, given its overall strength and financial capacity.

Composite Score of 4

Financial institutions with a composite 4 rating generally exhibit unsafe and unsound practices or conditions. They have serious financial or managerial deficiencies that result in unsatisfactory performance. The institution’s problems range from severe to critically deficient, and weaknesses and problems are not being satisfactorily addressed or resolved by the board of directors and management. Financial institutions in this group generally are not capable of withstanding business fluctuations. There may be significant non-compliance with laws and regulations. Risk management practices are generally unacceptable relative to the institution’s size, complexity, and risk profile. Close supervisory attention is required, which means formal enforcement action is necessary in most cases to address the problems. Institutions in this group pose a risk to the deposit insurance fund. Failure of the institution is a distinct possibility if the problems and weaknesses are not satisfactorily addressed and resolved.

Composite Score of 5

Financial institutions with a composite 5 rating exhibit extremely unsafe and unsound practices or conditions. Their performance is critically deficient and risk-management practices are inadequate relative to the institution’s size, complexity, and risk profile. These institutions are of the greatest supervisory concern. The volume and severity of problems are beyond management’s ability or willingness to control or correct. Immediate outside financial or other assistance is needed for the financial institution to be viable. Ongoing supervisory attention is necessary. Institutions in this group pose a significant risk to the deposit insurance fund and their failure is highly probable.

See Also

• Wikipedia entry on CAMELS

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