| Introduction: What does a Bank have to do with | | | | The result of such application should be the generation |
| CAMELS? Plenty! It could be the deciding factor in a | | | | of a stream of income necessary for repayment of |
| Bank being allowed to function, or even being shut up. | | | | the loan. The quality of loan assets, to a large extent |
| The higher the Bank climbs up the CAMELS, more the | | | | determines the viability of a Bank as a running concern. |
| chances of it being done in! This is one score a Bank | | | | 3) Management: By Management is meant the art and |
| would do well to keep low! | | | | science of accomplishing the goals of the institution by |
| Actually, CAMELS is the acronym for the six factors | | | | deploying all the necessary resources appropriately. |
| that form the basis for an international Bank rating | | | | Management includes Planning, Organizing, Staffing, |
| system. These six factors are: Capital Adequacy, | | | | Directing, and Controlling functions. |
| Asset Quality, Management Quality, Earnings, Liquidity, | | | | Planning is concerned with drawing up the blueprint for |
| and Sensitivity to Market Risk. | | | | the objectives and goals of the Bank, and lay the path |
| Under this rating system, Banks are rated in relation to | | | | to reach them. Planning is a all encompassing activity |
| the quality of these six factors. The strength of these | | | | that touches upon all the activities of the Bank. |
| six factors would determine the overall strength of the | | | | Organizing is the next step after planning, and is |
| Bank. The quality and strength of these six factors | | | | concerned with putting in place the necessary |
| underlines the inner strength of the Bank and how far it | | | | infrastructure, including human resources to achieve |
| can take care of itself against the market forces. | | | | the Bank's corporate goals. |
| Further, it also enables the regulatory authorities to | | | | Staffing, as the term indicates, is concerned with filling |
| focus on the Banks that are not doing well and to pay | | | | up the various positions in the Bank with suitable |
| special attention to them. | | | | people. |
| The regulatory authorities not only study the financial | | | | Directing means channeling the energies of the |
| statements of the Bank, but also carry out on site | | | | employees towards achieving the Bank's corporate |
| inspection, and thereafter rate the Bank. The rating | | | | goals, by motivating the employees with rewards, both |
| system is based on a scale of 1 to 5 with 1 being the | | | | monetary, as well as in terms of their career goals. |
| highest score and 5 the lowest. Banks scoring 1 would | | | | Controlling is a function of management that involves |
| be considered as among the top bracket in regard to | | | | establishing a performance standard for the |
| their financial soundness, and those scoring 5 would be | | | | employees and taking suitable steps in regard to the |
| seen to be at the bottom of the ladder. | | | | principle of reward and punishment. |
| Purpose: The purpose of this rating system is to | | | | A Bank that scores high in this area, namely, |
| examine the financial and other soundness of the | | | | management, is bound to come up with a strong |
| Bank, and alert the top management of the Bank to | | | | performance, and also contribute to the solidity of the |
| take timely measures to address any deficiencies and | | | | Banking industry, as a whole. |
| stop the Bank from sliding to the bottom of the heap. | | | | 4) Earnings: The earnings of a Bank refer to the net |
| The CAMELS rating is carried out with reference to | | | | profit made by it. Profit is the difference between |
| the following factors: | | | | income and expenditure. The major sources of income |
| 1) Capital Adequacy: Every Bank is expected to have | | | | for the Bank are interest earned on the loans and |
| sufficient capital to address its needs in relation to the | | | | other income derived from general banking activities |
| risk it undertakes in its operations. The ratio of the | | | | like, remittances, bills, etc. Apart from these, related |
| capital of a Bank in relation to its risk weighted assets | | | | activities undertaken by the Bank like Bancassurance, |
| must meet the minimum requirements. | | | | etc, also contribute to the Bank kitty. |
| The Basel II Accords promoted by the Bank for | | | | The expenditure of the Bank may relate, among other |
| International Settlements, Basel, Switzerland, stipulates | | | | things, to salaries, wages, administrative overheads, |
| a minimum Capital Adequacy Ratio of 8%. This is the | | | | rents, rates, taxes, etc. The net surplus that remains |
| bare minimum required, and Banks are strongly | | | | after taking care of all the expenses is the net profit. |
| recommended to have a comfortable Capital | | | | A healthy Bank should be able to generate decent |
| Adequacy Ratio that takes care of any untoward | | | | profits regularly and keep itself, as well as its investors, |
| occurrences. | | | | in good health. |
| The need for sufficient capital cannot be | | | | 5) Liquidity: Liquidity is simply the ease with which an |
| overestimated. It is the base on which the Bank stands, | | | | asset of the Bank can be encashed in times of need, |
| and its strength can be gauged by the strength of its | | | | or its fair value. It is that quality of an asset that |
| base. The edifice of the Bank draws its strength and | | | | enables a Bank to respond to any financial situation |
| succor from the foundation of capital. | | | | requiring urgent infusion of money or money's worth. |
| In line with the need for a strong capital base of a | | | | This quality of the asset ensures that a Bank faces |
| Bank, the Bank for International Settlements has come | | | | the minimum stress in dealing with such situations. |
| out with an elaborate set of recommendations that | | | | Apart from a financial crisis or crisis like situations, |
| are expected to put in place, a mechanism that is | | | | liquidity is also required to meet regular financial |
| proactive and responsive to the needs of the Bank in | | | | obligations of the Bank, especially without dipping into |
| countering the threat to its well-being from the | | | | its reserves. Liquidity marks the ability of the Bank to |
| elements of risk. For this purpose, weights are allotted | | | | field expected as well as unexpected financial |
| to each type of risk the Bank faces in its day to day | | | | problems and issues. |
| operations, and accordingly, the amount of capital | | | | 6) Sensitivity to Market Risk: Market forces are a |
| required to face up to this risk is worked out. | | | | major reason for shifts in the fortunes of businesses. |
| 2) Asset Quality: The term Asset Quality refers to the | | | | Favorable movements can boost the fortunes of a |
| quality of the loan portfolio of the Bank. Lending being | | | | Bank, while unfavorable ones can send the Bank |
| one of the primary activities of a commercial Bank, the | | | | packing to the cleaners. Market forces generally relate |
| welfare of the Bank is dictated to a large extent, by | | | | to the changes in Interest Rates, Currency Rates, |
| the quality of its loan portfolio. A sound loan portfolio | | | | Commodity Rates, and Stock Prices. Further these |
| means a steady income for the Bank, apart from | | | | changes are inter-related in a complex way, and |
| adding to the solvency of the Bank and consequently | | | | disturbances in one area are usually accompanied with |
| its rating. | | | | the same in other areas. |
| To ensure asset quality, the Bank has to follow a | | | | A sound Bank is expected to have sound risk |
| sound lending regimen that ensures compliance of all | | | | management practices in place, to take care of both |
| the related norms. Some of the parameters for judging | | | | known and unknown risks. The asset-liability match of |
| the soundness of a loan account are the components | | | | the Bank must be in consonance with risk |
| of safety, security, liquidity, purpose, profitability, etc. | | | | management principles. |
| In the process of lending, Bank has to take all | | | | Conclusion: The current Banking Crisis, which is quite |
| reasonable precautions to ensure the safety of its | | | | unprecedented, underlines the importance of regulatory |
| funds. The evaluation of credit proposals must focus | | | | issues and the affects of incompetence in this area. |
| on the technical feasibility and the financial viability of | | | | CAMELS, as a rating system for judging the |
| the project, or venture under consideration. The | | | | soundness of Banks is a quite useful tool, that can help |
| purpose of the loan must be in consonance with | | | | in mitigating the conditions and risks that lead to Bank |
| activities that relate to productive application of capital. | | | | failures. |