Assignment On:

“CAMEL” Rating: A Literature Review

1.1 Introduction
In 1979, the Uniform Financial Institutions Rating System (UFIRS) was implemented in U.S.
banking institutions, and later globally, following a recommendation by the U.S. Federal
Reserve. The system became internationally known with the abbreviation CAMEL, reflecting
five assessment areas: capital, asset quality, management, earnings and liquidity. In 1995 the
Federal Reserve and the OCC replaced CAMEL with CAMELS, adding the "S" which stands for
(S)ensitivity to Market Risk. This covers an assessment of exposure to market risk and adds the
1 to 5 rating for market risk management.

1.2 Definition of CAMEL rating

In simple sense the CAMELS rating system is a recognized international rating system that bank
supervisory authorities use in order to rate financial institutions according to six factors
represented by the acronym "CAMELS." Supervisory authorities assign each bank a score on a
scale, and a rating of one is considered the best and the rating of five is considered the worst
for each factor.

1.3 Concept of CAMEL rating

Analysist uses CAMEL rating as an internal rating system to evaluate:
 The soundness of credit unions
 Degree of risk to the share insurance fund and
 Credit unions requiring special supervisory attention.
In addition Analysist use CAMEL rating to allocate examiner resources. Many more exam hour
or budgetary supervise those credit union with poor composition of CAMEL rating of 4 AND 5 as
supposed to string rating of 1and 2.

1.4 Rating and description Rating Description

RATINGS DESCRIPTION
 Indicates strong performance and risk management practices
Rating 1  identifies all risks and employs compensating factors mitigating
concerns Rating
Rating 2  Reflects satisfactory performance and risk management practices
 Management identifies most risks and compensates accordingly
Rating 3  Represents performance that is flawed to some degree is of
supervisory concern.
 Risk management practices may be less than satisfactory relative to the
bank's or credit union's size, complexity, and risk profile
 Management may not identify and provide mitigation of significant
 risks Rating
Rating 4  Refers to poor performance that is of serious supervisory concern.
 Risk management practices are generally unacceptable relative to the
bank's or credit union's size,
 Complexity and risk profile. Key performance measures are likely to be
negative.
 Such performance, if left unchecked, would be expected to lead to
conditions that could threaten the viability of the bank or credit union.
 There may be significant noncompliance with laws and regulations.
 The board of directors and management are not satisfactorily resolving
the weaknesses and problems.
 A high potential for failure is present but is not yet imminent or
pronounced.
 Banks and credit unions in this group require close supervisory
attention.
Rating 5  Considered unsatisfactory performance that is critically deficientand in
need of immediate remedial attention.
 Such performance, by itself or in combination with other weaknesses,
directly threatens the viability of the bank or credit union.
 The volume and severity of problems are beyond management's ability
or willingness to control or correct.
 Banks and credit unions in this group have a high probability of failure
and will likely require liquidation and the payoff of shareholders, or
some other form of emergency assistance, merger, or acquisition.

1.5 Assessment in camel analysis

Board member should be familiar with letter in term of CAMEL rating system and corresponding
appendix. The letter includes detail description for each of the five component rating and detail
profit of each composite rating 1 to 5.
CAMEL is an aquanaut for the following five rating categories:
C - Capital Adequacy
A - Assets Quality
M -Management
E - Earning
L- Liquidity and assets and liability management
The three high level aseismic the examiner use to determine individual CAMEL rating include:
1.5.1Risk management programs: What system are in placed to identify, measure, monitor and
control risk for that rating factor.
1.5.2Financial Proxies: financial proxies are the four quantifiable rating sufficient for the type
and size of credit union.

 Is there enough capital orequity

 Are the assets quality measure with the delinquency
 Charge of ratio acceptable
 Is the earnings ratio sufficient and
 Is the liquidity sufficient
The analysist feel that who work with management to establish a corrective action with a level
of respective trends of these CAMEL components is considered unacceptable or insufficient
1.5.3Management Assessment: management engagement and decision making placed into all
of the rating. The management rating goes deeper into assessing effectiveness of the board and
staff and running the credit in a safe and sound manner. The 7 risk area or CLICSTR helps to
answer the high level questions that determinate the individual component rating. From there
an examiner comes with single composition CAMEL rating for the credit union.
Examiner consider the interrelationship between the CAMEL components when assigning the
overall rating. Credit union with higher composite CAMEL rating 3, 4 and 5 will be monitor more
frequently than those with lower composite CAMEL ratings 1 and 2. Frequent contest with high
risk credit union have proving to be an effective strategy for reducing the risk to the share
insurance fund. A CAMEL composite 1 rating indicate the least of risk to national credit share
insurance fund as a lending institution a certain level of risk is necessary and expected in order
to serve your member. Rating of one may suggest credit union has prioritize safety over service
to the membership. Indicated by a portfolio launched only the highest five score.
What is the level and type of risks you're willing to manage in order to serve your members?
ANALYSIST expects credit union to take on risk and then manage that risk.
What financial information does the examiner review?
The ANALYSIST examiner report will include a summary of key financial trends and a discussion
of having strength and key ratio factored into the risk assessments. The financial performance
report (FPR) is generated from credit union quarterly core report. The FPR will provide
comprehensive Financial Summary of the balance sheet, income statement and key ratios. The
FPR is generally the first tool examiner uses to make a preliminary assessment of risk. Board
member should review the FPR to track Financial Trends, compare the Actual results against
budgets and to set future realistic financial goals. The FPR includes extensive Financial
Summaries and many ratio for risk of categories. Some of the more important key ratio from
the ratio analysis page includes:
  Net worth to total assets
 Return on average assets
 Assets quality ratio: These includes the delinquency and net charge of ratio
 Cash and short term investments compared to assets

1.6 BREAKING DOWN 'CAMELS Rating System

The acronym CAMELS stand for the following factors that examiners use to rate bank
institutions:

Management Earnings

Asset Liquidity
Quality
CAMELS
Capital Sensitivity
Adequacy

 Capital Adequacy
Examiners assess institutions' capital adequacy through capital trend analysis. Examiners also
check if institutions comply with regulations pertaining to risk-based net worth requirement. To
get a high capital adequacy rating, institutions must also comply with interest and dividend
rules and practices. Other factors involved in rating and assessing an institution's capital
adequacy are its growth plans, economic environment, ability to control risk, and loan and
investment concentrations.
Commercial bank holds adequate capital depending on their requirement .capital
Adequacy ratio is measure of the amount of a bank’s capital as a percentage of its risk
Weighted credit exposure.
Total Capital fund
Capital Adequacy Ratio (CAR) = ×100 %
Total r isk weighted assests
Total core capital fund
Core Capital Ratio (CCR) = × 100 %
Total risk weight Assets
Where,
Total capital fund=core capital +supplementary capital
Total risk weighted asset= on balance sheet risk weighted items + off balance sheetrisk
weighted items

 Asset Quality
Asset quality covers an institutional loan's quality which reflects the earnings of the institution.
Assessing asset quality involves rating investment risk factors that the company may face and
comparing them to the company's capital earnings. This shows the stability of the company
when faced with particular risks. Examiners also check how companies are affected by fair
market value of investments when mirrored with the company's book value of investments.
Lastly, asset quality is reflected by the efficiency of an institution's investment policies and
practices.
To measure the quality Central bank uses certain type of criteria, one example is –
Gross NPA ( Non Performing Assets)
=
Gross Advances

 Management
Management assessment determines whether an institution is able to properly react to
financial stress. This component rating is reflected by the management's capability to point out,
measure, look after, and control risks of the institution's daily activities. It covers the
management's ability to ensure the safe operation of the institution as they comply with the
necessary and applicable internal and external regulations. Management analysis can be done
by using the following formulas
Net profit after tax
Management efficiency ratio (MER) =
Total no . of staff
 Earnings
An institution's ability to create appropriate returns to be able to expand, retain
competitiveness, and add capital is a key factor in rating its continued viability. Examiners
determine this by assessing the company's growth, stability, valuation allowances, net interest
margin, net worth level and the quality of the company's existing assets.
Generally higher earnings reflects better financial position. Similarly the aggregate performance
of the bank reflects from its earning.
 Net profit after tax
Earnings per share (EPS) =
No of outstanding shares
Net income after tax
Return on Equity (ROE) = ×100 %
Total shareholders fund
Net income after tax
Return on assets (ROA) = ×100 %
Total assets

 Liquidity
To assess a company's liquidity, examiners look at interest rate risk sensitivity, availability of
assets which can easily be converted to cash, dependence on short-term volatile financial
resources and ALM technical competence.
A measure of the extent to which a person or organization has the cash to meet immediate and
short-term obligations or assets that can be quickly converted to do this. Liquidity is the term
that denotes the ability of the organization to meet its financial obligation or debts in cash in
time. Liquidity refers to the short term financial position of the bank. Bank does not provide all
its deposits at loans and advances, but a certain percentage is kept as liquidity in the bank itself
or elsewhere. Basically bank measures liquidity through three methods. They are as follows:

 Cash Reserve Ratio (CCR)

It is the minimum amount of reserve a bank must hold in the form account balance with NRB.
This ratio ensures the minimum level of the bank's first line of defense in meeting the
depositor’s obligation. It is the mandatory reserve that the commercial bank has to keep in the
form of cash in their accounts in NRB for depositor’s assurance and safety of the banks which
also reflects the bank's goodwill. It is calculated as
Cash Balance∈ NRB
Cash Reserve Ratio =
Local Currency Deposit−Margin Deposit
 Cash and bank balance ratio (CBR)
The ratio measures the bankability to meet immediate obligations. So, an optimum balance
should maintain in order to meet their pay obligation. Further, this ratio is employed tomeasure
whether banks' cash balance is sufficient to cover unexpected demand made by the depositors.
It is calculated as follows.
Cash∧Bank Balance
Cash and bank balance ratio =
Total Deposit
 Investment in government security ratio (IGSR)
Government securities are known as risk-free assets, which are easily converted into cash to
meet the short term obligation. That’s why every commercial bank has to invest their certain
amount in government securities. This ratio calculated as
Investment ∈government security
Investment in government security ratio = × 100
Total deposit

 Sensitivity
Sensitivity covers how particular risk exposures can affect institutions. Examiners assess an
institution's sensitivity to market risk by monitoring the management of credit concentrations.
In this way, examiners are able to see how lending to specific industries affect an institution.
These loans include agricultural lending, medical lending, credit card lending, and energy sector
lending. Exposure to foreign exchange, commodities, equities and derivatives are also included
in rating the sensitivity of a company to market risk.
1.6.1 CAMELS Rating System of Bangladesh In Bangladesh
Recently, Bangladesh Bank has upgraded the CAMEL into CAMELS effective from June, 2006.
After inserting ‘S’ or ‘sensitivity to market risk’, it is presumed that this off-site supervision
technique of central bank would make it a more effective tool in rating banks. A single CAMEL
rating for each bank is the result of both off-site monitoring, which uses monthly financial
statement information, and an on-site examination, from which bank supervisors gather further
“private information” not reflected in the financial reports. These examinations result in the
development of "credit points" ranging from 0 to 100. As noted above, the six key performance
dimensions – capital adequacy, asset quality, management, earnings, liquidity and sensitivity to
market risk – are to be evaluated on a scale of 1 to 5 in ascending order. Following is a
description of the graduations of rating:
Rating 1 indicates strong performance: BEST rating.
Rating 2 reflects satisfactory performance.
Rating 3 represents performance that is flawed to some degree.
Rating 4 refers to marginal performance and is significantly below average and
Rating 5 is considered unsatisfactory: WORST rating.

1.7 Review of journals and articles

Several studies provide explanations for choice of CAMEL measures. For examples;
Baral (2005) study the performance of joint ventures banks in Nepal by applying the CAMEL
Model. His study was mainly based on secondary data drawn from the annual reports published
by joint venture banks. His report analyzed the financial health of joint ventures banks in the
CAMEL parameters. His findings of the study revealed that the financial health of joint ventures
is more effective than that of commercial banks. Moreover, the components of CAMEL showed
that the financial health of joint venture banks was not difficult to manage the possible impact
to their balance sheet on a large scale basis without any constraints inflicted to the financial
health.
Bodla&Verma (2006) examined the performance of SBI and ICICI through CAMEL model. Data
set for the period of 2000-01 to 2004-05 were used for the purpose of the study. With the
reference to the Capital Adequacy, it concluded that SBI has an advantage over ICICI. Regarding
to assets quality, earning quality and management quality, it can be said that ICICI has an edge
upon SBI. Therefore the liquidity position of both banks was sound and did not differ much.
Gupta and Kaur (2008) conducted a research on the sole aim of examining the performance of
Indian private Sector banks by using CAMEL model and by assigning rating to the top five and
bottom five banks. They rated 20 old and 10 new private sector banks based on CAMEL
framework. The study covered financial data for the period of 5 years i.e. from 2003-07. The
research as determined by CAMEL Model revealed that HDFC was at its higher position of all
private sectors banks in India succeeded by the KarurVyasa and the Tamilnad Mercantile Bank.
However the Gobal Trust Bank and the Nedungradi Banks was considered as bad management
The findings summarized that new private sector of banks have attained the higher position due
to core banking, aggressive marketing strategies and high level of technology. To attain
perfection banks should always concentrate on new financial assets, excellent service and
customer loyalty.
Wirnkar and Tanko (2008) analyzed the adequacy of CAMEL in evaluating the performance of
bank. This empirical research was implemented to find out the ampleness of CAMEL in
examining the overall performance of bank, to find out the importance of each component in
CAMEL and finally to look out for best ratios that bank regulators can adopt in assessing the
efficiency of banks. The analysis was performed from a sample of eleven commercial banks
operating in Nigeria. The study covered data from annual reports over a period of nine years
(1997-2005). The analysis disclosed the inability of each component in CAMEL to congregate
the full performance of a bank. Moreover the best ratios in each CAMEL parameter were
determined.
Cinko&Avci (2008) noticed that globally all the banking supervisory authorities are using CAMEL
rating system for many years. In this synthesis financial ratios were applied to calculate
components of CAMEL ratings for the period of 1996-2000. The financial ratios were also
employed to anticipate the delegation of commercial banks in 2001 to the SDIF by adopting
discriminant analysis, logistic regression and neural network models. However the conclusion
revealed that it was impossible to predict the transfer of a bank to SDIF by mode of CAMEL
ratios.
Hays, Lurgio& Arthur (2009) have utilized CAMEL model to examine the performance of low
efficiency vs. high efficiency community banks in conjunction with the logistical regression
analysis. The analysis used data which are based on quarterly reports by commercial banks. The
discriminant model derived from the CAMEL parameters is tested among data for 2006, 2007,
2008. Its results concluded that the model accuracy floats from approximately 88% to 96% for
both original and cross-validations data sets.
Dash & Das (2009) have analyzed the Indian Banking Industry under CAMELS framework. The
thesis compares the performance of public sector banks with that of private/ foreign banks. The
analysis was performed from a sample of 58 banks operating in India of which 29 were public
sector banks and 29 were private/foreign sector. The data used were from the audited financial
statement for the financial years 2003-2008. The findings concluded that private/foreign banks
have an edge over the public sector banks. The two factors of the CAMEL parameters that
contribute to the best performance of the private banking/foreign were the Management
Soundness and Earnings and profitability.
Agarwal &Sihna (2010) have analyzed the financial performance and thereby the sustainability
of micro finance institutions (MFIs) in India by employing the CAMEL model.

Kaur (2010) have made an analysis of commercial banks operating in India with reference to
CAMEL approach. In his article he has categorized the banks into Public sector Bank, Private
sector Banks and Foreign Banks. He used the CAMEL analysis technique with the purpose of
ranking the banks. Each component of CAMEL has been interpreted using two ratios and a final
composite index has been established. The data tools which were used was a sample of 28
public sector, 26 private sector and 28 Foreign banks and the data used was in secondary
nature which was collected from statistical tables related to the Banks in India in the financial
year 200-01 to 2006-07. The experiment revealed that the best bank from the public sector has
been awarded to Andhra Bank and State Bank of Patiala. In the category of private sector
banks, Jammu and Kashmir Bank has been assigned the first rank succeeded by HDFC Bank.
Among the foreign sector banks, Antwerp has bagged the first rank followed by JP Morgan
Chase Bank.

Sangmi&Nazir (2010) has evaluated the financial performance of 2 top major banks in the
northern India representing the biggest nationalized bank (i.e. Punjab national Bank, PNB) and
the biggest private sector bank (i.e. Jamuna and Kashmir Bank, JKB). These 2 banks were
selected in view their role and involvement in shaping the economic conditions of the northern
India, specifically in terms of advances, deposits, man power employment, branch network etc.
The research was mainly conducted on secondary data from annual reports of the respective
banks. And the data used is related to five financial years (i.e. 2001-2005). The results
highlighted that the position of the banks under study is sound and satisfactory as far as their
capital adequacy, asset quality management capability and liquidity is implicated.

1.8 Conclusion
In this assignment, CAMEL ration analysis has been discussed. It is a very comprehensive
method to assess in a risk-based way individual banks. It is commonly used by banking
supervisors as well as rating agencies.