Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
Emergence “CAMELS” An International Bank-Rating System :
Chapter Bangladesh
Shahriar Parvez
Banks serve as backbone to the financial sector, which facilitate the proper utilization of financial
resources of a country. The banking sector is increasingly growing and it has witnessed a huge flow
of investment. In addition to simply being involved in the financial intermediation activities, banks
are operating in a rapidly innovating industry that urges them to create more specialized financial
services to better satisfy the changing needs of their customers. For this reason banking financial
institutions need to be brought under the umbrella of supervision, as banks are highly leveraged
concern. With a view to protecting depositors’ interest and protecting the banks from collapse
supervision plays a vital role in two forms, on site supervision and off site supervision. This study
observes emergence of an international bank-rating system in Bangladesh, where bank supervisory
authorities’ rate institutions according to six factors. The six factors are represented by the acronym
"CAMELS (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity to the
market risk). The study also analysis CAMELS frame work, origin and process and its use in
Bangladesh.
JEL Code: G20; G21; G24
Keywords: CAMELS, Bank Rating System, Bangladesh Bank, Sensitivity, Sustainable,
Framework.
Introduction:
Banks serve as backbone to the financial sector, which facilitate the proper utilization of financial
resources of a country. The banking sector is increasingly growing and it has witnessed a huge
flow of investment. In addition to simply being involved in the financial intermediation activities,
banks are operating in a rapidly innovating industry that urges them to create more specialized
financial services to better satisfy the changing needs of their customers. For this reason
banking financial institutions need to be brought under the umbrella of supervision, as banks are
highly leveraged concern. With a view to protecting depositors’ interest and protecting the banks
from collapse supervision plays a vital role in two forms, on site supervision and off site
supervision. CAMELS (Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and
Sensitivity to the market risk) rating as off site supervision tool is used all over the world under
uniform rating system. Like other countries, Bangladesh Bank introduced CAMELS rating in
1993 under the Financial Sector Reform Project. All the banks are evaluated on half early basis
to assign a composite CAMELS rating. In case of unsoundness, the respective bank is closely
monitored and advised to take corrective action. As banks deal with depositors’ money,
customers possess the right to know the rank as well as financial soundness of the banks with
which they conduct their transactions. The need for a composite rating system is therefore
__________________________________________________________________________
Md. Shahriar Parvez, Assistant Professor, Department of Business Administration, City University, Bangladesh.
Phone:
0088-02-9893983,
0088-02-9861543;
Cell
Phone:
0088-01552-600738.
Email:
msparvez_educator@yahoo.co.uk
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
necessary which will serve the purpose of the central bank for effective supervision and the depositors’
need to identify the ranks of the banks. The report aims to familiarize the reader with basic knowledge
about banking supervision, of which the CAMELS framework is the main measure to evaluate the overall
safety and soundness of a bank. It also provides the significance of the CAMEL rating system in banking
examination in Bangladesh.
Objective of the paper:
The primary objective of this study is to discuss about CAMELS rating. More specifically, the objectives
are to explore about CAMELS frame work and find out the origin and process of CAMELS rating system
and its use in Bangladesh.
Literature Review:
The financial system, the bank in particular, is exposed to a variety of risks that are growing more
complex nowadays. Furthermore, the economic downturn of 2008 which resulted in bank failures, are
triggered in the U.S. and then wildly spread worldwide. The previous studies on this issue need further
explanation here.
According to, Barr et al. (2002 p.19) states that “CAMELS rating has become a concise and indispensable
tool for examiners and regulators”. This rating ensures a bank‟s healthy conditions by reviewing different
aspects of a bank based on variety of information sources such as financial statement, funding sources,
macroeconomic data, budget and cash flow. Nevertheless, Hirtle and Lopez (1999, p. 4) stress that the
bank‟s CAMELS rating is highly confidential, and only exposed to the bank‟s senior management for the
purpose of projecting the business strategies, and to appropriate supervisory staff. Its rating is never made
publicly available, even on a lagged basis. CAMELS is an acronym for six components of bank safety and
soundness:
Capital Adequacy
Management Quality
Liquidity
Asset Quality
Earning Ability
Sensitivity to
the market risk
Capital adequacy focuses on the total position of bank capital. It focuses on the risk weighted assets
which proposed to protect from the potential shocks of losses that a bank might incur. It is assessed
according to: the volume of risk assets, the volume of marginal and inferior assets, bank growth
experience, plans, and prospects; and the strength of management in relation to all the above factors
(Sundarajan and Errico, 2002). According to Grier (2007), “poor asset quality is the major cause of most
bank failures”. A most important asset category is the loan portfolio; the greatest risk facing the bank is
the risk of loan losses derived from the delinquent loans. The credit analyst should carry out the asset
quality assessment by performing the credit risk management and evaluating the quality of loan portfolio
using trend analysis and peer comparison. Measuring the asset quality is difficult because it is mostly
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
derived from the analyst‟s subjectivity. Frost (2004) stresses that the asset quality indicators highlight the
use of nonperforming loans ratios (NPLs) which are the proxy of asset quality. Grier (2007) suggests that
management is considered to be the single most important element in the CAMELS rating system because
it plays a substantial role in a bank‟s success; however, it is subject to measure as the asset quality
examination.
In accordance with Grier (2007)‟s opinion, a consistent profit not only builds the public confidence in the
bank but absorbs loan losses and provides sufficient provisions. It is also necessary for a balanced
financial structure and helps provide shareholder reward. Thus consistently healthy earnings are essential
to the sustainability of banking institutions. Profitability ratios measure the ability of a company to
generate profits from revenue and assets. Rudolf (2009) emphasizes that “the liquidity expresses the
degree to which a bank is capable of fulfilling its respective obligations”. Banks makes money by
mobilizing short-term deposits at lower interest rate, and lending or investing these funds in long term at
higher rates, so it is hazardous for banks mismatching their lending interest rate. The sensitivity to market
risk is a new component of CAMELS rating system. It makes it more effective and more efficient. The
sensitivity to market risk is evaluated from changes in market prices, notably interest rates; exchange
rates, commodity prices, and equity prices adversely affect a bank‟s earnings and capital. The major
consideration to measure the sensitivity to market risk is the sensitivity of the bank‟s earnings or the
economic value of its capital base or net equity value due to adverse effect in the interest rates of the
market. The amount of market risk arising from trading and foreign operations (Sahajwala and Bergh,
2000).
It therefore increasingly urges the need of more frequent banking examination. In order to cope with the
complexity and a mix of risk exposure to banking system properly, responsibly, beneficially and
sustainable, it is of great importance to evaluate the overall performance of banks by implementing a
regulatory banking supervision framework. This research paper will provides the information about
CAMELS rating in evaluating banking companies performance. The results of review so far done earlier
have further analysed the justification of the study. The study contain the overview of CAMELS rating
system, the emergence CAMELS rating system in Bangladesh and measurement technique and also
observe the recent change in CAMELS in Bangladesh.
Overview of CAMELS Rating System:
CAMELS rating system is a common phenomenon for all banking system all over the world. It is used in
all over the country in the world. It is mainly used to measure a ranking position of a bank on the basis of
few criteria. CAMELS rating system is an international bank-rating system where bank supervisory
authorities rate institutions according to six factors. The six factors are represented by the acronym
"CAMELS". The six factors examined are as follows:
{C - Capital adequacy, A - Asset quality, M - Management quality, E – Earnings, L – Liquidity, S Sensitivity to Market Risk}
Bank supervisory authorities assign a score on a scale of one (best) to five (worst) for each factor to each
bank. If a bank has an average score less than two it is considered to be a high- quality institution, while
banks with scores greater than three are considered to be less-than- satisfactory establishments. The
system helps the supervisory authority identify banks that are in need of attention. There were many
banks rating system available in the world. However, Camels rating system is the most successful bank
rating system in the world. The „Uniform Financial Institutions Rating System (UFIRS)‟ was created in
1979 by the bank regulatory agencies. Under the original UFIRS a bank was assigned ratings based on
performance in five areas: the adequacy of Capital, the quality of Assets, the capability of Management,
the quality and level of Earnings and the adequacy of Liquidity. Bank supervisors assigned a 1 through 5
rating for each of these components and a composite rating for the bank. This 1 through 5 composite
rating was known primarily by the short form CAMEL. A bank received the CAMEL rate 1 or 2 for their
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
sound or good performance in every respect of criteria.
The bank which exhibited unsafe and unsound practices or conditions, critically deficient performance
received the CAMEL rate 5 and that bank was of the greatest supervisory concern. While the CAMEL
rating normally bore close relation to the five component ratings, it was not the result of averaging
those five grades. Supervisors consider each institution‟s specific situation when weighing component
ratings and review all relevant factors when assigning ratings to a certain extent. The process and
component and composite system exist similar for all banking companies. In 1996, the UFIRS was
revised and CAMEL became CAMELS with the addition of a component grade for the Sensitivity of the
bank to market risk. Sensitivity is the degree to which changes in market prices such as interest rates
adversely affect a financial institution. The communication policy for bank ratings was also changed
at end of 1996. Starting in 1997, the supervisors were to report the component rating to the bank. Prior
to that, supervisors only reported the numeric composite rating to the bank. CAMELS‟ ratings in the
Ninth District as of the third quarter of 1998 reflect the excellent banking conditions and performance
over the last several years.
Comparison between the distribution of ratings in the most recent quarter and 10 years ago during the
height of the national banking crisis is illustrative (221 banks failed nationally in 1988 while 3 banks
failed in 1998). Nearly 100 percent of Ninth District banks currently fall into the top two ratings with
40 percent receiving the top grade. Ten years ago one-third of Ninth District banks fell into the bottom
three ratings and only about one of 10 banks received the highest grade.
Six factors of CAMELS ratings system:
Capital Adequacy: A banking company is expected to maintain capital commensurate with the nature
and extent of risks to the institution and the ability of management to identify, measure, monitor, and
control these risks. The effect of credit, market, and other risks on the institution's financial condition
should be considered when evaluating the adequacy of capital. The types and quantity of risk inherent in
an institution's activities will determine the extent to which it may be necessary to maintain capital at
levels above required regulatory minimums to properly reflect the potentially adverse consequences that
these risks may have on the institution's capital.
The capital adequacy of a banking company is rated based upon, but not limited to, an assessment depends
on, the level and quality of capital and the overall financial condition of the institution, the ability of
management to address emerging needs for additional capital, the nature, trend, and volume of problem
assets, and the adequacy of allowances for loan and lease losses and other valuation reserves, balance
sheet composition, including the nature and amount of intangible assets, market risk, concentration risk,
and risks associated with nontraditional activities, risk exposure represented by off-balance sheet
activities, the quality and strength of earnings, and the reasonableness of dividends, Prospects and plans
for growth, as well as past experience in managing growth and Access to capital markets and other
sources of capital, including support provided by a parent holding company.
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
Rating Indicates:
1
Indicates a strong
capital level
relative to the
institution's risk
profile
2
Indicates a
satisfactory capital
level relative to the
financial
institution's risk
profile.
3
4
5
Indicates a less
than satisfactory
level of capital that
does not fully
support the
institution's risk
profile. The rating
indicates a need for
improvement, even
if the institution's
capital level
exceeds minimum
regulatory and
statutory
requirements.
Indicates a
deficient level of
capital. In light of
the institution's risk
profile, viability of
the institution may
be threatened.
Assistance from
shareholders or
other external
sources of financial
support may be
required.
Indicates a
critically deficient
level of capital
such that the
institution's
viability is
threatened.
Immediate
assistance from
shareholders or
other external
sources of financial
support is required.
Asset Quality: The asset quality rating reflects the quantity of existing and potential credit risk associated
with the loan and investment portfolios, other real estate owned, and other assets, as well as off-balance
sheet transactions. The ability of management to identify, measure, monitor, and control credit risk is also
reflected here. The evaluation of asset quality should consider the adequacy of the allowance for loan and
lease losses and weigh the exposure to counterparty, issuer, or borrower default under actual or implied
contractual agreements.
All other risks that may affect the value or marketability of an institution's assets, including, but not
limited to, operating, market, reputation, strategic, or compliance risks should also be considered.
The asset quality of a financial institution is rated based upon, but not limited to, an assessment depends
on, the adequacy of underwriting standards, soundness of credit administration practices, and
appropriateness of risk identification practices, the level, distribution, severity, and trend of problem,
classified, no accrual, restructured, delinquent, and nonperforming assets for both on- and off-balance
sheet transactions, the adequacy of the allowance for loan and lease losses and other asset valuation
reserves, the credit risk arising from or reduced by off-balance sheet transactions, such as unfunded
commitments, credit derivatives, commercial and standby letters of credit, and lines of credit, the
diversification and quality of the loan and investment portfolios, the extent of securities underwriting
activities and exposure to counterparties in trading activities, the existence of asset concentrations, the
adequacy of loan and investment policies, procedures, and practices, the ability of management to
properly administer its assets, including the timely identification and collection of problem assets, the
adequacy of internal controls and management information systems, the volume and nature of credit
documentation exceptions.
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
Rating Indicates:
1
2
3
4
5
Indicates strong
asset quality and
credit
administration
practices.
Identified
weaknesses are
minor in nature and
risk exposure is
modest in relation
to capital
protection and
management's
abilities. Asset
quality in such
institutions is of
minimal
supervisory
concern.
Indicates
satisfactory asset
quality and credit
administration
practices. The level
and severity of
classifications and
other weaknesses
warrant a limited
level of
supervisory
attention. Risk
exposure is
commensurate with
capital protection
and management's
abilities.
Is assigned when
asset quality or
credit
administration
practices are less
than satisfactory.
Trends may be
stable or indicate
deterioration in
asset quality or an
increase in risk
exposure. The level
and severity of
classified assets,
other weaknesses,
and risks require an
elevated level of
supervisory
concern. There is
generally a need to
improve credit
administration and
risk management
practices.
Is assigned to
financial
institutions with
deficient asset
quality or credit
administration
practices. The
levels of risk and
problem assets are
significant,
inadequately
controlled, and
subject the
financial institution
to potential losses
that, if left
unchecked, may
threaten its
viability.
Represents
critically deficient
asset quality or
credit
administration
practices that
present an
imminent threat to
the institution's
viability.
Management: The capabilities of the board of directors and management, in their respective role, to
identify, measure, monitor, and control the risks of an institution's activities and to ensure a financial
institution's safe, sound, and efficient operation in compliance with applicable laws and regulations is
reflected in this rating. Generally, directors need not be actively involved in day-to-day operations;
however, they must provide clear guidance regarding acceptable risk exposure levels and ensure that
appropriate policies, procedures, and practices have been established. Senior management is responsible
for developing and implementing policies, procedures, and practices that translate the board's goals,
objectives, and risk limits into prudent operating standards.
Depending on the nature and scope of an institution's activities, management practices may need to
address some or all of the following risks: credit, market, operating or transaction, reputation, strategic,
compliance, legal, liquidity, and other risks. Sound management practices are demonstrated by: active
oversight by the board of directors and management; competent personnel; adequate policies, processes,
and controls taking into consideration the size and sophistication of the institution; maintenance of an
appropriate audit program and internal control environment; and effective risk monitoring and
management information systems.
This rating should reflect the board's and management's ability as it applies to all aspects of banking
operations as well as other financial service activities in which the institution is involved.
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
The capability and performance of management and the board of directors is rated based upon, but not
limited to, an assessment depends on, the level and quality of oversight and support of all institution
activities by the board of directors and management, the ability of the board of directors and management,
in their respective roles, to plan for, and respond to, risks that may arise from changing business
conditions or the initiation of new activities or products, the adequacy of, and conformance with,
appropriate internal policies and controls addressing the operations and risks of significant activities, the
accuracy, timeliness, and effectiveness of management information and risk monitoring systems
appropriate for the institution's size, complexity, and risk profile, the adequacy of audits and internal
controls to: promote effective operations and reliable financial and regulatory reporting; safeguard assets;
and ensure compliance with laws, regulations, and internal policies, compliance with laws and regulations,
responsiveness to recommendations from auditors and supervisory authorities, management depth and
succession, the extent that the board of directors and management is affected by, or susceptible to,
dominant influence or concentration of authority, reasonableness of compensation policies and avoidance
of self-dealing, demonstrated willingness to serve the legitimate banking needs of the community, the
overall performance of the institution and its risk profile.
Rating Indicates:
1
2
3
4
5
Indicates strong
performance by
management and
the board of
directors and
strong risk
management
practices relative to
the institution's
size, complexity,
and risk profile.
All significant
risks are
consistently and
effectively
identified,
measured,
monitored, and
controlled.
Management and
the board have
demonstrated the
ability to promptly
and successfully
address existing
and potential
problems and risks.
Indicates
satisfactory
management and
board performance
and risk
management
practices relative to
the institution's
size, complexity,
and risk profile.
Minor weaknesses
may exist, but are
not material to the
safety and
soundness of the
institution and are
being addressed. In
general, significant
risks and problems
are effectively
identified,
measured,
monitored, and
controlled.
Indicates
management and
board performance
that need
improvement or
risk management
practices that are
less than
satisfactory given
the nature of the
institution's
activities. The
capabilities of
management or the
board of directors
may be insufficient
for the type, size,
or condition of the
institution.
Problems and
significant risks
may be
inadequately
identified,
measured,
monitored, or
controlled.
Indicates deficient
management and
board performance
or risk
management
practices that are
inadequate
considering the
nature of an
institution's
activities. The level
of problems and
risk exposure is
excessive.
Problems and
significant risks are
inadequately
identified,
measured,
monitored, or
controlled and
require immediate
action by the board
and management to
preserve the
soundness of the
institution.
Replacing or
strengthening
management or the
board may be
Indicates critically
deficient
management and
board performance
or risk
management
practices.
Management and
the board of
directors have not
demonstrated the
ability to correct
problems and
implement
appropriate risk
management
practices. Problems
and significant
risks are
inadequately
identified,
measured,
monitored, or
controlled and now
threaten the
continued viability
of the institution.
Replacing or
strengthening
management or the
board of directors
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Proceedings of 11th Asian Business Research Conference
26-27 December, 2014, BIAM Foundation, Dhaka, Bangladesh, ISBN: 978-1-922069-68-9
necessary.
is necessary.
Earnings: This rating reflects not only the quantity and trend of earnings, but also factors that may affect
the sustainability or quality of earnings. The quantity as well as the quality of earnings can be affected by
excessive or inadequately managed credit risk that may result in loan losses and require additions to the
allowance for loan and lease losses, or by high levels of market risk that may unduly expose an
institution's earnings to volatility in interest rates. The quality of earnings may also be diminished by
undue reliance on extraordinary gains, nonrecurring events, or favorable tax effects. Future earnings may
be adversely affected by an inability to forecast or control funding and operating expenses, improperly
executed or ill advised business strategies, or poorly managed or uncontrolled exposure to other risks.
The rating of an institution's earnings is based upon, but not limited to, an assessment depends on, the
level of earnings, including trends and stability, the ability to provide for adequate capital through retained
earnings, the quality and sources of earnings, the level of expenses in relation to operations, the adequacy
of the budgeting systems, forecasting processes, and management information systems in general, the
adequacy of provisions to maintain the allowance for loan and lease losses and other valuation allowance
accounts, the earnings exposure to market risk such as interest rate, foreign exchange, and price risks.
Rating Indicates:
1
2
3
4
5
Indicates earnings
that are strong.
Earnings are more
than sufficient to
support operations
and maintain
adequate capital
and allowance
levels after
consideration is
given to asset
quality, growth,
and other factors
affecting the
quality, quantity,
and trend of
Indicates earnings
that are
satisfactory.
Earnings are
sufficient to
support operations
and maintain
adequate capital
and allowance
levels after
consideration is
given to asset
quality, growth,
and other factors
affecting the
quality, quantity,
Indicates earnings
that need to be
improved.
Earnings may not
fully support
operations and
provide for the
accretion of capital
and allowance
levels in relation to
the institution's
overall condition,
growth, and other
factors affecting
the quality,
quantity, and trend
Indicates earnings
that are deficient.
Earnings are
insufficient to
support operations
and maintain
appropriate capital
and allowance
levels. Institutions
so rated may be
characterized by
erratic fluctuations
in net income or
net interest margin,
the development of
significant negative
Indicates earnings
that are critically
deficient. A
financial institution
with earnings rated
5 is experiencing
losses that
represent a distinct
threat to its
viability through
the erosion of
capital.
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Proceedings of 11th Asian Business Research Conference
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earnings.
and trend of
earnings. Earnings
that are relatively
static, or even
experiencing a
slight decline, may
receive a 2 rating
provided the
institution's level
of earnings is
adequate in view of
the assessment
factors listed
above.
of earnings.
trends, nominal or
unsustainable
earnings,
intermittent losses,
or a substantive
drop in earnings
from the previous
years.
Liquidity: In evaluating the adequacy of a banking company‟s liquidity position, consideration should be
given to the current level and prospective sources of liquidity compared to funding needs, as well as to the
adequacy of funds management practices relative to the institution's size, complexity, and risk profile. In
general, funds management practices should ensure that an institution is able to maintain a level of
liquidity sufficient to meet its financial obligations in a timely manner and to fulfill the legitimate banking
needs of its community. Practices should reflect the ability of the institution to manage unplanned changes
in funding sources, as well as react to changes in market conditions that affect the ability to quickly
liquidate assets with minimal loss. In addition, funds management practices should ensure that liquidity is
not maintained at a high cost, or through undue reliance on funding sources that may not be available in
times of financial stress or adverse changes in market conditions.
Liquidity is rated based upon, but not limited to, an assessment depends on, the adequacy of liquidity
sources compared to present and future needs and the ability of the institution to meet liquidity needs
without adversely affecting its operations or condition, the availability of assets readily convertible to cash
without undue loss, access to money markets and other sources of funding, the level of diversification of
funding sources, both on- and off-balance sheet, the degree of reliance on short-term, volatile sources of
funds, including borrowings and brokered deposits, to fund longer term assets, the trend and stability of
deposits, the ability to securitize and sell certain pools of assets, the capability of management to properly
identify, measure, monitor, and control the institution's liquidity position, including the effectiveness of
funds management strategies, liquidity policies, management information systems, and contingency
funding plans.
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Rating Indicates:
1
2
3
4
5
Indicates strong
liquidity levels and
well-developed
funds management
practices. The
institution has
reliable access to
sufficient sources
of funds on
favorable terms to
meet present and
anticipated
liquidity needs.
Indicates
satisfactory
liquidity levels and
funds management
practices. The
institution has
access to sufficient
sources of funds on
acceptable terms to
meet present and
anticipated
liquidity needs.
Modest
weaknesses may be
evident in funds
management
practices.
Indicates liquidity
levels or funds
management
practices in need of
improvement.
Institutions rated 3
may lack ready
access to funds on
reasonable terms or
may evidence
significant
weaknesses in
funds management
practices.
Indicates deficient
liquidity levels or
inadequate funds
management
practices.
Institutions rated 4
may not have or be
able to obtain a
sufficient volume
of funds on
reasonable terms to
meet liquidity
needs.
Indicates liquidity
levels or funds
management
practices so
critically deficient
that the continued
viability of the
institution is
threatened.
Institutions rated 5
require immediate
external financial
assistance to meet
maturing
obligations or other
liquidity needs.
Sensitivity to Market Risk: The sensitivity to market risk component reflects the degree to which
changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect a
financial institution's earnings or economic capital. When evaluating this component, consideration should
be given to: management's ability to identify, measure, monitor, and control market risk; the institution's
size; the nature and complexity of its activities; and the adequacy of its capital and earnings in relation to
its level of market risk exposure. For many institutions, the primary source of market risk arises from no
trading positions and their sensitivity to changes in interest rates. In some larger institutions, foreign
operations can be a significant source of market risk. For some institutions, trading activities are a major
source of market risk.
Market risk is rated based upon, but not limited to, an assessment depends on, the sensitivity of the
financial institution's earnings or the economic value of its capital to adverse changes in interest rates,
foreign exchanges rates, commodity prices, or equity prices, the ability of management to identify,
measure, monitor, and control exposure to market risk given the institution's size, complexity, and risk
profile, the nature and complexity of interest rate risk exposure arising from non trading positions, where
appropriate, the nature and complexity of market risk exposure arising from trading and foreign
operations.
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Rating Indicates:
1
2
3
4
5
Indicates that
market risk
sensitivity is well
controlled and that
there is minimal
potential that the
earnings
performance or
capital position
will be adversely
affected. Risk
management
practices are strong
for the size,
sophistication, and
market risk
accepted by the
institution. The
level of earnings
and capital provide
substantial support
for the degree of
market risk taken
by the institution.
Indicates that
market risk
sensitivity is
adequately
controlled and that
there is only
moderate potential
that the earnings
performance or
capital position
will be adversely
affected. Risk
management
practices are
satisfactory for the
size, sophistication,
and market risk
accepted by the
institution. The
level of earnings
and capital provide
adequate support
for the degree of
market risk taken
by the institution.
Indicates that
control of market
risk sensitivity
needs improvement
or that there is
significant
potential that the
earnings
performance or
capital position
will be adversely
affected. Risk
management
practices need to
be improved given
the size,
sophistication, and
level of market risk
accepted by the
institution. The
level of earnings
and capital may not
adequately support
the degree of
market risk taken
by the institution.
Indicates that
control of market
risk sensitivity is
unacceptable or
that there is high
potential that the
earnings
performance or
capital position
will be adversely
affected. Risk
management
practices are
deficient for the
size, sophistication,
and level of market
risk accepted by
the institution. The
level of earnings
and capital provide
inadequate support
for the degree of
market risk taken
by the institution.
Indicates that
control of market
risk sensitivity is
unacceptable or
that the level of
market risk taken
by the institution is
an imminent threat
to its viability.
Risk management
practices are
wholly inadequate
for the size,
sophistication, and
level of market risk
accepted by the
institution.
CAMELS rating system in Bangladesh:
All over the world, CAMELS rating is a common figure to all banking industry. Like all other
countries, it is also used in Bangladesh. Bangladesh Bank (BB), as central bank, has the statutory task of
regulating and supervising the banking system of Bangladesh. To play this vital role, it is imperative that
BB be able to assess the overall strength of the banking system as a whole, as well as the safety and
soundness of each individual banking company.
In Bangladesh, the five components of CAMEL have been used for evaluating the five crucial
dimensions of a bank‟s operations that reflect in a complete institution‟s financial condition, compliance
with banking regulations and statutes and overall operating soundness since the early nineties. In 2006,
Bangladesh Bank has upgraded the CAMEL into CAMELS. „Sensitivity to market risk‟ or „S‟ is the new
rating component which is included in CAMEL and make it into CAMELS. The new rating component
makes the system more effective and efficient. The new system needs bank‟s regular condition and
performance according to predetermined stress testing on asset and liability and foreign exchange
exposures, procedures, rules and criteria and on the basis of the results obtained through risk-based audits
under core risk management guidelines. A bank‟s single CAMELS rating has come from off-site
monitoring, which uses monthly financial statement information, and an on-site examination, from
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Proceedings of 11th Asian Business Research Conference
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which bank supervisors gather further “private information” not reflected in the financial reports. The
development of "credit points" examination result is ranging from 0 to 100. 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.
Under the CAMELS rating system in Bangladesh, banking companies should be assigned two sets of
ratings:
Performance ratings, which comprise six (6) individual ratings that address each of the CAMELS
components;
The six aspects of CAMELS performance encompass: Capital Adequacy, Asset Quality, Management,
Earnings, Liquidity and Sensitivity to market risk. Each of these component areas is to be evaluated on a
numerical scale of “1” to “5.” A "1" indicates the highest rating, the strongest performance, best risk
management practices and least supervisory concern. A "5" is the lowest rating, indicating the weakest
performance, inadequate risk management practices, and the highest degree of supervisory concern.
The following is a description of the gradations to be utilized in assigning performance ratings for the six
components:
Rating “1” - Indicates strong performance;
Rating “2” - Indicates above average performance that adequately provides for the safe and sound
operations of the banking company;
Rating “3” - Indicates performance that is flawed to some degree;
Rating “4” - Indicates unsatisfactory performance. If left unchecked, such performance could
threaten the solvency of the banking company;
Rating “5”- Indicates very unsatisfactory performance in need of immediate remedial attention for
the sake of the banking company‟s survival.
Composite rating, which is a single rating that is based on a comprehensive assessment of the overall
condition of the banking company.
Composite ratings are based on a careful evaluation of an institution's managerial, operational, financial,
and compliance performance. 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,
the adequacy of liquidity, and sensitivity to market risk. The 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 5 rating indicates: the most
critically deficient level of performance; inadequate risk management practices relative to the institution's
size, complexity, and risk profile; and the greatest supervisory concern. The composite ratings are defined
as follows:
Composite 1: (Strong)
Financial institutions in this group are sound in every respect; as such, all
components are rated 1 or 2. Any weakness is minor and can be handled in a routine manner by
management. Substantial compliance with laws and regulations is noted. These financial institutions are
more capable of withstanding the vagaries of business conditions and are resistant to outside influences
such as economic instability in their trade area. As a result, these financial institutions exhibit the strongest
performance and risk management practices and give no cause for supervisory concern.
Composite 2: (Satisfactory) - Financial institutions in this group are fundamentally sound. For a financial
institution to receive this rating, normally no component rating should be more severe than 3. Only modest
weaknesses are present and are well within management's capabilities and willingness to correct. These
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Proceedings of 11th Asian Business Research Conference
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financial institutions are stable and are capable of withstanding business fluctuations. These financial
institutions are in substantial compliance with laws and regulations and there are no material supervisory
concerns. Overall risk management practices are satisfactory. As a result, the supervisory response is
informal and limited.
Composite 3: (Fair) - Financial institutions in this group exhibit some degree of supervisory concern in
one or more of the component areas. These financial institutions exhibit a combination of weaknesses that
may range from moderate to severe. Risk management practices may be less than satisfactory. The
concerns, however, are not of the magnitude to cause a component to be rated more severely than 4.
Financial institutions in this group generally are less capable of withstanding business fluctuations; are
more vulnerable to outside influences than those institutions rated a composite 1 or 2; and, management
may lack the ability or willingness to effectively address weaknesses within appropriate time frames.
Additionally, these financial institutions may be in significant noncompliance with laws and regulations.
These financial institutions are a supervisory concern and require more than normal supervision, which
may include formal or informal enforcement actions. Failure appears unlikely, however, given the overall
strength and financial capacity of these institutions.
Composite 4: (Marginal) - Financial institutions in this group are in an unsafe and unsound condition.
These are serious financial or managerial deficiencies that result in unsatisfactory performance. The
problems range from severe to critically deficient. Risk management practices are generally unacceptable.
The weaknesses and problems are not being satisfactorily addressed or resolved by management. There
may be significant noncompliance with laws and regulations. Financial institutions in this group generally
are not capable of withstanding business fluctuations. Close supervisory attention is required, which
means, in most cases, formal enforcement action is necessary to address the problems. Institutions in this
group pose a risk to the deposit insurance fund. Failure is a distinct possibility if the problems and
weaknesses are not satisfactorily addressed and resolved.
Composite 5: (Unsatisfactory) - Financial institutions in this group are in an extremely unsafe and
unsound condition, exhibit a critically deficient performance, often contain the weakest risk management
practices, and are of the greatest supervisory concern. The volume and severity of problems is beyond
management's ability or willingness to control or correct. Immediate outside financial or other assistance
is needed in order for the financial institution to be viable. Continuous close supervisory attention is
warranted. Institutions in this group pose a significant risk to the deposit insurance fund. Failure is highly
probable and the least-cost resolution alternatives are being considered by the appropriate agencies.
Table 1: Composite CAMELS and their Interpretation
Rating
Composite Range
Description
Rating analysis interpretation
1
1-1.49
Strong
Sound in every respect, no supervisory responses required.
2
1.5-2.49
Satisfactory
Fundamentally sound with modest correctable weakness,
supervisory response limited
3
2.5-3.49
Fair
Combination of weaknesses if n o t r e d i r e c t e d w i l l
b e c o m e s e v e r e . Watch category. Requires more than
normal supervision.
4
3.5-4.49
Marginal
Immoderate weakness unless properly addressed could
impair future viability of the bank. Needs close
supervision
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5
4.5-5
Unsatisfactory
High risk of failure in the near term. Under constant
supervision/cease and desist order.
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
Companies.”
Measurement Process CAMELS Rating (Bangladesh Bank):
CAMEL rating has some formula and standard level of values for each measure for rating the bank‟s
performance as strong, satisfactory, fair, marginal and unsatisfactory.
The rating formulas with its standards are given below:
Capital Adequacy Ratio:
a. Risk based capital ratio = Total capital / Risk weighted assets
Table 2: Risk based capital ratio-rating scale
Rating
1
Remarks
Strong
Percentage
3.00% or more above reqired ratio
2
Satisfactory
1% to 2% above required ratio
3
Fair
Required minimum ratio
4
Marginal
1% to 2% below required ratio
5
Unsatisfactory
More than 2% below required ratio
Source: Bangladesh Bank, “Guidelines
Guidelines for Determination of CAMELS Rating for Banking Companies.”
b. Core capital ratio = Core capital (Tier I capital) /Risk weighted assets
Table 3: Core capital ratio rating scale
Rating
1
Remarks
Strong
Percentage
More than 5%
2
Satisfactory
4.5% to 5%
3
Fair
3.5%to less than 4.5%
4
Marginal
3%to less than 3.5%
5
Unsatisfactory
Below 3%
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
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Proceedings of 11th Asian Business Research Conference
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Asset Quality Ratio
a. Classified loans ratio = Classified loans (Non performing Loans) / Total Loans
Table 4: Classified loan ratio rating scale
Rating
Remarks
Percentage
1
Strong
Less than 3%
2
Satisfactory
3% to less than 5%
3
Fair
5% to less than 10%
4
Marginal
10% to less than 15%
5
Unsatisfactory
15% or greater
Source: Bangladesh Bank, , “Guidelines for Determination of CAMELS Rating for Banking Companies.”
b. Ratio of classified loans to industry average = Classified loans to total loans / Industry average
of classified loans to total loans
Table 5: Classified loan to industry average ratio rating scale
Rating
1
Remarks
Strong
Percentage
50% and below
2
Satisfactory
More than 50% to 100%
3
Fair
More than 100% to 125%
4
Marginal
More than125% to 150%
5
Unsatisfactory
Over 150%
Source: Bangladesh Bank,,“Guidelines for Determination of CAMELS Rating for Banking Companies.”
c. Provisioning adequacy ratio = Actual provisioning / Required provisioning
Table 6: Provisioning adequacy ratio rating scale
Rating
Remarks
Percentage
1
Strong
100%
2
Satisfactory
95% to less than 100%
3
Fair
80% to less than 95%
4
Marginal
50% to less than 80%
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Proceedings of 11th Asian Business Research Conference
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5
Unsatisfactory
Below 50%
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
Management Quality Ratio
Management is the composition of capital adequacy, asset quality, earnings and liquidity and sensitivity to
the market risk position. The average position of these four components represents the management
quality of a bank.
Management Quality = (C+A+E+L+S)/5
Table 7: Management Rating scale
Rating
Remarks
Management Rating Scale
1
Strong
1.00-1.49
2
Satisfactory
1.50-2.49
3
Fair
2.50-3.49
4
Marginal
3.50-4.49
5
Unsatisfactory
4.50-5.00
Source: Bangladesh
gladesh
Bank,
“
Guidelines
for
Determination
of
CAMELS
Rating
for Banking Companies.”
Ban
Earning Ratio
Earning ratio is the ratiois the average of ROA, ROE and Net Interest Margin. It measures that how much
the bank earns utilizing its total assets. If earnings are higher, the bank is certainly in good position.
a. ROA = Net income / Total Asset
Table 8: ROA Rating scale
Rating
Remarks
ROA
1
Strong
1.3% or more
2
Satisfactory
0.8% to less than 1.3%
3
Fair
0.4% to less than 0.8%
4
Marginal
0.16% to less than 0.4%
5
Unsatisfactory
Below 0.16%
Source: Bangladesh Bank, , “Guidelines for Determination of CAMELS Rating for Banking Companies.”
b. ROE = Net income / Equity Capital
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Table 9: ROE Rating scale
Rating
Remarks
Management Rating Scale
1
Strong
9% or more
2
Satisfactory
7% to less than 9%
3
Fair
5% to less than 7%
4
Marginal
2% to less than 5%
5
Unsatisfactory
Below 2%
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
c. Net Interest Margin = (Interest Income-Interest Expense)/Earning Assets
Table
: Net Interest Margin Rating scale
Rating
Remarks
Management Rating Scale
1
Strong
5% or more
2
Satisfactory
4.5% to less than 5%
3
Fair
4% to less than 4.5%
4
Marginal
3% to less than 4%
5
Unsatisfactory
Below 3%
Source: Bangladesh Bank, , “Guidelines for Determination of CAMELS Rating for Banking Companies.”
Liquidity Ratio
Liquidity is one of most important decision on the part of a bank. Because if a bank has not enough liquid
money, it will not be able to meet up the public demand which in result deposit position may be deemed.
So banks have to maintain a good amount of liquid money to meet up the public demand.
Liquidity Ratio = Liquid assets / Total time and demand deposits
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Table 1 : Liquidity Rating scale
Rating
Remarks
Rating Scale
1
Strong
2
Satisfactory
Up to 2% above requirement
3
Fair
Required SLR
4
Marginal
1% to 2% below requirement
More than 2% above requirement
5
Unsatisfactory
More than 2% below requirement
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
Sensitivity to Market Risk Ratio
The sensitivity to market risk is evaluated from changes in market prices, notably interest rates; exchange
rates. The sensitivity to market risk ratio is the average of interest rate risk and exchange rate risk and the
ratio indicates how well the bank manage its market risk. The ratios are calculated as follows:
a. Interest rate risk ratio = interest rate risk / Average quarterly earnings
Table 1 : Interest rate risk ratio Rating scale
Rating
Remarks
Rating Scale
1
Strong
4% or less
2
Satisfactory
4% to less than 6%
3
Fair
6% to less than 8%
4
Marginal
8% to 10%
5
Unsatisfactory
Above 10%
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
b. Exchnge rate risk ratio = Exchange rate risk / Core capital
Table 1 : Exchnge rate risk ratio Rating scale
Rating
Remarks
Rating Scale
1
Strong
Less than 15%
2
Satisfactory
15% to less then 20%
3
Fair
20% to less than 25%
4
Marginal
25% to 30%
5
Unsatisfactory
More than 30%
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
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Composite Rating
Composite rating is the average of all rating.
Composite rating = (C+A+M+E+L) / 5
Table 1 : Composite Rating Scale
Rating
1.1.1 Remarks
Composite Rating Scale
1
Strong
1.00-1.49
2
Satisfactory
1.50-2.49
3
Fair
2.50-3.49
4
Marginal
3.50-4.49
5
Unsatisfactory
4.50-5.00
Source: Bangladesh Bank, “Guidelines for Determination of CAMELS Rating for Banking Companies.”
BB to revise CAMELS rating calculation method:
The central bank is going to use the latest technique by revising the CAMELS rating calculation method to
get the exact picture of the country's commercial banks. A good number of off-balance sheet items
including letters of credit, inland bill purchase (IBP), foreign bill purchases (FBPs), loans against trust
receipts (LTRs), payment against documents (PADs) and loan against imported merchandise (LIM) will
be considered in determination of the CAMELS rating along with the existing balance sheet items. The
central bank already undertook various reformative and redesigned actions under the financial sector
supervision framework with a view to energizing and encouraging supervision activity.
Liquidity coverage ratio (LCR) and net stable funding ratio (NSFR) in the revised guidelines on CAMELS
rating calculation to ensure adequate liquidity in the banking sector, the central banker noted. he LCR is a
new liquidity standard introduced by the Basel Committee to ensure that a bank maintains an adequate
level of unencumbered and high-quality liquid assets that can be converted into cash to meet its liquidity
needs for 30 days. The NSFR is a new standard introduced by the Basel Committee to limit the overreliance on short-term wholesale funding assessment of liquidity risks across all on-balance sheet and offbalance sheet items.
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Currently, a nine-member high-powered committee, headed by BB Deputy Governor Abu Hena
Mohammad Razee Hassan is now working to revise the guidelines. Another Deputy Governor of the BB,
Mr SK Sur Chowdhury, is an adviser to the committee, according to the BB officials.
Under the existing CAMELS rating method, any bank, categorised as marginal or unsatisfactory, is
generally identified as a problem bank. Activities of these banks are closely monitored by the BB.
Two private commercial banks (PCBs) have been categorised as 'problem banks.' They have been asked to
submit special reports on a quarterly basis so their real financial position can be reviewed. As per the
existing provisions, the problem banks have to follow specific guidelines in addition to normal banking
rules and regulations to improve their financial health. The BB earlier had introduced the Early Warning
System (EWS) of supervision from March 2005 to address the difficulties faced by banks in any of the
areas of CAMELS. Any bank found to have faced difficulty in any area of operation, is included in the
Early Warning category and monitored very closely to help improve its performance. (The Financial
Express, 22 March 2013).
Finding & Conclusion:
The findings revealed that the CAMELS rating is significant to banking supervision and is currently
popular among regulators worldwide. This research paper tried to find out the framework and calculation
process of CAMELS rating in Bangladesh, CAMELS rating is playing an important role to monitor the
sample banks on the part of the central bank. By using CAMELS rating system it commercial banks easily
know what is there needs to maintain such kind of {C - Capital adequacy, A - Asset quality, M Management quality, E – Earnings, L – Liquidity, S - Sensitivity to Market Risk}.
The report revealed that the CAMELS rating is significant to banking supervision and is currently popular
among regulators worldwide. Its approach is beneficial as it is an internationally standardized rating, and
provides flexibility between on-site and off-site examination; hence, it is the dominant model in assessing
banks performance. Meanwhile, it has disadvantages of not following and ignoring the interaction with
bank‟s top management and overlooking the provisions as well as allowance for loan loss ratios. The
interview with an expert helped the writer further discuss the current sovereign debt crisis and banking
crisis in Europe which tend to rise sharply. The stress test is introduced to be a practical risk management
tool to identify the failed banks with inadequate capital position.
Reference:
o Bangladesh Bank, February, 2006 “Guidelines For Determination Of Camels Rating For Banking
Companies”
o Barr, Richard S. et al. (2002). “Evaluating the Productive Efficiency and Performance of U.S.
Commercial Banks”. Engineering Management, 28(8), p. 19.
o Duttweiler, Rudolf (2009). “Managing Liquidity in Banks: A Top down Approach’. John Wiley
and Sons, p1.
o Frost, Stephen M., (2004). "Chapter 20 - Corporate Failures and Problem Loans". The Bank
Analyst's Handbook: Money, Risk and Conjuring Tricks. John Wiley and Sons.
o Grier, Waymond A. (2007). “Credit Analysis of Financial Institutions”. 2nd ed. Euromoney
Institution Investor PLC.
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Proceedings of 11th Asian Business Research Conference
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o Hirtle, Beverly J. and Lopez, Jose A. (1999). “Supervisory Information and the Frequency of Bank
Examination”. FRBNC Economic Review, p. 4.
o Rose, Peter. “Commercial Bank Management” Boston: McGraw-Hill Companies, Inc., 1996.
o Sundarajan, V. and L. Errico (2002). Islamic Financial Institutions and Products in the Global
Financial System: Key Issues in Risk Management and Challenges Ahead. IMF Working Paper No.
WP/02/192, November.
o Sahajwala, R and P. V. D. Bergh (2000). Supervisory Risk Assessment and Early Warning
Systems. Basel Committee on Banking Supervision Working Papers No. 4, Bank for International
Settlements (BIS). Basel, Switzerland, December
Websites:
o http://www.bangladeshbank.org
o http://www.thefinancialexpress
bd.com/old/index.php?ref=MjBfMDNfMjJfMTNfMV8xXzE2NDA1Nw==
o http://masterbari.blogspot.com/2012/10/camels-rating-assessment-theory_2501.html
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