Question

What is the CAMELS rating system? In your answer, explain why it is important to commercial banks.

Answer 1

CAMELS stand for Capital Adequacy, Asset Quality, Management, Earnings, Liquidity and Sensitivity which was developed by JP Morgan. CAMELS rating is used for assessment of financial institutions.

The CAMELS is important for commercial banks because commercial banks are evaluated by supervisors based on factors of CAMELS. Broadly, supervisors assign rating based on below factors which is explained in brief:

·       Capital adequacy is assessed to ensure sufficient capital.

·       Asset quality of institution is examined by its quality of loan and its ability of repayment.

·       Management should be able to respond quickly to upcoming financial crisis.

·       Earning potential is evaluated based on stability and consistency.

·       Liquidity analysis is done to see how quickly invested asset can be converted into cash in times of financial crisis.

·       Sensitivity analysis covers particular risk which can harm the financial institution at the time of crisis.