The ABCs of CAMELS

This post is part of a series titled “Supervising Our Nation’s Financial Institutions.” The series, written by Julie Stackhouse, executive vice president and officer-in-charge of supervision at the St. Louis Federal Reserve, appears at least once each month.

The health of banks is important to everyone, whether a borrower or a saver, an individual or a business. Subject to certain restrictions, bank deposits up to $250,000 are insured by the Federal Deposit Insurance Corp. The agency’s deposit insurance fund is financed by banks through fees. For catastrophic events, the fund is further supported by a $100 billion line of credit at the Treasury Department, meaning that taxpayers serve as the ultimate backstop in the event of a crisis. The FDIC may borrow money from the U.S. Treasury, the Federal Financing Bank and individual banks to replenish the fund on a temporary basis. See the FDIC’s Federal Deposit Insurance Act page for more information.

Because of the government safety net and in support of financial stability, bank supervisors monitor the health of banks through periodic examinations. At the conclusion of its exam, each bank is assigned a rating—called CAMELS—that allows comparisons of bank health over time and with peers.

CAMELS as a Health Monitor

CAMELS is an acronym representing its six components:

• Capital adequacy
• Asset quality
• Management
• Earnings
• Liquidity
• Sensitivity to market risk

Banks are rated on each component, and a composite rating is also computed. Ratings range from one to five:

• 1 is “strong.”
• 2 is “satisfactory.”
• 3 is “less than satisfactory.”
• 4 is “deficient.”
• 5 is “critically deficient.”

To earn a 1 on any component, a bank must show the strongest performance and risk management practices in that area. Alternatively, a rating of 5 indicates weak performance, inadequate risk management practices and the highest degree of supervisory concern.

The overall, or composite, rating for each bank is based on the six components. However, it is not an arithmetic average of the individual component ratings. Rather, some components are weighed more heavily than others based on examiner judgment of risk.

For community banks, the asset quality rating is critical because of the size of the loan portfolio at small banks. We’ll take a deeper dive into asset quality and the other individual components of CAMELS in upcoming posts.

Who Sees the Rating?

At the conclusion of each examination, the bank’s rating is revealed to senior bank management and the board of directors. If the rating is 3, 4 or 5, the board is typically required to enter into an agreement with bank supervisors to correct the issues. The most serious deficiencies can result in formal supervisory actions that can be enforced in court.

Each bank’s CAMELS ratings and examination report are confidential and may not be shared with the public, even on a lagged basis. In fact, it is a violation of federal law to disclose CAMELS ratings to unauthorized individuals. Violators may be assessed criminal penalties under 18 USC §641. Outsiders may monitor bank health through private-sector firms that use publicly available financial data to produce their own analysis of bank health, sometimes even using their own rating system.

In next month’s post, we’ll begin a discussion of the individual components of the CAMELS rating, starting with the “C,” or capital, component.

Notes and References

¹ The FDIC may borrow money from the U.S. Treasury, the Federal Financing Bank and individual banks to replenish the fund on a temporary basis. See the FDIC’s Federal Deposit Insurance Act page for more information.

² Violators may be assessed criminal penalties under 18 USC §641.

Additional Resources

• Bank Supervision
• Community Banking in the 21st Century
• FDIC: Federal Deposit Insurance Act