The Condition of Banks: What Are Examiners Finding?

R. Alton Gilbert

Federal law requires supervisory agencies to examine each bank at least once every 18 months. Most examinations assess six aspects of a bank's operations (spelling the word "CAMELS"):

  • C capital protection,
  • A asset quality,
  • M management competence,
  • E earnings strength,
  • L liquidity risk and
  • S sensitivity to market risk.

All banks receive a rating of 1 (best) through 5 (worst) on each of these six aspects along with a composite rating. A composite CAMELS rating of 1 or 2 indicates that the supervisors consider a bank to be in satisfactory condition. Supervisors use a 3 rating for banks that exhibit some degree of concern in one or more areas; a rating of 4 or 5 indicates more serious problems.

While the CAMELS ratings assigned to individual banks are confidential, a comparison of CAMELS ratings across all banks over time may provide useful information about the condition of U.S. banks as a whole.

figuresFigure 1 illustrates one method of measuring banking industry condition: the percentage of banks rated as being in unsatisfactory condition. According to this measure, banking industry condition has worsened slightly since the mid-1990s for both large and small banks. This measure, however, remains much stronger in recent quarters than during the recession period of 1990-91.

Figure 1 has limitations as a method for measuring current condition. Given the timing of examinations, the percentages reflect the results of examinations conducted at various points in time during the prior 18 months. Additionally, the percentage of banks rated as being in unsatisfactory condition could change over time if the downgraded banks (CAMELS 3-5) recover to ratings of 1 or 2 either faster or more slowly than in the past.

Figure 2 illustrates another method of measuring banking industry condition: the percentage of banks rated 1 or 2 at the beginning of a quarter that were downgraded to 3-5 during examinations begun that same quarter. The denominator of the ratio equals the number of banks that entered the quarter rated 1 or 2 and were subject to examinations that began during the quarter. The numerator is the number of these banks that received ratings of 3, 4 or 5 on the examinations that began during the quarter. The percentages reflect the results of examinations conducted during each quarter.

Figures 1 and 2 illustrate different pictures of banking industry condition during recent quarters. Figure 1 indicates deterioration—a rising percentage of both large and small banks being rated less than satisfactory by supervisors during recent years. In contrast, figure 2 indicates that the examinations conducted since around the end of 2000 have resulted in relatively small percentages of banks being downgraded to unsatisfactory condition. Regardless, both Figures 1 and 2 suggest that the condition of the banking industry during recent quarters has been much stronger than during the 1990-91 recession.

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