MANAGERIAL ECONOMICS

Presented By:O Tiwari PriyankaO Juned ZatamO Javin KaithavalappilO Jacob Alexander

CAMEL APPROACH IN FINANCE

AND BANKING

INTRODUCTION

• The Camel ratings is a US supervisory rating of the bank’s overall condition.

• This rating is based on financial statements of the bank and on-site examination by regulators like the FED, and the Federal Deposit Insurance Corporation.

• This approach helps to evaluate banks with complete coverage of factors affecting banks creditworthiness.

• This methodology is now industry standard

• It came in India in early 1990’s

• In 1995, RBI had set up a working group

• A rating system for domestic and foreign banks based on the international CAMELS model was introduced

HISTORY• The Camel Rating system was adopted by NCUA

in October 1987.(National Credit Administration in October 1987).

• It is used as an internal tool to measure risk and allocate resources for supervision purposes.

• The last version of Camel Ratings System was published in Letter to Credit Unions No.161,dated December 1994.

Capital adequacyAsset qualityManagementEarningsLiquiditySensitivity to market

KEY COMPONENTS OF CAMEL RATING

The purpose of CAMELS ratings is to determine a bank’s overall condition and to identify its strengths and weaknesses:

FinancialOperationalManagerial

PURPOSE OFCAMEL RATING

WHY IT IS USED???

It is being used by the United States government in response to the global financial crisis of 2008 to help it decide which banks to provide special help for and which to not as part of its capitalization program authorized by the Emergency Economic Stabilization Act of 2008.

CAMEL COMPOSITE RATINGS

• Each bank is accorded a composite rating that is predicated upon the evaluation of the specific performances dimensions

• The composite rating is also based upon a scale of 1 through 5 in ascending order of supervisory concern.

• The Camels rating components have the following weights:

• Capital Adequacy 20%• Asset Quality 20%• Management 25%• Earnings 15%• Liquidity 10%• Sensitivity to market risk 10%

CAMEL RATINGS

• The scale is from 1 to 5 with 1 being strongest and 5 being the weakest.

• Banks with a rating of 1 are considered most stable; banks with a rating of 2 or 3 are considered average, and those with rating of 4 or 5 are considered below average, and are closely monitored to ensure their viability.

CAMEL NUMERICAL RATING

STRONG-indicative of performance that is significantly higher than average.

SATYSFACTORY- reflects performance that is average or above.

FAIR- represents performance that is flawed to some degree.

MARGINAL- reflects performance that is significantly at below average.

UNSATISFACTORY- indicative of performance that is critically deficient and in need of immediate remedial attention.

CAMEL’S RATINGS OF BANKS

CAPITALS RATING FACTOR

Capital adequacy is measured by the ratio of capital to risk weight assets.

A sound capital base strengths confidence of depositors:

• Nature and volume of assets in relation to total capital and adequacy.

• Balance Sheet structure including off balance sheet items.

• Nature of business activities and risks to the bank.

• Asset and capital growth experience and prospects.

• Earnings performance and distribution of dividends.

ASSETS QUALITY RATING

• Asset represents all the assets of the bank, current and fixed, loan portfolio, investments and real estate owned as well as off balance sheet transactions

• Volume of problem of all assets

• Volume of overdue or rescheduled loans

• Ability of management to administer all the assets of the bank

• Large concentrations of loans, diversification of investments

• Loan Portfolio management, written policies, procedures internal control,

• Growth of loans volume in relation to the bank’s capacity

MANAGEMENT RATING FACTOR

• Management includes all key managers and the Board of Directors:

• Quality of the monitoring and activities by the board and management

• Ability to understand and respond to the risk and to plan for the future

• Development and implementation of policies, procedures, risk monitoring system, compliance with laws and regulations.

• Availability of internal and external audit function

• Overall performance of the bank and its risk profile

EARNING’S RATINGFACTOR

• All income from operations, non-traditional sources, extraordinary items.

• It can be measured as the return on asset ratio.

Earnings are rated according to the following factors:

• Sufficient earnings to cover potential losses, provide adequate capital and pay reasonable dividends.

• Composition of net income. • Reliance on extraordinary items, securities transactions,

high risk activities.• Non traditional or operational sources

LIQUIDITY RATING FACTOR

• Cash maintained by the banks and balances with central bank, to total asset ratio is an indicator of bank's liquidity.

Liquidity is rated based on the following factors:

• Sources and volume of liquid funds available to meet short term obligations

• Volatility of deposits and loan demand.• Interest rates and maturities of assets and liabilities.• Access to money market and other sources of funds.• Reliance on inter-bank market for short term funding.• Management ability to plan, control and measure liquidity

process.

RATING FACTORS FOR SENSITIVITY TO MARKET RISK

Sensitivity to market risks is not taken into consideration by CBI.Market risk is based primarily on the following evaluation factors:-Sensitivity to adverse changes in interest rates, foreign exchange rates, commodity prices, fixed assets

• Nature of the operations of the bank• Trends in the foreign currencies exposure• Changes in the value of the fixed assets of the

bank• Importance of real estate assets resulting from

loans write off