How to balance and improve CAMELS ratings: Efficiency and transparency
As explained in a previous post, the CAMELS rating is a measure of a financial institution’s riskiness based on the bank’s financial statements. The rating includes an assessment of several, interrelated components within the financial institution so a change in one component can impact—sometimes negatively—a bank’s rating in another component. It can be a challenge to balance the competing areas of the rating during a bank examination.
A financial institution can prepare for its examination by injecting efficiency and transparency into its risk management process. If a financial institution seems to be proactive in both recognizing and appropriately mitigating the risks inherent in bank operations, then examiners will be less likely to view that bank as “at risk.”
Here are just a few questions that can help a financial institution improve efficiencies and provide additional transparency, which will help balance and facilitate the CAMELS analysis.
1. Risk Identification
Does the financial institution have commercial loan grades that are consistent with the institution’s loan policy?
Can the financial institution show evidence that the risk ratings are helping identify potential risk within the loan portfolio?
Can the financial institution provide thorough documentation during the exam?
2. Proper Analysis
Is the financial institution performing a comprehensive global cash flow analysis on its customers?
Can the financial institution demonstrate its ability to properly analyze loan applications in order to continue lending and therefore to maintain earnings capability?
Does the financial institution have a process in place to evaluate the profitability of each lending decision relative to its risk?
3. Document Management and Covenant Tracking
Does the financial institution’s data management track policy and covenant exceptions within its loan portfolio, thereby demonstrating the ability to react to problems accordingly?
Does the financial institution have a loan administration system that ensures consistent communication with loan customers?
Can the financial institution show examiners how its management can reduce write offs and eliminate potential problems within the portfolio?
Even if a financial institution can answer all these questions with a resounding “yes,” a perfect CAMELS rating still isn’t guaranteed. Nonetheless, for a positive exam experience, it’s critical that the bank is working to implement systems that improve asset quality, drive earnings, increase liquidity, and provide the bank with adequate capital.
