30-11-2012, 03:53 PM
CAMELS APPROACH AND THE EVALUATION OF THE PERFORMANCE OF BANKS
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Introduction to The CAMELS Framework
There have been numerous banking reforms over the past couple of decades. All these have resulted in a much more enhanced form of banking regulation and supervision, though the results are not as they are expected to be, but over a period of time, they will be, as the implementation will start yielding results.
The purpose of The CAMELS framework is to assess a Bank’s over all condition and to identify its strengths and weaknesses. Covering the entire spectrum from financial, operational to managerial aspects of the bank’s business.
During an on-site bank examination, supervisors gather private information, such as details on difficult loans, with which to evaluate a bank's financial condition and to monitor its compliance with laws and regulatory policies. A key product of such an exam is a supervisory rating of the bank's overall condition, commonly referred to as a CAMELS rating.
The acronym "CAMELS" refers to the five components of a bank's condition that are assessed: Capital adequacy, Asset quality, Management Quality, Earnings Quality, and Liquidity. A sixth component, a bank's Sensitivity to Market Risk was added in 1997; hence the acronym was changed to CAMELS.
CAMELS is primarily a ratio-based model for evaluating the performance of banks.
Rating System
Each bank is assigned a uniform composite rating based on six parameters. It is a standardized procedure providing an assessment of the quality of the bank based on standard criteria.
When assigning a composite rating, some components may be given more weight than others depending on the situation at the bank. Composite ratings may include factors that have a significant bearing on overall condition and soundness.
Rating Provisions
Each element of the composite rating scale is assigned a numerical rating based on certain key components identified. These key components are mostly quantitative financial metrics that gauge the performance of the bank in terms of the element they represent. For example, under The Capital Adequacy Parameter a number of key quantitative performance metrics will be identified and a rating on the Capital Adequacy Parameter alone will be derived from the performance of the bank in these parameters. This process will be repeated for all six parameters and based on the individual parameter ratings and the weight assigned to each parameter based on the peculiar risk characteristics of the bank an overall composite rating will be assigned to the
bank.
METHODOLOGY
As a group we believe that we cannot do justice to this project by mere reading of research papers and available text on the CAMELS framework. Also, as students of finance it was our ardent desire to be creative and involve some numbers in our project to make it an interesting, value adding and creative experience for us. Our methodology for this project combines theory with practical application. We have attempted to immediately apply what we have learned from the study of the theoretical accounts of our project topic. Details of our project methodology are as follows:
1. Basic Understanding and Explanation of the concept We have gained a basic understanding of the concept through reading various published and non published sources on the topic. This has enabled us to obtain a firm grasp on the concepts related to the project. This enables us to better see and experience the link between practical application and theory.