CAMELS Framework

CAMELS Framework

‘CAMELS’ is a framework for composite evaluation of banks (and financial intermediaries, in general). The acronym stands for:

• Capital Adequacy

This is a measure of financial strength, in particular its ability to cushion operational and abnormal losses. It is calculated based on the asset structure of the bank, and the risk weights that have been assigned by the regulater for each asset class.

•Asset Quality

This depends on factors such as concentration of loans in the portfolio, related party
exposure and provisions made for loan loss.

• Management

Management of the bank obviously influences the other parameters. Operating cost per unit of money lent and earnings per employee are parameters used.

• Earnings

This can be measured through ratios like return on assets, return on equity and interest spread.

• Liquidity

In order to meet obligations as they come, the bank needs an effective asset-liability
management system that balances gaps in the maturity profile of assets and liabilities. However, if the bank provides too much liquidity, then it will suffer in terms of profitability.
This can be measured by the Loans to Deposit ratio, separately for short term, mediumterm and long term.

• Sensitivity to Market Risk

Longer the maturity of debt investments, more prone it is to valuation losses, if interest rates go up. More sensitive the portfolio is to market risk, the more risky the bank is.
The CAMELS framework was first used by the regulaters in the United States. Based on this, they rated the banks on a scale of 5 – the strongest was rated as 1; the weakest was rated as 5.