The ratings are assigned based on a ratio analysis of the financial statements, combined with on-site examinations made by a designated supervisory regulator.
The system became internationally known with the abbreviation CAMEL, reflecting five assessment areas: capital, asset quality, management, earnings and liquidity.
The rating system is designed to take into account and reflect all significant financial and operational factors examiners assess in their evaluation of an institutions performance.
Both historical and projected key performance measures should generally be positive with any exceptions being those that do not directly affect safe and sound operations.
Banks and credit unions in this group are stable and able to withstand business fluctuations quite well; however, minor areas of weakness may be present which could develop into conditions of greater concern.
The supervisory response is limited to the extent that minor adjustments are resolved in the normal course of business and that operations continue to be satisfactory.
Both historical and projected key performance measures may generally be flat or negative to the extent that safe and sound operations may be adversely affected.
Banks and credit unions in this group are only nominally resistant to the onset of adverse business conditions and could easily deteriorate if concerted action is not effective in correcting certain identifiable areas of weakness.
Banks and credit unions in this group have a high probability of failure and will likely require liquidation and the payoff of shareholders, or some other form of emergency assistance, merger, or acquisition.
Determining the adequacy of a credit union's capital begins with a qualitative evaluation of critical variables that directly bear on the institution's overall financial condition.
Further, there should be no significant asset quality problems, earnings deficiencies, or exposure to credit or interest-rate risk that could negatively affect capital.
This includes loans, investments, other real estate owned (ORE0s), and any other assets that could adversely impact a credit union's financial condition.
Rating 5 indicates that the credit union's viability has deteriorated due to the corrosive effect of its asset problems on its earnings and level of capital.
Management is the most forward-looking indicator of condition and a key determinant of whether a credit union possesses the ability to correctly diagnose and respond to financial stress.
Prompt corrective action may require the development of a net worth restoration plan ("NWRP") in the event the credit union becomes less than adequately capitalized.
They are responsive to changing economic conditions and other concerns and are able to cope successfully with existing and foreseeable problems that may arise in the conduct of the credit union's operation.
The continued viability of a credit union depends on its ability to earn an appropriate return on its assets which enables the institution to fund expansion, remain competitive, and replenish and/or increase capital.
A 3 rating should be accorded if current and projected earnings are not fully sufficient to provide for the absorption of losses and the formation of capital to meet and maintain compliance with regulatory requirements.
Examiners review (a) interest rate risk sensitivity and exposure; (b) reliance on short-term, volatile sources of funds, including any undue reliance on borrowings; (c) availability of assets readily convertible into cash; and (d) technical competence relative to ALM, including the management of interest rate risk, cash flow, and liquidity, with a particular emphasis on assuring that the potential for loss in the activities is not excessive relative to its capital.
Interest-rate risk is evaluated principally in terms of the sensitivity and exposure of the value of the credit union's investment and loan portfolios to changes in interest rates.
In appraising ALM, attention should be directed to the credit union's liability funding costs relative to its yield on assets and its market environment.
These policies should outline individual responsibilities, the credit union's risk tolerance, and ensure timely monitoring and reporting to the decision-makers.
Liquidity is evaluated on the basis of the credit union's ability to meet its present and anticipated cash flow needs, such as, funding loan demand, share withdrawals, and the payment of liabilities and expenses.
These policies should outline individual responsibilities, the credit union's risk tolerance, and ensure timely monitoring and reporting to the decision makers.
Examiners will have regulatory concern if one or more of the following circumstances exist: A rating of 1 indicates that the credit union exhibits only modest exposure to balance sheet risk.
A rating of 3 may also indicate the credit union is not meeting its self-imposed risk limits or is not taking timely action to bring performance back into compliance.
Unlike classic ratio analysis, which most of CAMELS system was based on, which relies on relatively certain, historical, audited financial statements, this forward look approach involved examining various hypothetical future price and rate scenarios and then modelling their effects.
In June 1996 a Joint Agency Policy Statement was issued by the OCC, Treasury, Fed and FDIC defining interest rate risk as the exposure of a bank's financial condition to adverse movements in interest rates resulting from the following:[5] The CAMELS system failed to provide early detection and prevention of the financial crisis of 2007–2008.
These are the employees of the Division of Supervision and Consumer Protection (DSC) who visit the banks, apply the official guidelines to practical situations, make assessments, and assign the CAMELS ratings on behalf of the FDIC.
What began as an assessment of interest rate and farm commodity price risk exposures has grown exponentially over time.