The acronym “CAMEL” refers to the five components of a bank’s condition that are assessed: Capital adequacy, Asset quality, Management, Earnings, and Liquidity. A sixth component, a bank’s Sensitivity to market risk, was added in 1997; hence the acronym was changed to CAMELS. Ratings are assigned for each component in addition to the overall rating of a bank’s financial condition. The ratings are assigned on a scale from 1 to 5. Banks with ratings of 1 or 2 are considered to present few, if any, supervisory concerns, while banks with ratings of 3, 4, or 5 present moderate to extreme degrees of supervisory concern.
C- Capital Adequacy
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A-Assets Quality or Level of NPA
M- Management Effectiveness.
E- Earning or Profitability.
S- System and Controls.
Capital Adequacy: The capital adequacy measures the bank’s capacity to handle the losses and meet all its obligations towards the customers without ceasing its operations.This can be met only on the basis of an amount and the quality of capital, a bank can access. A ratio of Capital to Risk Weighted Assets determines the bank’s capital adequacy.
Asset Quality: An asset represents all the assets of the bank, Viz. Current and fixed, loans, investments, real estates and all the off-balance sheet transactions. Through this indicator, the performance of an asset can be evaluated. The ratio of Gross Non-Performing Loans to Gross Advances is one of the criteria to evaluate the effectiveness of credit decisions made by the bankers.
Management Quality: The board of directors and top-level managers are the key persons who are responsible for the successful functioning of the banking operations. Through this parameter, the effectiveness of the management is checked out such as, how well they respond to the changing market conditions, how well the duties and responsibilities are delegated, how well the compensation policies and job descriptions are designed, etc.
Earnings: Income from all the operations, non-traditional and extraordinary sources constitute the earnings of a bank. Through this parameter, the bank’s efficiency is checked with respect to its capital adequacy to cover all the potential losses and the ability to pay off the dividends.Return on Assets Ratio measures the earnings of the banks.
Liquidity: The bank’s ability to convert assets into cash is called as liquidity. The ratio of Cash maintained by Banks and Balance with the Central Bank to Total Assets determines the liquidity of the bank.
Sensitivity to Market Risk: Through this parameter, the bank’s sensitivity towards the changing market conditions is checked, i.e. how adverse changes in the interest rates, foreign exchange rates, commodity prices, fixed assets will affect the bank and its operations.