Originally CAMEL method was devised as a supervision tool. Regulators assess the financial condition of banks through on-site and off-site surveillance. They rely on two analytical tools for off-site surveillance: supervisory screens and econometric models. Supervisory screens are combinations of financial ratios, derived from bank balance sheets and income
statements that have in the past given forewarning of safety and soundness problems. Econometric models use sets of variables from banks’ financial statements and economic environment to compute the probability that a bank will fail in a future period. In both methods, relevant variables have to be identified. In 1979, the bank regulatory agencies created the uniform financial
institution rating system (UFIRS). Under the original UFIRS, a bank was assigned rating based on performance in five areas: Capital adequacy (C), Assets quality (A), Management quality (M), Earning capacity (E) and Liquidity risk (L). Bank supervisors assigned a 1 through 5 rating for each of these components to form a composite rating for the bank. This 1 through 5 composite rating was known by the acronym CAMEL. The UFIRS was revised at the end of 1996 and CAMEL became CAMELS with the addition of a component grade for the sensitivity to market risk. CAMEL(s) thus provides a
measurement of a bank’s current overall financial, managerial, and operational and compliance performance. It is supposed to allow regulators to identify ailing banks, before failure happens and take corrective actions. Although CAMEL was initially devised for the American banking system, similar methodologies have been developed by various supervision authorities. |
