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Camels Rating System in Bangladesh

Essay by   •  August 11, 2011  •  Case Study  •  2,886 Words (12 Pages)  •  4,071 Views

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Overview

During an on-site bank exam, supervisors gather private information, such as details on problem 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.

CAMELS Rating System:

CAMELS is an international bank-rating system with which bank supervisory authorities rate institutions according to six factors. The six areas examined are represented by the acronym "CAMELS."

The six factors examined are as follows:

C - Capital Adequacy

A - Asset Quality

M - Management Efficiency

E - Earnings Record

L - Liquidity Position

S - Sensitivity to Market Risk

Soundness of a bank measured on a scale of 1 (strongest) to 5 (weakest). Bank examiners (trained and employed by the country's central bank) award these ratings on the basis of the adequacy and quality of a bank's Capital, Assets (loans and investments), Management, Earnings, Liquidity, and Sensitivity (to systemic-risk). Banks with a rating of 1 are considered most stable; banks with a rating of 2 or 3 are considered average, and those with rating of 4 or 5 are considered below average, and are closely monitored to ensure their viability. These ratings are disclosed only to the bank's management and not to other banks or the general public. CAMELS rating is an advanced version of the older "MACRO rating".

Banking Sector of Bangladesh and CAMELS Rating:

A total of 48 scheduled commercial banks including 9 foreign banks have been operating business in Bangladesh through 6,562 Branches. Out of total business 56.5% handled by private commercial banks (PCBs) and rest 43.5% dealt by nationalized commercial banks (NCBs).

The total operations of every bank were assessed according to six fixed criteria [As the sensitivity of market risk added in July 01, 2006 in Bangladesh banking sector, there is no data (published) available. Before that time the total operations of every bank were assessed according to five fixed criteria - CAMEL].

1. Capital Adequacy:

Capital adequacy focuses on the total position of bank capital and protects the depositors from the potential shocks of losses that a bank might incur. It helps absorbing major financial risks (like credit risk, market risk, foreign exchange risk, interest rate risk and risk involved in off-balance sheet operations). It is measured by following ratios:-

 Capital Adequacy Ratio CAR

* Formula: .

Where risk can either be weighted assets ( ) or the respective national regulator's minimum total capital requirement. If using risk weighted assets, .

It should be 10%, a common requirement for regulators conforming to the Basel Accords. Two types of capital are measured: tier one capital (T1 above), which can absorb losses without a bank being required to cease trading, and tier two capital (T2 above), which can absorb losses in the event of a winding-up and so provides a lesser degree of protection to depositors.

* Purpose: To determine the capacity of the bank in terms of meeting the time liabilities and other risk such as credit risk, operational risk, etc.

* Definition: Also called Capital to Risk (Weighted) Assets Ratio (CRAR) is a ratio of a bank's capital to its risk.

 Capital to Assets Ratio

* Formula: Capital/Total performing assets

* Purpose: Shows overall capital sufficiency

* Definition: Capital - net worth (Assets-Liabilities). Includes equity or equity equivalent instruments including retained earnings and subordinated debt. Does not include donations and grants.

 Debt to Asset Ratio

* Formula: Total liabilities/Total performing assets

* Purpose: Indicates provisioning requirements on loan portfolio for current period.

* Definition: Loan loss provision - allocation in current period to the loan loss reserve.

Banks in Bangladesh have to maintain a minimum CAR of not less than 9.0 percent of their risk-weighted assets (with at least 4.5 percent in core capital) or Taka 1.0 billion whichever is higher. It is also the coverage of financial debacles like loan loss, share market loss, foreign currency dealing loss, interest rate fluctuation loss and the protection for off balance sheet affairs hit. At present, capital adequacy requirement of the banking sector in Bangladesh is based on Basel-I accord. Bangladesh has decided in principle to adopt the new capital adequacy framework finalized by the Basel Committee on Banking Supervision (BCBS) known as Basel-II.

2. Asset Quality:

A total of 60.7% assets of banking sector were used as loans and advances. The high concentration of loans and advances indicates vulnerability of assets to credit risk, especially since the portion of non-performing assets is significant. A huge infected loan portfolio has been the major predicament of banks particularly of the state owned banks. In the total assets, the share of loans and advances is followed by the investment in government bills and bonds covering 11.0 percent.

 Loan Loss Provision Ratio

* Formula: Loan loss provision/average performing assets

* Purpose: Indicates provisioning requirements on loan portfolio for current period

* Definition: Loan Loss Provision - Allocation in current period to the loan loss reserve.

 Portfolio in Arrears

* Formula: Balance of loans in arrears/value of loans outstanding

* Purpose: Measures amount of default in portfolio

* Definition: Arrears - past due; typically calculated in the basis of the loan advance.

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