Bank Rating - Explained
What is a Bank Rating?
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Table of ContentsWhat is a Bank Rating?How Does a Bank Rating Work?Bank Rating and Examples of CAMELS Criteria
What is a Bank Rating?
Bank Rating refers to a formula developed by the Federal Deposit Insurance Corporation (FDIC) to rate the safety and soundness of banks, thrifts, and other financial institutions. The Formula used for bank rating is CAMELS, an acronym that represents the capital of the bank, asset quality, management, earnings, liquidity, and sensitivity to risk. The bank rating uses a rating system on a scale of 1 to 5, the rating also used alphabetical ranking. If a bank or thrift institution has a rating of 1 to 2, it means the bank is sound.
How Does a Bank Rating Work?
Bank ratings or CAMELS ratings are not released to the public by FDIC, these ratings are high-class information not meant for public consumption. Also, it is not only the FDIC that rates financial institutions, there are other rating services for the safety and soundness of banks. If a financial institution gets a rating of 1 and 2, it means it is in a sound condition while 3 indicates an average condition. 4 to 5 rating on the CAMELS scale tells that the bank or financial institution has serious fundamental problems that need to be checked by regulatory bodies. A rating of 5 is rarely given, except in cases where the bank or financial institution is absolutely prone to fail or collapse in the nearest time.
Bank Rating and Examples of CAMELS Criteria
There are different rating services and agencies, each agency may give a rating different from others. While the common criteria used for reading banks and financial institutions is CAMELS, there are some other criteria used by other agencies. According to the CAMELS standard, there are clear cut criteria that must be considered when reading banks. There are six of them, they are:
- C - Bank's capital
- A - Asset quality
- M - Management
- E - Earnings
- L - Liquidity
- S - Sensitivity to risk.
All these criteria are important when rating a financial institution.