Banking business is full of risk. This business is taking extra risk for making their own business. They received money as Fixed Deposit. With the help of that money, they will give loans to others. Risk is that what if the loans were not paid? What if Depositor come and ask for his money before time? What if there is not sufficient return on Loan book or other investments? It is a big risk for any bank. For taking care for all this, there is special type of rating which is helpful for banking. It is known as CAMELS rating.
- C means capital say Equity and Reserves. For doing business, every business need capital. Banks are also not exception for this rule. This capital is like cushion for bank. It help in absorbing the extra risk attached with the business. There are Basel norms for capital and how much it supposed to be like how much equity, how much Preferred capital, how much debentures etc. It decided in to 3 level. Tire I, II, III.
- A means asset quality. To whom bank is giving loans. Its a big issue. If bank started giving subprime loans, it will affect financial health of bank as The loans given are assets for bank. If they don’t perform as expected then it is big issue for bank. 2008 crisis is all about Subprime loans. Plus, today’s world is different. Giving loans is not only business of banks. There are banks which are doing many other business. Take an example of CityGroup. They are doing lot more than just banking. The same thing is with state Bank, Deutsch bank and so on. We called it Financial Supermarkets. If this business is not performing then it also affect to financial health of bank as there are certain costs related with every business.
- Management is the next criteria for it. If the management is good, the possibility of survival is higher. Perfect example is Vikram Pandit. During crisis in Citibank, he manage it and now the bank is in good position. This part is not only limited with inside. Head of central bank is also like bank management. Like Ben Bernanke. During crisis, he is the Right man at Right place. It helps whole banking and economy of US.
- E is earnings. As banking is also business, then earning is also important for banking. If the earning is not good, then in another terms, banking company is ready to liquidate itself. It is very bad for whole business world. As bank is not only giving loan, but doing lot many business like taking deposit. If it fails then it means Deposites and not coming to you. Plus most of the time, banking is like icon of your economy, if it fails, then overseas investors think bad about your economy. If affects in terms of employment generation.
- L means liquidity. Think of it this way. Bank collect money from one side and give as loan. If all of sudden depositor come or saving account holder come to it and ask for money, then what? Up to certain limit its possible but how to decide that what limit? The fact here is if bank have total fund worth say 500 mn then not all is available in liquidity. Some of them are there in form of intangible money. It come into existence as bank generate it through debt. It increase the risk further.
- S means sensitivity to market risk. This factor arises all because of today’s market driven economy. Banks are integral part of economy so it is impossible for them to intact themselves from bubbles in market economy. This not one single factor but combination of many. Like management play important role here. Assets quality if it’s good that bank is not that much at risk. If sufficient capital is there with bank then possible for bank survive even after bad windfall of profit. If liquidity is available or easy to liquidate some of your current assets then this bank is not at that much risk. If reserver is available to hedge this situation and if it is sufficient then bank will untouched with any bad situation. Banks will rate with this like rating 1, rating 2 etc Rating 1 is very high security. Rating 5 is worst.
Going to end this post with statement. If the banking system is strong then whole economy is intact for any Difficult situations.
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