TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
Attached is an interagency document that provides common answers to
questions raised about the application of the recently revised Uniform Financial
Institutions Rating System, familiarly called CAMELS. The guidance seeks to facilitate
the consistent and uniform implementation of the rating system by examiners of each
of the supervisory agencies. It was prepared under the direction of the Federal
Financial Institutions Examination Council's Task Force on Supervision.
This guidance should be distributed to the chief executive officer of each
state member bank and to each state banking department in your district. A
suggested transmittal letter is attached. A copy should also be provided to each
supervisory official and examiner at your Reserve Bank.
If you have any questions regarding the guidance, please contact either
Connie Powell at (202/452-3506) or Kevin Bertsch at (202/452-5265).
Director
Cross-reference: SR 96-38, "Uniform Financial Institutions
Ratings System"
To the chief executive officer of each state member bank and bank holding
company or state banking department:
Attached is interagency guidance providing common answers to
questions raised about the application of the recently revised Uniform Financial
Institutions Rating System, familiarly called CAMELS. The guidance seeks to facilitate
the consistent and uniform implementation of the rating system by examiners of each
of the supervisory agencies and was prepared under the direction of the Federal
Financial Institutions Examination Council's Task Force on Supervision.
If you have any questions regarding this guidance, please contact
[Reserve Bank contact person].
OFFICE OF THE COMPTROLLER OF THE CURRENCY
OFFICE OF THRIFT SUPERVISION BOARD OF GOVERNORS OF THE FEDERAL RESERVE SYSTEM FEDERAL DEPOSIT INSURANCE CORPORATION
March 4, 1997
JOINT INTERAGENCY COMMON QUESTIONS AND ANSWERS
On March 4, 1997, the Task Force on Supervision of the Federal
Financial Institutions Examination Council approved the issuance of common
questions and answers about the recently revised Uniform Financial Institutions Rating
System. The Office of the Comptroller of the Currency (OCC), the Office of Thrift
Supervision (OTS), the Federal Reserve Board (FRB), and the Federal Deposit
Insurance Corporation (FDIC) collectively developed common responses to questions
asked to date by bankers and examiners regarding the revised rating system. The
responses were coordinated with the Conference of State Bank Supervisors. The
purpose of the questions and answers is to provide additional interagency guidance
and clarification regarding the revised rating system.
On December 9, 1996, the Federal Financial Institutions Examination
Council (FFIEC) adopted the revised Uniform Financial Institutions Rating System
(UFIRS or CAMELS rating system). The UFIRS is an internal rating system used by
the federal and state regulators for assessing the soundness of financial institutions on
a uniform basis and for identifying those insured institutions requiring special
supervisory attention. A final notice was published in the Federal Register on
December 19, 1996 (61 FR 67021), effective January 1, 1997.
The major changes to UFIRS include an increased emphasis on the
quality of risk management practices and the addition of a sixth component called
"Sensitivity to Market Risk." The updated rating system also reformats and clarifies
component rating descriptions and component rating definitions, revises composite
rating definitions to parallel the other changes in the rating system, and highlights risks
that may be considered in assigning component ratings.
The attached questions and answers are being distributed to bankers
and examiners to ensure consistent and uniform implementation of the revised rating
system.
UNIFORM FINANCIAL INSTITUTIONS RATING SYSTEM
The rating assigned to the S component should reflect a combined assessment of both
the level of market risk and the ability to manage market risk. Low market risk
sensitivity alone may not be sufficient to achieve a favorable S rating. Indeed,
institutions with low risk, but inadequate market risk management, may be subject to
unfavorable S ratings. Conversely, institutions with moderate levels of market risk and
the demonstrated ability to ensure that market risk is, and will remain, well controlled
may receive favorable S component ratings.
In assessing the level of market risk exposure and the risk management process in
place to control it, examiners will rely on existing supervisory guidance issued by their
respective agencies, including guidance issued on interest rate risk, investment,
financial derivatives, and trading activities.
In line with the general thrust of the agencies' various guidance on market risk, the
sophistication of an institution's risk management system is expected to be
commensurate with the complexity of its holdings and activities and appropriate to its
specific needs and circumstances. Institutions with relatively noncomplex holdings
and activities, and whose senior managers are actively involved in the details of daily
operations, may be able to rely on relatively basic and less formal risk management
systems. If the procedures for managing and controlling market risks are adequate,
communicated clearly, and well understood by all relevant parties, these basic
processes may, when combined with low to moderate levels of exposure, be sufficient
to receive a favorable rating for the S component.
Organizations with more complex holdings, activities and business structures may
require more elaborate and formal market risk management processes in order to
receive ratings of 1 or 2 for the S component.
The weight attributed to any individual component in determining the composite rating should vary depending on the degree of supervisory concern associated with the component. The composite rating does not assume a predetermined weight for each component and it does not represent an arithmetic average of assigned component ratings. As a result, for most institutions where market risk is not a significant issue, less weight should be placed on the S component in determining a composite rating than on other components.
For most small community banks or thrifts, sensitivity to market risk will primarily
reflect interest rate risk. Regardless of the size of an institution, the quality of risk
management systems must be commensurate with the nature and complexity of its
risk-taking activities, and management's ability to identify, measure, monitor and
control the risk. Evaluation of this component will be based on the degree to which
interest rate risk exposure can affect the institution's earnings and capital, and the
effectiveness of the institution's asset/liability or interest rate risk management system,
given its particular situation.
The rating assigned to the S component should reflect a combined assessment of both
the level of market risk and the ability to manage market risk. Accordingly, changes
in either quantitative or qualitative aspects of market risk exposure or management
may necessitate changes in the rating assigned to the S component. While changes in
the level of market risk between examinations may in some circumstances necessitate
a change in the rating assigned to the S component, this does not automatically imply
a rating change. For example, an institution that accepts additional market risk
between examinations, but maintains risk management processes and earnings and
capital levels commensurate with the level of risk, need not have its S rating changed.
The updated rating system incorporates examination considerations that were not
explicitly noted in the prior rating system. Under the prior rating system, examiners
considered market risk exposure and risk management practices when assigning
component and composite ratings. Consequently, examiners are not required to
perform any additional procedures, and institutions are not required to add to their
management procedures or practices, solely because of the updated rating system.
The revised rating system generally should not result in a change in the composite rating assigned to a particular bank or thrift simply because of the addition of the new component and the increased emphasis on risk management practices. The level of market risk has traditionally been taken into consideration when evaluating an institution's capital, earnings and liquidity. The quality of an institution's risk management practices has also traditionally been considered by examiners when assessing an institution's condition and assigning ratings, particularly in the Management component.
The CAMELS rating system assesses an institution's overall condition based on both
quantitative and qualitative elements. Quantitative data such as the level of classified
assets remain an integral part of that measurement. Qualitative elements, such as the
adequacy of board and senior management oversight, policies, risk management
practices, and management information systems are also central to the evaluation of
components. The relative importance given to the qualitative considerations for each
component depends on the circumstances particular to the institution. Risk
management systems should be appropriate for the nature and level of risks the
institution assumes. However, unacceptable risk levels or an unsatisfactory financial
condition will often outweigh other factors and result in an adverse component rating.
Peer data are an integral part of the evaluation process and, when available and
relevant, may be used in assigning a rating. However, peer data should be used in
conjunction with other pertinent evaluation factors and not relied upon in isolation
when assigning a rating.
No. Examiners have the flexibility to consider any other evaluation factors that, in
their judgment, relate to the component area under review. The evaluation factors
listed under a component area are not intended to be all-inclusive, but rather a list of
the more common factors considered under that component. Only those factors
believed relevant to fully support the rating being assigned by the examiner need be
addressed in the report and in discussions with senior management.
Each component is interrelated with one or more other components. For example, the
level of problem assets in an institution is a primary consideration in assigning an
asset quality component rating. But it is also an item that affects the capital and
earnings component ratings. The level of market risk and the quality of risk
management practices are elements that also can affect several components.
Examiners consider relevant factors and their interrelationship among components
when assigning ratings.
Market risk is evaluated primarily under the new S component and is only one of
several evaluation factors used to assess the earnings and capital components.
Whether the institution's exposure to market risk results in an unfavorable rating for
earnings or capital, however, is based on a careful analysis of the effect of this factor
in relation to the other factors considered under these components. The capital
component is evaluated based on the risk profile of an institution, including the effect
of market risk, and whether the level of capital supports those risks. The earnings
component evaluates the ability of earnings to support operations and maintain
adequate capital after considering factors, such as market risk exposure, that affect the
quantity, quality, and trend of earnings. The importance accorded to an evaluation
factor should thus depend on the situation at the institution.
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