TO THE OFFICER IN CHARGE OF SUPERVISION AT EACH FEDERAL RESERVE BANK
On December 20, 1996, the Board adopted a revised Uniform
Financial Institutions Rating System (UFIRS), which was developed by the staffs of
the four banking agencies under the auspices of the Federal Financial Institutions
Examination Council (FFIEC). The FFIEC recommended on December 9, 1996, that
the agencies adopt the updated rating system. The revised UFIRS set forth in
Attachment 1 becomes effective January 1, 1997, and is to be used in
examinations of all commercial banks and thrifts commencing after that date.
The banking agencies originally adopted the UFIRS on the
recommendation of the FFIEC in 1979. This rating system has been known as
CAMEL, an acronym of the five components it evaluates: capital adequacy, asset
quality, management and administration, earnings, and liquidity. Over the years,
the UFIRS has proven to be an effective internal supervisory tool for evaluating the
soundness of financial institutions on a uniform basis and for identifying those
institutions requiring special attention or concern. Changes within the banking
industry, as well as in the banking agencies' supervisory policies and procedures,
prompted a review and revision of the 1979 rating system. Earlier this year, a
proposed revision to the UFIRS was issued for public comment and distributed to
examiners for field testing. The final revised UFIRS incorporates changes to the
proposed version suggested by commenters and examiners.
The revisions to the UFIRS reflect factors that, while not explicitly
addressed by the original rating system, have routinely been considered by
examiners in evaluating a bank's condition. Thus, the revisions should not
significantly affect the conduct of examinations, nor add to the regulatory burden
of examined institutions. The revised UFIRS retains the basic framework of the
original rating system and continues to take into consideration certain financial,
managerial and compliance factors that are common to all institutions.
A major revision has been the addition of a sixth component
addressing sensitivity to market risks; thus, the revised UFIRS will be referred to as
the CAMELS rating system. The new "S" component will focus on an institution's
ability to monitor and manage market risk and provide a clear indication of
supervisory concerns related to market risk. For most institutions, market risk
primarily reflects exposures to changes in interest rates. Examiners have long
considered a bank's exposure to market risk in assigning ratings, and so, the
introduction of the "S" component should not have a significant effect on
supervisory expectations for an institution's management of market risk, or the
composite rating.
Other major revisions to the UFIRS include the explicit reference to the
quality of risk management processes in the management component and the
identification of risk elements within the composite and component rating
descriptions. Examiners currently consider the quality of risk management
practices in evaluating a bank's condition. The need for institutions to have sound
risk management systems has intensified as the industry broadens the range of
financial products offered and accelerates the pace of transactions affecting market
risk. Accordingly, under the revised rating system, the descriptions accompanying
each component emphasize the need to reflect in the rating, management's ability
to identify, measure, monitor, and control risks. Evaluation of risk management
practices must take into account the size, complexity, and risk profile of a financial
institution. Thus, while less complex banks are not required to have elaborate and
highly formalized risk management systems in order to receive strong or
satisfactory component or composite ratings, they are expected to manage their
risks effectively.
In order to facilitate implementation of the CAMELS rating system, an
interagency working group has developed the attached new report pages for the
Interagency Bank Examination Report (see Attachment 2). These pages are to be
used by all of the banking agencies for examinations beginning after January 1,
1997. Additional guidance pertaining to the inclusion of individual component
ratings in examination reports can be found in SR 96-26, "Provision of Individual
Components of Supervisory Rating Systems to Management and Boards of
Directors."
Also attached is a suggested transmittal letter to be sent to all state
member banks in your District (see Attachment 3). The purpose of the letter is to
inform each bank of the effective date of the revised rating system and to assure
bank management that the revisions are not intended to add to the regulatory
burden of institutions and do not require additional policies or processes. The
revisions are primarily intended to promote and complement efficient examination
processes.
Should your staff have any questions, please have them contact Jack
Jennings (ext. 3053), Kevin Bertsch (ext. 5265), or Connie Powell (ext. 3506).
Deputy Director
UNIFORM FINANCIAL INSTITUTIONS1 RATING SYSTEM
Introduction
The Uniform Financial Institutions Rating System (UFIRS) was adopted by the
Federal Financial Institutions Examination Council (FFIEC) on November 13, 1979.
Over the years, the UFIRS has proven to be an effective internal supervisory tool
for evaluating the soundness of financial institutions on a uniform basis and for
identifying those institutions requiring special attention or concern. A number of
changes, however, have occurred in the banking industry and in the Federal
supervisory agencies' policies and procedures which have prompted a review and
revision of the 1979 rating system. The revisions to UFIRS include the addition of
a sixth component addressing sensitivity to market risks, the explicit reference to
the quality of risk management processes in the management component, and the
identification of risk elements within the composite and component rating
descriptions.
The revisions to UFIRS are not intended to add to the regulatory burden of
institutions nor require additional policies or processes. The revisions are intended
to promote and complement efficient examination processes. The revisions have
been made to update the rating system, while retaining the basic framework of the
original rating system.
The UFIRS takes into consideration certain financial, managerial, and compliance
factors that are common to all institutions. Under this system, the supervisory
agencies endeavor to ensure that all financial institutions are evaluated in a
comprehensive and uniform manner, and that supervisory attention is appropriately
focused on the financial institutions exhibiting financial and operational weaknesses
or adverse trends.
The UFIRS also serves as a useful vehicle for identifying problem or deteriorating
financial institutions, as well as for categorizing institutions with deficiencies in
particular component areas. Further, the rating system assists Congress in
following safety and soundness trends and in assessing the aggregate strength and
soundness of the financial industry. As such, the UFIRS assists the agencies in
fulfilling their collective mission of maintaining stability and public confidence in the
nation's financial system.
Overview
Under the UFIRS, each financial institution is assigned a composite rating based on
an evaluation and rating of six essential components of an institution's financial
condition and operations. These component factors address the adequacy of
capital, the quality of assets, the capability of management, the quality and level of
earnings, the adequacy of liquidity, and the sensitivity to market risk. Evaluations
of the components take into consideration the institution's size and sophistication,
the nature and complexity of its activities, and its risk profile.
Composite and component ratings are assigned based on a 1 to 5 numerical scale.
A 1 indicates the highest rating, strongest performance and risk management
practices, and least degree of supervisory concern, while a 5 indicates the lowest
rating, weakest performance, inadequate risk management practices and,
therefore, the highest degree of supervisory concern.
The composite rating generally bears a close relationship to the component ratings
assigned. However, the composite rating is not derived by computing an
arithmetic average of the component ratings. Each component rating is based on a
qualitative analysis of the factors comprising that component and its
interrelationship with the other components. When assigning a composite rating,
some components may be given more weight than others depending on the
situation at the institution. In general, assignment of a composite rating may
incorporate any factor that bears significantly on the overall condition and
soundness of the financial institution. Assigned composite and component ratings
are disclosed to the institution's board of directors and senior management.
The ability of management to respond to changing circumstances and to address
the risks that may arise from changing business conditions, or the initiation of new
activities or products, is an important factor in evaluating a financial institution's
overall risk profile and the level of supervisory attention warranted. For this
reason, the management component is given special consideration when assigning
a composite rating.
The ability of management to identify, measure, monitor, and control the risks of
its operations is also taken into account when assigning each component rating. It
is recognized, however, that appropriate management practices vary considerably
among financial institutions, depending on their size, complexity, and risk profile.
For less complex institutions engaged solely in traditional banking activities and
whose directors and senior managers, in their respective roles, are actively involved
in the oversight and management of day-to-day operations, relatively basic
management systems and controls may be adequate. At more complex
institutions, on the other hand, detailed and formal management systems and
controls are needed to address their broader range of financial activities and to
provide senior managers and directors, in their respective roles, with the
information they need to monitor and direct day-to-day activities. All institutions
are expected to properly manage their risks. For less complex institutions engaging
in less sophisticated risk taking activities, detailed or highly formalized management
systems and controls are not required to receive strong or satisfactory component
or composite ratings.
Foreign Branch and specialty examination findings and the ratings assigned to
those areas are taken into consideration, as appropriate, when assigning
component and composite ratings under UFIRS. The specialty examination areas
include: Compliance, Community Reinvestment, Government Security Dealers,
Information Systems, Municipal Security Dealers, Transfer Agent, and Trust.
The following two sections contain the composite rating definitions, and the
descriptions and definitions for the six component ratings.
COMPOSITE RATINGS
Composite ratings are based on a careful evaluation of an institution's managerial,
operational, financial, and compliance performance. The six key components used
to assess an institution's financial condition and operations are: capital adequacy,
asset quality, management capability, earnings quantity and quality, the adequacy
of liquidity, and sensitivity to market risk. The rating scale ranges from 1 to 5,
with a rating of 1 indicating: the strongest performance and risk management
practices relative to the institution's size, complexity, and risk profile; and the level
of least supervisory concern. A 5 rating indicates: the most critically deficient level
of performance; inadequate risk management practices relative to the institution's
size, complexity, and risk profile; and the greatest supervisory concern. The
composite ratings are defined as follows:
Composite 1
Financial institutions in this group are sound in every respect and generally have
components rated 1 or 2. Any weaknesses are minor and can be handled in a
routine manner by the board of directors and management. These financial
institutions are the most capable of withstanding the vagaries of business
conditions and are resistant to outside influences such as economic instability in
their trade area. These financial institutions are in substantial compliance with
laws and regulations. As a result, these financial institutions exhibit the strongest
performance and risk management practices relative to the institution's size,
complexity, and risk profile, and give no cause for supervisory concern.
Composite 2
Financial institutions in this group are fundamentally sound. For a financial
institution to receive this rating, generally no component rating should be more
severe than 3. Only moderate weaknesses are present and are well within the
board of directors' and management's capabilities and willingness to correct.
These financial institutions are stable and are capable of withstanding business
fluctuations. These financial institutions are in substantial compliance with laws
and regulations. Overall risk management practices are satisfactory relative to the
institution's size, complexity, and risk profile. There are no material supervisory
concerns and, as a result, the supervisory response is informal and limited.
Composite 3
Financial institutions in this group exhibit some degree of supervisory concern in
one or more of the component areas. These financial institutions exhibit a
combination of weaknesses that may range from moderate to severe; however, the
magnitude of the deficiencies generally will not cause a component to be rated
more severely than 4. Management may lack the ability or willingness to
effectively address weaknesses within appropriate time frames. Financial
institutions in this group generally are less capable of withstanding business
fluctuations and are more vulnerable to outside influences than those institutions
rated a composite 1 or 2. Additionally, these financial institutions may be in
significant noncompliance with laws and regulations. Risk management practices
may be less than satisfactory relative to the institution's size, complexity, and risk
profile. These financial institutions require more than normal supervision, which
may include formal or informal enforcement actions. Failure appears unlikely,
however, given the overall strength and financial capacity of these institutions.
Composite 4
Financial institutions in this group generally exhibit unsafe and unsound practices or
conditions. There are serious financial or managerial deficiencies that result in
unsatisfactory performance. The problems range from severe to critically deficient.
The weaknesses and problems are not being satisfactorily addressed or resolved by
the board of directors and management. Financial institutions in this group
generally are not capable of withstanding business fluctuations. There may be
significant noncompliance with laws and regulations. Risk management practices
are generally unacceptable relative to the institution's size, complexity, and risk
profile. Close supervisory attention is required, which means, in most cases,
formal enforcement action is necessary to address the problems. Institutions in
this group pose a risk to the deposit insurance fund. Failure is a distinct possibility
if the problems and weaknesses are not satisfactorily addressed and resolved.
Composite 5
Financial institutions in this group exhibit extremely unsafe and unsound practices
or conditions; exhibit a critically deficient performance; often contain inadequate
risk management practices relative to the institution's size, complexity, and risk
profile; and are of the greatest supervisory concern. The volume and severity of
problems are beyond management's ability or willingness to control or correct.
Immediate outside financial or other assistance is needed in order for the financial
institution to be viable. Ongoing supervisory attention is necessary. Institutions in
this group pose a significant risk to the deposit insurance fund and failure is highly
probable.
COMPONENT RATINGS
Each of the component rating descriptions is divided into three sections: an
introductory paragraph; a list of the principal evaluation factors that relate to that
component; and, a brief description of each numerical rating for that component.
Some of the evaluation factors are reiterated under one or more of the other
components to reinforce the interrelationship between components. The listing of
evaluation factors for each component rating is in no particular order of
importance.
Capital Adequacy
A financial institution is expected to maintain capital commensurate with the nature
and extent of risks to the institution and the ability of management to identify,
measure, monitor, and control these risks. The effect of credit, market, and other
risks on the institution's financial condition should be considered when evaluating
the adequacy of capital. The types and quantity of risk inherent in an institution's
activities will determine the extent to which it may be necessary to maintain capital
at levels above required regulatory minimums to properly reflect the potentially
adverse consequences that these risks may have on the institution's capital.
The capital adequacy of an institution is rated based upon, but not limited to, an
assessment of the following evaluation factors:
Ratings
Asset Quality
The asset quality rating reflects the quantity of existing and potential credit risk
associated with the loan and investment portfolios, other real estate owned, and
other assets, as well as off-balance sheet transactions. The ability of management
to identify, measure, monitor, and control credit risk is also reflected here. The
evaluation of asset quality should consider the adequacy of the allowance for loan
and lease losses and weigh the exposure to counterparty, issuer, or borrower
default under actual or implied contractual agreements. All other risks that may
affect the value or marketability of an institution's assets, including, but not limited
to, operating, market, reputation, strategic, or compliance risks should also be
considered.
The asset quality of a financial institution is rated based upon, but not limited to,
an assessment of the following evaluation factors:
Ratings
Management
The capability of the board of directors and management, in their respective roles,
to identify, measure, monitor, and control the risks of an institution's activities and
to ensure a financial institution's safe, sound, and efficient operation in compliance
with applicable laws and regulations is reflected in this rating. Generally, directors
need not be actively involved in day-to-day operations; however, they must provide
clear guidance regarding acceptable risk exposure levels and ensure that
appropriate policies, procedures, and practices have been established. Senior
management is responsible for developing and implementing policies, procedures,
and practices that translate the board's goals, objectives, and risk limits into
prudent operating standards.
Depending on the nature and scope of an institution's activities, management
practices may need to address some or all of the following risks: credit, market,
operating or transaction, reputation, strategic, compliance, legal, liquidity, and
other risks. Sound management practices are demonstrated by: active oversight by
the board of directors and management; competent personnel; adequate policies,
processes, and controls taking into consideration the size and sophistication of the
institution; maintenance of an appropriate audit program and internal control
environment; and effective risk monitoring and management information systems.
This rating should reflect the board's and management's ability as it applies to all
aspects of banking operations as well as other financial service activities in which
the institution is involved.
The capability and performance of management and the board of directors is rated
based upon, but not limited to, an assessment of the following evaluation factors:
Ratings
Earnings
This rating reflects not only the quantity and trend of earnings, but also factors
that may affect the sustainability or quality of earnings. The quantity as well as
the quality of earnings can be affected by excessive or inadequately managed
credit risk that may result in loan losses and require additions to the allowance for
loan and lease losses, or by high levels of market risk that may unduly expose an
institution's earnings to volatility in interest rates. The quality of earnings may also
be diminished by undue reliance on extraordinary gains, nonrecurring events, or
favorable tax effects. Future earnings may be adversely affected by an inability to
forecast or control funding and operating expenses, improperly executed or ill-advised business strategies, or poorly managed or uncontrolled exposure to other
risks.
The rating of an institution's earnings is based upon, but not limited to, an
assessment of the following evaluation factors:
Ratings
Liquidity
In evaluating the adequacy of a financial institution's liquidity position,
consideration should be given to the current level and prospective sources of
liquidity compared to funding needs, as well as to the adequacy of funds
management practices relative to the institution's size, complexity, and risk profile.
In general, funds management practices should ensure that an institution is able to
maintain a level of liquidity sufficient to meet its financial obligations in a timely
manner and to fulfill the legitimate banking needs of its community. Practices
should reflect the ability of the institution to manage unplanned changes in funding
sources, as well as react to changes in market conditions that affect the ability to
quickly liquidate assets with minimal loss. In addition, funds management
practices should ensure that liquidity is not maintained at a high cost, or through
undue reliance on funding sources that may not be available in times of financial
stress or adverse changes in market conditions.
Liquidity is rated based upon, but not limited to, an assessment of the following
evaluation factors:
Ratings
The sensitivity to market risk component reflects the degree to which changes in
interest rates, foreign exchange rates, commodity prices, or equity prices can
adversely affect a financial institution's earnings or economic capital. When
evaluating this component, consideration should be given to: management's ability
to identify, measure, monitor, and control market risk; the institution's size; the
nature and complexity of its activities; and the adequacy of its capital and earnings
in relation to its level of market risk exposure.
For many institutions, the primary source of market risk arises from nontrading
positions and their sensitivity to changes in interest rates. In some larger
institutions, foreign operations can be a significant source of market risk. For some
institutions, trading activities are a major source of market risk.
Market risk is rated based upon, but not limited to, an assessment of the following
evaluation factors:
Ratings
CAPITAL ADEQUACY Capital adequacy is evaluated in relation to supervisory guidelines, the nature and extent of risks to the organization, and the ability of management to address these risks; consideration is given to the level and quality of capital and overall financial condition of the bank; the nature, trend and volume of problem assets and the adequacy of the allowance for loan and lease losses and other valuation reserves; risk exposures presented by off-balance sheet activities; quality and strength of earnings; balance sheet composition, including the nature and amount of intangible assets, market risk, concentration risk, and nontraditional activity risk; growth experiences, plans, and prospects; reasonableness of dividends; access to capital markets and other appropriate sources of financial assistance; and ability of management to address emerging needs for additional capital. Component Rating X
ASSET QUALITY Asset quality is evaluated in relation to the level, distribution, severity, and trend of problem, classified, delinquent, nonaccrual, nonperforming, and restructured assets, both on- and off-balance sheet; the adequacy of the allowance for loan and lease losses and other valuation reserves; demonstrated ability to identify, administer and collect problem assets; the diversification and quality of loan and investment portfolios; adequacy of loan and investment policies, procedures, and practices; extent of securities underwriting activities and exposure to counterparties in trading activities; credit risk arising from or reduced by off-balance sheet transactions; asset concentrations; volume and nature of documentation exceptions; effectiveness of credit administration procedures, underwriting standards, risk identification practices, controls, and management information systems. Component Rating X
MANAGEMENT/ADMINISTRATION Management and the board of directors are evaluated against all factors necessary to operate the institution in a safe and sound manner and their ability to identify, measure, monitor, and control the risks of the institution's activities. Consideration is given to level and quality of oversight and support provided by management and the board; compliance with regulations and statutes; ability to plan for and respond to risks that may arise from changing business conditions or initiation of new products or services; accuracy, timeliness, and effectiveness of management information and risk monitoring systems; adequacy of and compliance with internal policies and controls; adequacy of audit and internal control systems; responsiveness to recommendations from auditors and supervisory authorities; reasonableness of compensation policies and avoidance of self-dealing; demonstrated understanding and willingness to serve the legitimate banking needs of the community; management depth and succession; the extent that management is affected by or susceptible to dominant influence or concentration of authority; and the overall performance of the institution and its risk profile. Component Rating X
EARNINGS Quality and quantity of earnings are evaluated in relation to the ability to provide for adequate capital through retained earnings; level, trend, and stability of earnings; quality and sources of earnings; level of expenses in relation to operations; vulnerability of earnings to market risk exposures; adequacy of provisions to the allowance for loan and lease losses and other valuation reserves; reliance on unusual or nonrecurring gains or losses; the contribution of extraordinary items, securities transactions, and tax effects to net income; and adequacy of budgeting systems, forecasting processes, and management information systems. Component Rating X
LIQUIDITY -- ASSET/LIABILITY MANAGEMENT Liquidity and asset/liability management is evaluated in relation to the trend and stability of deposits; the degree and reliance on short-term, volatile sources of funds, including any undue reliance on borrowings or brokered deposits, to fund longer term assets; availability of assets readily convertible to cash without undue loss; availability to securitize and sell certain pools of assets; access to money markets and other sources of funding; the adequacy of liquidity sources and ability to meet liquidity needs; the effectiveness of liquidity policies and practices, funds management strategies, management information systems, and contingency funding plans; capability of management to properly identify, measure, monitor, and control liquidity; and the level of diversification of funding sources, both on- and off-balance sheet. Component Rating X
SENSITIVITY TO MARKET RISK Sensitivity to market risk reflects: the degree to which changes in interest rates, foreign exchange rates, commodity prices, or equity prices can adversely affect earnings or the economic value of capital; the ability of management to identify, measure, monitor, and control exposures to market risk given the bank's size, complexity, and risk profile; the nature and complexity of interest rate risk exposure arising from nontrading positions; and, where appropriate, the nature and complexity of interest rate risk arising from trading and foreign operations. Component Rating X
Attachment 3
Since 1979, state member banks have been rated using the interagency Uniform Financial
Institutions Rating System (UFIRS), which was recommended by the Federal Financial Institutions
Examination Council (FFIEC) and adopted by the Federal Reserve and the other banking agencies.
This rating system has been known as CAMEL, an acronym of the five components it evaluates:
capital adequacy, asset quality, management and administration, earnings, and liquidity. The
UFIRS was recently revised and updated to address changes in the financial services industry and in
supervisory policies and procedures since 1979. The revised UFIRS is to be used in examinations of
all commercial banks and thrifts commencing after January 1, 1997.
The revisions to the UFIRS reflect factors that, while not explicitly addressed by the
original rating system, have been routinely considered by examiners in evaluating a bank's condition.
Thus, the revisions should not have a significant effect on the conduct of examinations, nor add to
the regulatory burden of examined institutions. Earlier this year, a proposed revision to the UFIRS
was issued for public comment and distributed to examiners for field testing. The final revised
UFIRS incorporates changes to the proposed version suggested by commenters and examiners.
The major revisions to the UFIRS are an increased emphasis on risk management
processes and the introduction of a sixth component to evaluate an institution's sensitivity to market
risk. To reflect the addition of this new component, the revised rating system will be referred to as
CAMELS. The revised rating system also clarifies component rating descriptions and rating
definitions, identifies risks considered in assigning component ratings, and revises composite rating
definitions.
The new "S" component will focus on an institution's ability to monitor and manage
market risk and provide a clear indication of supervisory concerns related to market risk. For most
institutions, market risk primarily reflects exposures to changes in interest rates. Given that
examiners already consider a bank's exposure to market risk in assigning ratings, supervisory
expectations for an institution's management of market risk remain unchanged. Accordingly, the
addition of the new component is not expected to result in a change to the composite rating assigned
to an institution.
Examiners currently consider the quality of risk management practices in evaluating a
bank's condition. The need for institutions to have sound risk management systems has intensified as
the industry broadens the range of financial products they offer and accelerates the pace of
transactions. Accordingly, under the revised rating system, the descriptions accompanying each
component emphasize the need to reflect in the rating, management's ability to identify, measure,
monitor and control risks. Evaluation of risk management practices must take into account the size,
complexity, and risk profile of a financial institution. Thus, while less complex banks are not
required to have elaborate and highly formalized risk management systems in order to receive strong
or satisfactory component or composite ratings, they are expected to manage their risks effectively.
A copy of the revised rating system is enclosed for your bank management and directorate.
Any questions your bank may have on UFIRS should be directed to , , at the
Reserve Bank.
Enclosure
Footnotes 1. For purposes of this rating system, the term "financial institution" refers to those insured depository institutions whose primary Federal supervisory agency is represented on the Federal Financial Institutions Examination Council (FFIEC). The agencies comprising the FFIEC are the Board of Governors of the Federal Reserve System, the Federal Deposit Insurance Corporation, the National Credit Union Administration, the Office of the Comptroller of the Currency, and the Office of Thrift Supervision. The term "financial institution" includes Federally supervised commercial banks, savings and loan associations, mutual savings banks and credit unions. Return to text |
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