Seal of the Board of Governors of the Federal Reserve System
BOARD OF GOVERNORS
OF THE
FEDERAL RESERVE SYSTEM

WASHINGTON, D. C.  20551

DIVISION OF BANKING
SUPERVISION AND REGULATION


SR 96-38 (SUP)
December 27, 1996

TO THE OFFICER IN CHARGE OF SUPERVISION
          AT EACH FEDERAL RESERVE BANK


SUBJECT: Uniform Financial Institutions Rating System

                        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).


Stephen C. Schemering
Deputy Director


Supersedes: SR 80-583, "Uniform Financial Institutions Rating System"
S-2371; May 12, 1978

Partially supersedes: SR 93-71, "Final Commercial Bank Examination Manual Instruction for the Interagency Bank Examination Report"

Cross-References: AD 96-47, "Field Testing of Proposed Uniform Financial Institutions Rating System"
SR 96-26, "Provision of Individual Components of Supervisory Rating Systems to Management and Boards of Directors"


ATTACHMENTS TRANSMITTED ELECTRONICALLY BELOW


Attachment 1

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:

  • The level and quality of capital and the overall financial condition of the institution.  

  • The ability of management to address emerging needs for additional capital.

  • The nature, trend, and volume of problem assets, and the adequacy of allowances for loan and lease losses and other valuation reserves.

  • Balance sheet composition, including the nature and amount of intangible assets, market risk, concentration risk, and risks associated with nontraditional activities.

  • Risk exposure represented by off-balance sheet activities.

  • The quality and strength of earnings, and the reasonableness of dividends.

  • Prospects and plans for growth, as well as past experience in managing growth.

  • Access to capital markets and other sources of capital, including support provided by a parent holding company.

Ratings

1 A rating of 1 indicates a strong capital level relative to the institution's risk profile.

2 A rating of 2 indicates a satisfactory capital level relative to the financial institution's risk profile.

3 A rating of 3 indicates a less than satisfactory level of capital that does not fully support the institution's risk profile.  The rating indicates a need for improvement, even if the institution's capital level exceeds minimum regulatory and statutory requirements.

4 A rating of 4 indicates a deficient level of capital.  In light of the institution's risk profile, viability of the institution may be threatened.  Assistance from shareholders or other external sources of financial support may be required.

5 A rating of 5 indicates a critically deficient level of capital such that the institution's viability is threatened.  Immediate assistance from shareholders or other external sources of financial support is required.

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:

  • The adequacy of underwriting standards, soundness of credit administration practices, and appropriateness of risk identification practices.

  • The level, distribution, severity, and trend of problem, classified, nonaccrual, restructured, delinquent, and nonperforming assets for both on- and off-balance sheet transactions.

  • The adequacy of the allowance for loan and lease losses and other asset valuation reserves.

  • The credit risk arising from or reduced by off-balance sheet transactions, such as unfunded commitments, credit derivatives, commercial and standby letters of credit, and lines of credit.

  • The diversification and quality of the loan and investment portfolios.

  • The extent of securities underwriting activities and exposure to counterparties in trading activities.

  • The existence of asset concentrations.

  • The adequacy of loan and investment policies, procedures, and practices.

  • The ability of management to properly administer its assets, including the timely identification and collection of problem assets.

  • The adequacy of internal controls and management information systems.

  • The volume and nature of credit documentation exceptions.

Ratings

1 A rating of 1 indicates strong asset quality and credit administration practices.  Identified weaknesses are minor in nature and risk exposure is modest in relation to capital protection and management's abilities.  Asset quality in such institutions is of minimal supervisory concern.

2 A rating of 2 indicates satisfactory asset quality and credit administration practices.  The level and severity of classifications and other weaknesses warrant a limited level of supervisory attention.  Risk exposure is commensurate with capital protection and management's abilities.

3 A rating of 3 is assigned when asset quality or credit administration practices are less than satisfactory.  Trends may be stable or indicate deterioration in asset quality or an increase in risk exposure.  The level and severity of classified assets, other weaknesses, and risks require an elevated level of supervisory concern.  There is generally a need to improve credit administration and risk management practices.

4 A rating of 4 is assigned to financial institutions with deficient asset quality or credit administration practices.  The levels of risk and problem assets are significant, inadequately controlled, and subject the financial institution to potential losses that, if left unchecked, may threaten its viability.

5 A rating of 5 represents critically deficient asset quality or credit administration practices that present an imminent threat to the institution's viability.

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:

  • The level and quality of oversight and support of all institution activities by the board of directors and management.

  • The ability of the board of directors and management, in their respective roles, to plan for, and respond to, risks that may arise from changing business conditions or the initiation of new activities or products.

  • The adequacy of, and conformance with, appropriate internal policies and controls addressing the operations and risks of significant activities.

  • The accuracy, timeliness, and effectiveness of management information and risk monitoring systems appropriate for the institution's size, complexity, and risk profile.

  • The adequacy of audits and internal controls to: promote effective operations and reliable financial and regulatory reporting; safeguard assets; and ensure compliance with laws, regulations, and internal policies.

  • Compliance with laws and regulations.

  • Responsiveness to recommendations from auditors and supervisory authorities.

  • Management depth and succession.

  • The extent that the board of directors and management is affected by, or susceptible to, dominant influence or concentration of authority.

  • Reasonableness of compensation policies and avoidance of self-dealing.

  • Demonstrated willingness to serve the legitimate banking needs of the community.

  • The overall performance of the institution and its risk profile.

Ratings

1 A rating of 1 indicates strong performance by management and the board of directors and strong risk management practices relative to the institution's size, complexity, and risk profile.  All significant risks are consistently and effectively identified, measured, monitored, and controlled.  Management and the board have demonstrated the ability to promptly and successfully address existing and potential problems and risks.

2 A rating of 2 indicates satisfactory management and board performance and risk management practices relative to the institution's size, complexity, and risk profile.  Minor weaknesses may exist, but are not material to the safety and soundness of the institution and are being addressed.  In general, significant risks and problems are effectively identified, measured, monitored, and controlled.

3 A rating of 3 indicates management and board performance that need improvement or risk management practices that are less than satisfactory given the nature of the institution's activities.  The capabilities of management or the board of directors may be insufficient for the type, size, or condition of the institution.  Problems and significant risks may be inadequately identified, measured, monitored, or controlled.

4 A rating of 4 indicates deficient management and board performance or risk management practices that are inadequate considering the nature of an institution's activities.  The level of problems and risk exposure is excessive. Problems and significant risks are inadequately identified, measured, monitored, or controlled and require immediate action by the board and management to preserve the soundness of the institution.  Replacing or strengthening management or the board may be necessary.

5 A rating of 5 indicates critically deficient management and board performance or risk management practices.  Management and the board of directors have not demonstrated the ability to correct problems and implement appropriate risk management practices.  Problems and significant risks are inadequately identified, measured, monitored, or controlled and now threaten the continued viability of the institution.  Replacing or strengthening management or the board of directors is necessary.

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:

  • The level of earnings, including trends and stability.
  • The ability to provide for adequate capital through retained earnings.
  • The quality and sources of earnings.
  • The level of expenses in relation to operations.
  • The adequacy of the budgeting systems, forecasting processes, and management information systems in general.
  • The adequacy of provisions to maintain the allowance for loan and lease losses and other valuation allowance accounts.
  • The earnings exposure to market risk such as interest rate, foreign exchange, and price risks.

Ratings

1 A rating of 1 indicates earnings that are strong.  Earnings are more than sufficient to support operations and maintain adequate capital and allowance levels after consideration is given to asset quality, growth, and other factors affecting the quality, quantity, and trend of earnings.

2 A rating of 2 indicates earnings that are satisfactory.  Earnings are sufficient to support operations and maintain adequate capital and allowance levels after consideration is given to asset quality, growth, and other factors affecting the quality, quantity, and trend of earnings.  Earnings that are relatively static, or even experiencing a slight decline, may receive a 2 rating provided the institution's level of earnings is adequate in view of the assessment factors listed above.

3 A rating of 3 indicates earnings that need to be improved.  Earnings may not fully support operations and provide for the accretion of capital and allowance levels in relation to the institution's overall condition, growth, and other factors affecting the quality, quantity, and trend of earnings.

4 A rating of 4 indicates earnings that are deficient.  Earnings are insufficient to support operations and maintain appropriate capital and allowance levels. Institutions so rated may be characterized by erratic luctuations in net income or net interest margin, the development of significant negative trends, nominal or unsustainable earnings, intermittent losses, or a substantive drop in earnings from the previous years.

5 A rating of 5 indicates earnings that are critically deficient.  A financial institution with earnings rated 5 is experiencing losses that represent a distinct threat to its viability through the erosion of capital.

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:

  • The adequacy of liquidity sources compared to present and future needs and the ability of the institution to meet liquidity needs without adversely affecting its operations or condition.

  • The availability of assets readily convertible to cash without undue loss.

  • Access to money markets and other sources of funding.

  • The level of diversification of funding sources, both on- and off-balance sheet.

  • The degree of reliance on short-term, volatile sources of funds, including borrowings and brokered deposits, to fund longer term assets.

  • The trend and stability of deposits.

  • The ability to securitize and sell certain pools of assets.

  • The capability of management to properly identify, measure, monitor, and control the institution's liquidity position, including the effectiveness of funds management strategies, liquidity policies, management information systems, and contingency funding plans.

Ratings

1 A rating of 1 indicates strong liquidity levels and well-developed funds management practices.  The institution has reliable access to sufficient sources of funds on favorable terms to meet present and anticipated liquidity needs.  

2 A rating of 2 indicates satisfactory liquidity levels and funds management practices.  The institution has access to sufficient sources of funds on acceptable terms to meet present and anticipated liquidity needs.  Modest weaknesses may be evident in funds management practices.

3 A rating of 3 indicates liquidity levels or funds management practices in need of improvement.  Institutions rated 3 may lack ready access to funds on reasonable terms or may evidence significant weaknesses in funds management practices.

4 A rating of 4 indicates deficient liquidity levels or inadequate funds management practices.  Institutions rated 4 may not have or be able to obtain a sufficient volume of funds on reasonable terms to meet liquidity needs.

5 A rating of 5 indicates liquidity levels or funds management practices so critically deficient that the continued viability of the institution is threatened. Institutions rated 5 require immediate external financial assistance to meet maturing obligations or other liquidity needs.


Sensitivity to Market Risk

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:

  • The sensitivity of the financial institution's earnings or the economic value of its capital to adverse changes in interest rates, foreign exchanges rates, commodity prices, or equity prices.

  • The ability of management to identify, measure, monitor, and control exposure to market risk given the institution's size, complexity, and risk profile.

  • The nature and complexity of interest rate risk exposure arising from nontrading positions.

  • Where appropriate, the nature and complexity of market risk exposure arising from trading and foreign operations.

Ratings

1 A rating of 1 indicates that market risk sensitivity is well controlled and that there is minimal potential that the earnings performance or capital position will be adversely affected.  Risk management practices are strong for the size, sophistication, and market risk accepted by the institution.  The level of earnings and capital provide substantial support for the degree of market risk taken by the institution.

2 A rating of 2 indicates that market risk sensitivity is adequately controlled and that there is only moderate potential that the earnings performance or capital position will be adversely affected.  Risk management practices are satisfactory for the size, sophistication, and market risk accepted by the institution.  The level of earnings and capital provide adequate support for the degree of market risk taken by the institution.

3 A rating of 3 indicates that control of market risk sensitivity needs improvement or that there is significant potential that the earnings performance or capital position will be adversely affected.  Risk management practices need to be improved given the size, sophistication, and level of market risk accepted by the institution.  The level of earnings and capital may not adequately support the degree of market risk taken by the institution.  

4 A rating of 4 indicates that control of market risk sensitivity is unacceptable or that there is high potential that the earnings performance or capital position will be adversely affected.  Risk management practices are deficient for the size, sophistication, and level of market risk accepted by the institution.  The level of earnings and capital provide inadequate support for the degree of market risk taken by the institution.  

5 A rating of 5 indicates that control of market risk sensitivity is unacceptable or that the level of market risk taken by the institution is an imminent threat to its viability.  Risk management practices are wholly inadequate for the size, sophistication, and level of market risk accepted by the institution.

Attachment 2

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

Capital Ratios and Trends
Ratio Exam Date Period Ended Period Ended
/00/00 /00/00 /00/00
Total Risk Based Capital/Risk Weighted Assets 0.00 0.00 0.00
Tier 1 Risk Based Capital/Risk Weighted Assets 0.00 0.00 0.00
Tier 1 Leverage Capital/Average Total Assets 0.00 0.00 0.00
Tangible Equity Capital/Average Total Assets 0.00 0.00 0.00
Capital Category      


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

Asset Quality Ratios and Trends
Ratio Exam Date Prior Exam Prior Exam
/00/00 /00/00 /00/00
Total Adversely Classified Items/Tier 1 Capital + Allowance 0.00 0.00 0.00
Total Adversely Classified Assets/Total Assets 0.00    
Past Due & Non-Accrual Loans & Ls/Gross Lns & Leases 0.00    


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

Component Ratios and Trends
Ratio Exam Date Period Ended Period Ended
/00/00 /00/00 /00/00
Net Income (After Tax)/Average Assets 0.00 0.00 0.00
Net Operating Income (After Tax)/Average Assets 0.00 0.00 0.00


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


TO THE CHIEF EXECUTIVE OFFICER OF EACH STATE MEMBER BANK:

                        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.

Sincerely yours,

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


SR letters | 1996