All information about Ratings of Banks: Banking Awareness Special Series

Team Adda247 and Bankers Adda have introduced a Special Banking Awareness series for SBI and IBPS Interviews 2021. In this series, we will introduce the candidates to some banking awareness topics Daily that will improve their general awareness and ensure that the candidates do not lack in any banking term when it comes to the interview round. Today the topic of our Banking Awareness Series is All information about the Ratings of Banks.

All information about Ratings of Banks

Ratings of Banks are given by credit rating agencies. It is a measurement of financial soundness for banks and also shows its efficiency to do all operations pertaining to the banking industry. 

Some of the worldwide credit rating agencies are Standard & Poor’s (S&P), Moody’s, Fitch which gives credit ratings to individuals and corporations, and the Federal Deposit’s Insurance Corporation (FDIC) gives credit ratings to banks and financial institutions.

Bank ratings are generally given between a rate of 1 to 5, in which a rate of 1 is used as the best and 5 is for being worst. Bank ratings are measured by using the CAMELS rating system which is recognized globally as a rating system that measures the financial soundness of banks and financial institutions based on six factors. Below are the six components of the CAMELS rating system.

CAMELS full form: C for Capital Adequacy, A for Asset Quality, M for Management, E for Earnings, L for Liquidity, and S for Sensitivity

1.) Capital Adequacy:

Capital adequacy calculated on cash reserves of banks and financial institutions regarding to the minimum capital requirements set by regulatory authorities. Banks and financial institutions can get high ratings on capital adequacy by maintaining the capital requirements set by the regulators. Banks and institutions also have to meet other requirements set by regulatory agencies, including guidelines and regulatory policies related to interest and dividends.

2.) Asset Quality: 

  It measures the quality of a bank’s credit and other assets based on both credit and market risk. It identifies the potential risk factors which relate to the capital earning generation. The quality of loans and credit worthiness of borrowers is assessed to measure the credit risk. 

The asset quality rating also considers the market risk by evaluating the bank’s market value in terms of investments which changes under different economic environments. 

3.) Management:

The measurement of Management is calculated by checking the ability of the management of the company to run the operations and execution of them in a systematic way. Management’s ability to adapt to the volatility of the market and to manage its investment by calculating risk factors is important in the measurement of Management. It consists of an internal review of management policies to ensure that they comply with regulatory guidelines.

4.) Earnings:

Earnings are measured for a bank’s ability to generate stable and consistent income regularly. A bank’s future viability and its prospects depend on the key determinants of growing earnings and deposits. Most of the time regulators measure the quality of earnings by assessing the bank’s growth in deposits, balance sheet stability, quality of credits, and interest rate spread.

5.) Liquidity: 

Liquidity measures the ability of a bank’s meeting up short-term obligations which includes deposit withdrawals. It is assessed by evaluating the amount and quality of liquid assets which are related to the short-term obligations of the institution. The liquidity coverage ratio generally used to assess holdings of the banks’ liquid assets. High-quality liquid assets are considered normal for the evaluation. 

6.) Sensitivity: 

It is a measurement of the sensitivity of a bank or financial institution’s earnings. Regulators are used to understanding the sensitive information of exposures of the institution and its distribution among specific industries. The information is also used to assess how lending capital specifies to industries that can impact the bank’s income and credit risk. 

Income sensitivity based on exposure to volatility in foreign exchange, commodities, equities, and derivative markets is also considered for measuring Sensitivity.