3.

1 CAMELS Ratios Methodology

Because of the special nature of the banking institutions in relation to other

businesses it is appropriate to use specialized ratios for their financial evaluation. A very
popular method which uses a group of specialized financial ratios is known as CAMELS
ratios analysis.
The CAMELS methodology was developed in 1979 on a proposal by the Federal
Financial Institutions Examinations Council (FFIEC) and is based on the evaluation of 6
critical elements of the financial institutions operation: Capital, Asset quality,
Management, Earnings, Liquidity, Sensitivity. The choice of the CAMELS methodology
factors is based on the idea that each one represents an important element in the financial
statements of the bank (Dash & Das, 2009).
The CAMELS ratios consist a reliable method of assessing risk of banking
institutions and constitute an alternative or additional way assessment of banks in relation
to the assessment of the International Credit Rating Agencies. In Greece they are used
extensively for supervisory purposes, since both quantitative and qualitative
characteristics of the banks are taken into account.4
The methodology selected for this study is the analysis with the specialized for
banks ratios, the CAMELS. It offers a quick and reliable assessment of the profitability of
banking organizations and is easy to implement.

3.2 Calculation of CAMELS ratios

This method requires the calculation of specific ratios which are presented below:

3.3.1(C): Capital adequacy ratio

CAR ratio indicates the strength of a bank expressed by the adequacy of its capital
in relation to their risk -weighted exposures. The ratio is expressed as a percentage of a
bank's risk weighted credit exposures and its value should be greater than 8%.
1. TIER 1: equity (common and preferred shares, convertible bonds, minority stakes
rights of the bank subsidiaries).
2. TIER 2: Hybrid Funds (funds from bonds issued by the bank and uses them as
capital. In other words, these consist foreign capital but have the characteristics of
equity.
Total Capital = Tier 1 Capital + Tier 2 Capital
Tier 1 Capital = Common Equity Tier 1 + Additional Tier 1\

Common Equity Tier 1 + Additional Tier 1 + Tier 2 Capital

CAR =
Risk-weighted Exposures
 The highest value of this ratio the less need there is for external funding and
therefore more efficient than other banks with lowest index capital adequacy and more
higher is the protection given to the investors.

3.3.2 (A): Asset quality

Asset quality ratio is calculate as follows:
Net-Non Performing Assets (loans overdue more than 30 days- Provisions)
Α=
Loans
The numerator includes the total amount of loans overdue more than 90 days (the
time as defined by the rules of Basel), reduced by reserve capital of the bank to cover
possible losses from overdue loans. This ratio should be kept as small as possible, which
means that the provisions for overdue loans are close to actual delays. This means correct
forecasting which makes the portfolio reliable and of good quality.

3.3.3 (Μ): Management capability

Management ratio is calculated as follows:
Management expenses
Μ=
Net Operating Revenues
Lower values of this ratio suggest better management quality of the bank.
The ratio shows the proper (effectively) operation of the bank and the ability of the
management to restrict each form of risk inherent in any activity of the bank. The
numerator shows the administrative costs which is related to the general operating costs of
the bank. The denominator includes revenues and in particular interest and similar
income.

3.3.4 (Ε): Earnings

The Earnings ratio consists of two individual indicators (ROA, ROE) which shall
be calculated as follows:
Net Profits
ROA =
Average Total Assets
It reflects the profitability of the bank in relation to the total assets, while it also
shows how a bank manages its assets to achieve profits.
The higher the ratio, the better the efficiency of the bank’s assets, therefore the
more efficient the management of its assets.
3.3.5 (L):Liquidity
Liquidity ratio consists of two individual ratios, L1 and L2 which are calculated as
follows:
Total Loans/
L1 =
Total Customer Deposits
The result of this ratio shows the dependence of the bank from the interbank
market.
It displays the relationship between the liquid assets of the total current assets to
current liabilities of the bank.
The target for the bank is to finance the loans granted out from the deposits (and
still having some funds for reserves). In other words, the bank should not have to borrow
in inter-bank market to grant loans.
The smaller is the ratio the better is the liquidity of the bank. The ratios’ value
lower than the unit (1) is interpreted as security in case of allocations, since the deposits
are sufficient for the granting of loans.
The second liquidity ratio is as follows:
Current Assets
L2 =
Average Total Assets
The result of this ratio shows the extent of (indirect) liquidity of the bank with
regard to its current assets. In other words, the immediate liquidable assets, such as the
receivables from interbank and from customers, cash and securities (investment portfolio
and portfolio transactions of holding bonds to maturity).
The higher the value of the ratio the greater the liquidity of the bank.
This implies a large current assets, which, however, entails substantial costs for the
bank, which prefers to come from deposits.
For the determination of the liquidity ratio the procedure is the same as the
profitability ratio, and it is calculated as the average of the two individual indicators L1
and L2. The greater the L ratio, the better is the bank under consideration.

3.3.6 (S): Sensitivity

Sensitivity ratio is calculate as follows:
Total Volatile Liabilities
S=
Average Total Assets
The ratio refers to everything that is subject to an increase of market risk such as
the securities (shares, bonds, derivatives, mutual funds). It shows the performance
obtained by the securities portfolio of the bank.
The bank should pursuit to keep the ratio low, which implies that the bank will
react better to market risks.
The CAMELS ratios provide for each bank a rating for the overall performance and
six individual scores for each ratio category separately. Based on a weighting for each of
the six ratios the overall condition of the bank under consideration is revealed.
 Performance of the Greek banking sector... 53

The weights used and assigned to each ratio are presented:

Weights by risk category:
Capital Risk = 20%
Assets Risk =20%
Management Risk= 20%
Earnings Risk = 10% Liquidity
Risk = 20% Sensitivity to Risk
= 10%
The provision of camels indicators defined as follows:
The grading scale ranges from 1 to 5 where 1 is the highest rating and reflects the excellent
performance and the existence of adequate mechanisms for managing risk while the 5 corresponds to
the lowest rating and the bank is considered of low performance

6-9. Saylor County National Bank presents us with these figures for the year just concluded.
Please determine the net profit margin, equity multiplier, asset utilization ratio, and ROE:

Net Income = $18

Total Operating Revenues = $125
Total Assets = $1,500
Total Equity Capital Accounts = $155

a. Net Profit Margin = Net Income = $18 mill. = 0.144 or 14.4%

Total Operating Revenue $125 mill.

b. Asset Utilization = Total Operating Revenues = $125 mill. = 0.083 or 8.3%

Total Assets $1500 mill.

c. Equity Multiplier = Total Assets = $1500 mill. = 9.68 times

Common Equity $155 mill.
Capital

d. ROE = Net Income = $18 mill. = 0.1161 or 11.61%

Common Equity Capital $155 mill.
q-2

Blue and White National Bank holds total assets of $1.69 billion and equity capital of $139 million
and has just posted an ROA of 1.1 percent. What is this bank’s ROE? Make sure you use common
equity.

Total Assets $1,690

ROE = ROA * Equity Capital = 0.011 * $139 = 0.1337 or 13.37%