This lesson introduces the CAMELS framework, the industry-standard method for analysing the financial health and risk profile of a bank .

5.1 Introduction to CAMELS
CAMELS is an acronym for six key components of a bank’s financial condition:

  • Capital Adequacy

  • Asset Quality

  • Management

  • Earnings

  • Liquidity

  • Sensitivity to Market Risk

The CAMELS framework provides a structured approach for assessing bank performance and identifying potential risks .

5.2 Capital Adequacy Ratios
Capital adequacy measures the bank’s ability to absorb losses. Key ratios include:

  • Common Equity Tier 1 (CET1) Ratio: CET1 capital divided by risk-weighted assets (RWA).

  • Tier 1 Capital Ratio: Tier 1 capital divided by RWA.

  • Total Capital Ratio: Total capital (Tier 1 + Tier 2) divided by RWA.

  • Leverage Ratio: Tier 1 capital divided by total exposure .

5.3 Asset Quality Ratios
Asset quality measures the health of the bank’s loan portfolio. Key ratios include:

  • Non-Performing Loans (NPL) Ratio: NPLs divided by total loans. A higher ratio indicates lower asset quality.

  • Provision Coverage Ratio: Loan loss reserves divided by NPLs.

  • Net Charge-Off Ratio: Net charge-offs divided by average loans .

5.4 Earnings Ratios
Earnings ratios measure the bank’s profitability. Key ratios include:

  • Return on Equity (ROE): Net income divided by shareholders’ equity.

  • Return on Assets (ROA): Net income divided by total assets.

  • Net Interest Margin (NIM): NII divided by average earning assets .

5.5 Liquidity Ratios
Liquidity ratios measure the bank’s ability to meet its short-term obligations. Key ratios include the Loan-to-Deposit Ratio, the Liquidity Coverage Ratio (LCR), and the Net Stable Funding Ratio (NSFR) .

5.6 Sensitivity to Market Risk
Sensitivity to market risk measures the bank’s exposure to changes in interest rates, exchange rates, and other market variables. This includes measures such as Value at Risk (VaR), and the Earnings at Risk (EaR) measure .

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