Bank Capital Requirements - - The “C” in CAMEL

IDC Financial Publishing, Inc. (IDCFP) uses the acronym CAMEL and its component financial ratios to evaluate the safety and soundness of commercial banks and savings institutions.  This article explains how IDCFP uses the bank capital requirements ratios as a component of its CAMEL ranking system and why it is valuable and important to monitor.

The capital ratio requirements used by the FDIC to determine if an institution is “Well-Capitalized” are:

1.    Tier 1 Leverage Capital Ratio (Tier 1 capital divided by Tier 1 assets) of 5% or higher

2.    Total Risk Based Capital Ratio (Tier 1 + Tier 2 capital divided by risk-based assets) of 10% or higher

3.    Tier 1 Risk Based Capital Ratio (Tier 1 capital divided by risk-based assets) of 6% or higher

IDCFP also reviews enforcement actions by the FDIC to determine if an institution is required to file a written “Capital Plan” to increase capital above the threshold of ratios indicated above.  As an example, a letter of consent for an institution might require a Tier 1 leverage ratio of 9% vs. the standard 5%, and then IDCFP uses the 9% or higher Tier 1 requirement to be “Well-Capitalized” until the enforcement action is terminated.

Commercial Banks and Savings Institutions with Capital Ratios Below the Requirements Outlined above are Not “Well-Capitalized” and Receive an IDCFP Rank Below “125” (300 the Highest and 1 the Lowest).

As seen in the table below, the number of commercial banks and savings institutions, ranked less than the industry standard for investment grade of “125”, peaked in the 2nd quarter of 2009 at 2,471 or 31% of the 8,267 total number of domestic commercial banks and savings institutions.  The number of commercial banks and savings institutions not “Well-Capitalized” (the C component), however, peaked at 511 four quarters later, June 30, 2010.

Other rating agencies that primarily depend on financial institutions to be well-capitalized or institutions that only use capital ratios to define risk are late in risk determination and only recognize a small portion of the risk of being ranked below investment grade or “125” by IDCFP.  As seen in the analysis of the components of CAMEL as calculated by IDCFP, categories of CAMEL with their rank calculations lag behind the unique and timely combination of these components in IDCFP’s summary rank of financial ratios.

This illustrates that all 5 categories of rank, C-Capital, A-Adequacy of Capital, M-Margins as a Measurement of Management, E-Earnings from Operations and, separately, Earnings from Financial Leverage, and finally, L-Liquidity all together provide a timely indication of risk and potential failure.

Most important, the number of banks and savings institutions with IDCFP ranks below “125” began sharply increasing after the 2nd quarter of 2006, well before the financial crisis of 2008 and 2009.

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IDCFP has been helping CD brokers and investors, insurance companies, federal agencies and a host of other institutions make better decisions using its unique and proprietary CAMEL rating methodology since 1985.  For more information on CAMEL go to www.idcfp.com or call 1-800-525-5475.

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