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A prime task of bank supervisors is to judge evaluate the financial condition of the banks for which they are responsible.
In evaluating or "rating" a bank, it is important that a standard system be used all bank supervisors can look at it in the same way.
With a clear rating system, everyone from the Governor to the newest staff member in bank supervision can quickly understand the financial condition of a bank by learning its rating.
However, such a system needs to take into account all the financial aspects that are important to a bank's soundness.
In the United States, the three bank supervision agencies, the Federal Reserve, the Comptroller of the Currency, and the Federal Deposit Insurance Corporation, all previously used their own rating systems.
In 1978, these three agencies all agreed to standardize their rating system. This agreed upon system has been in place since then.
This rating system takes into account all the major components of bank soundness. Thus, learning the system in detail serves as a method of teaching financial analysis of banks.
Because this system is clear and most of its concepts are easily understood, even by those not highly trained in bank supervision, many supervisory authorities in developing countries are now using this system for rating their banks.
The American bank rating system is called “CAMEL” as the first letter of each component that is analyzed spells out that word:
" C " is for capital adequacy. The system measures how much capital a bank has to protect its depositors and if this amount is sufficient.
" A " is for asset quality. The system determines the collectibility of assets and off-balance sheet items, as well as the financial impact of problem advances.
" M " is for management. The system evaluates a bank's management based on performance, policies established, controls, depth, and adherence to law and regulation.
" E " is for earnings, or profitability. The system measures bank profitability to see if it is sufficient to support future growth.
" L " is for liquidity. The system determines if a bank is liquid enough to meet regular and most unexpected obligations.
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