Module 17.2 – 17.5: CAMELS: Capital Adequacy and Liquidity Position

CAMELS is an acronym for the six factor analysis of bank health. It covers capital adequacy, asset quality, management, earnings, liquidity and sensitivity.

Capital adequacy refers to the required amount of capital banks must hold to remain solvent. It is based on risk weighted assets, where the weightings are specified by regulators. Higher risk assets receive higher weights.

Capital is assessed by the tier group it belongs two.

  1. Tier 1 Capital:
    1. Common Equity Tier 1 capital: Common stock, additional paid-in capital, retained earnings, and OCI less intangibles and deferred tax assets.
    2. Other Tier 1 capital: subordinated instruments with no specified maturity and no contractual dividends (e.g., preferred stock with discretionary dividends).
  2. Tier 2 capital: Subordinated instruments with original (i.e., when issued) maturity of more than five years.

Total capital refers to a banks sum of tier 1 and tier 2 capital. Under current Basel III guidelines, Common Equity Tier 1 capital must be 4.5% of risk weighted assets, and total tier 1 capital must be 6% of risk weighted assets. Total bank capital must be 8% of RWA.

Liquidity Position is evaluated under Basel III with two minimum standards, liquidity coverage ratio and net stable funding ratio.

LCR = Highly liquid assets/expected cash outflows

NSFR = available stable funding/required stable funding

The LCR uses 1-month cash outflows from a stress scenario, the Basel 3 recommends a minimum of 100% coverage. Available funding comes from the tenor mix of a banks funding sources, and the recommended minimum NSFR is 100%. NSFR is

Other liquidity monitoring metrics recommended by Basel III include concentration of funding and maturity mismatch. Relatively concentrated funding indicates a bank’s reliance on relatively few funding sources. This lack of diversification may pose a problem when the sources withdraw funding, resulting in heightened liquidity risk for the bank. Maturity mismatch occurs when the asset maturities differ meaningfully from maturity of the liabilities (funding sources). The higher the mismatch, the higher the liquidity risk for the bank. 

Table of Contents

1 thought on “Module 17.2 – 17.5: CAMELS: Capital Adequacy and Liquidity Position”

Leave a Comment