X. Read the passage below and explain the meanings of the words which have been highlighted.

The third component of the CAMEL rating system is management. However, bank supervisors usually evaluate management last, as it brings together all other areas of importance.

• Of course, management must be rated subjectively and thus a ratio cannot be used, unlike with the other components of the CAMEL system.

• Evaluation of management begins by looking at the performance of the bank.

• Well managed banks should have adequate capital, good asset quality, adequate profits, and sufficient liguidity;

• As a result, bank supervisors using the CAMEL system will not rate management until after the other four areas have been rated.

• It is equally important to judge management through policies, systems, and controls that have been put in place.

• Policies set a specific framework for key banking areas, such as lending, foreign exchange, and liquidity to guide managers in day to day activities;

• Systems and controls help ensure policies are carried out efficiently and are adhered to.

• Management should also be evaluated on the bank's adherence to laws and regulations, including timely and accurate submission of reports to the Central Bank.

• Finally, supervisors evaluate management depth, which looks at the development of future top managers for the bank.

The fourth part of the CAMEL rating system is evaluation of bank earnings: in other words, how profitable is the bank.

• Banks need to be profitable in order to add to their capital.

• While new capital can come from outside sources such as issuing new shares or an injection of capital from shareholders, most new capital comes from earnings;

• Earnings are only valuable in building capital if they are retained, as a bank which pays out almost all its profits as dividends does little to increase its capital.

• As was true with capital, earnings can be measured in a quantitative way, that is, through a ratio.

• The ratio most widely used to measure bank profitability is return on average assets. This measures profits after tax as a percentage of the assets from which the profits were earned.

  • The numerator is net profit after tax, but before dividends are paid out;

  • The denominator is average total assets the bank had in the year in which profits were earned, though profits can also be measured on a quarterly basis.

• It is also important to analyze the quality of earnings. Are the profits truly genuine (derived using proper accounting standards)? Are they of a recurring nature and not due to large and one-time-only transactions?

6. Study the following notes and prepare an oral presentation

Mrs. Charlotte Ameasbury summons Karl Brewer to her office and asks him to prepare the final part of the CAMEL rating system liquidity, which indicates the ability of the bank to quickly meet its obligations. So, Karl has brought some notes on liquidity he prepared the other day. He also reminds Charlotte of CAMEL ratings: 1= strong; 2 = satisfactory; 3 = fair; 4 = marginal; 5 = unsatisfactory.

The final part of the camel rating system is liquidity, which indicates the ability of a bank to quickly meet its obligations.

• It is important to remember that for a bank to properly manage its liquidity, it must be able to meet its obligations without a loss.

• Banks must have available liquid assets which can quickly be turned into cash, or they must be able to raise funds on very short notice to meet an obligation;

• Managing liquidity involves both sides of the balance sheet, meaning having available back-up sources to raise liquidity quickly.

• Since liquidity involves many factors, no single ratio measures all a supervisor needs to know about liquidity. Several ratios can be indicators as will be discussed.

• As part of an on-site examination, the examiners review how liquidity is managed which includes:

• Are specific policies in place to set liquidity targets and limits to meet statutory requirements and to manage liquidity as set by directors and senior management?

• Are reporting systems and data bases sufficient to give quick and accurate information on a bank's position?

• How much reliance has the bank placed on deposits or other funding which might be withdrawn on very short notice?

• The on-site review is combined with an analysis of various liquidity ratios to determine the trend of liquidity and how it compares to other banks.

Using their judgment in both the on-site examination of how a bank manages its liquidity and from liquidity ratios, liquidity is then rated as sound, satisfactory, fair, marginal, or unsatisfactory.

Karl also presents component ratings. They are: