The system of inspection of banks was received in 1991 by a banking group chaired by Sh. S Padmanabham, which suggested method for on site and off site supervision of the banks

The committee suggested that banks be placed in the following two categories for purpose of examination, depending on the known and reported condition of the banks in financial, operational, management and compliance terms:

Those that need to be experienced on an annual cycle Those that may be examined on a wider time scale say within 2

years from the date of last examination

For evaluating and rating of Indian banks the committee has suggested CAMELS ratings model on the level of model employed by the supervisory authorized in the USA

During an on-site bank exam, supervisors gather private information, such as details on problem loans, with which to evaluate a bank's financial condition and to monitor its compliance with laws and regulatory policies.

The rating system initially emerged as CAMEL covering the first five parameters only. A sixth component, a bank's Sensitivity to market risk, was added in 1997; hence the acronym was changed to CAMELS.

The Off-site Monitoring and Surveillance System (OSMOS) was introduced in 1995 as an additional tool for supervision of commercial banks to supplement the on-site examinations. The system consists of 12 returns (called DSB returns) focusing on supervisory concerns such as capital adequacy, asset quality, large credits and concentrations, connected lending, earnings and risk exposures (viz. currency, liquidity and interest rate risks).

The supervisory intervention by the RBI is normally triggered by the deterioration in the level of capital adequacy, NPAs, credit concentration, lower earnings, and larger incidence of frauds which reflect the quality of control.

RATING SYMBOLS

A Basically sound in every respect

B Fundamentally sound but with moderate weaknesses

C Financial, operational or compliance weaknesses that give cause for supervisory concern

D Serious or immoderate finance, operational and managerial weaknesses that could impair future viability

E Critical financial weaknesses that render the possibility of failure high in the near term.

The ratings symbols assigned A to E indicate as follows: The sum total of ratings under all six components is aggregate

rating. Each of six parameters is weighted on a scale of 1 to 10 and contains several sub parameters with individual weighted

Rating determines the regulators least or most

supervisory concerns related to a bank.

Capital Adequacy is a measure of a bank’s financial

strength, in particular its ability to cushion operational

and abnormal losses Volume of risk assets: Total of the impaired values of assets at the

date of making the advance to the sub borrower.

Volume of marginal and inferior quality assets Its future prospectus and plans Strength of management in relation to the above points

C – Capital Adequacy

The asset quality rating reflects the quantity of existing and potential credit risk associated with the loan and investment portfolios, other real estate owned (OREO), and other assets, as well as off-balance sheet transactions.

The ability of management to identify, measure, monitor, and control credit risk is also reflected here.

The evaluation of asset quality should consider the adequacy of the allowance for loan and lease losses and weigh the exposure to counterparty issuer or borrower default under actual or implied contractual agreements.

All other risks that may affect the value or marketability of a credit union’s assets, including but not limited to the seven risk categories, should be considered.

A – Asset Quality

Technical Competence Fair and sound practices Achievement of Corporate Mission Adequacy and control

M - Management

Discription

The competence of the management is the key in evaluating the performance of the bank, as it is the management who is responsible to mobilize the resources of the bank and to create a sound control environment and risk management practices. Thus, this review is focused on appraising the competence, involvement and integrity of the management in the day to day administration of the bank, involvement in formulating policies and procedures and the implementation of systems and controls; and in ensuring the bank’s compliance with applicable laws and regulations.

Ability to cover losses and provide capital Earning Trends Comparison with other peer group Quality and Composition of Income Dividend Payment rate of Growth in the retained

earnings and adequacy of capital

E – Earnings Performance

Discription

The earnings of the bank should be able to absorb normal and expected losses in a given period and provide a source of financial support by contributing to the institution’s internal generation of capital and its ability to access capital externally. The earnings are, thus, assessed to evaluate the current and future earning capability and the efficiency of the bank based on the existing asset and liability structure, as well as pricing and costs.

Volatility of Deposits• With the fluctuations in interest rate, deposits of banks also

fluctuate. An increasing volatility in interest rates, and the availability of other attractive investment avenues has diverted prospective investors away from longer-term deposits schemes. An increasing number of people are opting to invest their money in commercial bank schemes of shorter maturity periods of less than two years. Thus to gain better rating banks should stabilize their interest rate and thereby decrease volatility of deposits.

L - Liquidity

Structure of Liabilities• Structure of liabilities of a bank should be such that it has enough funds

to lend and to meet investment opportunities along with maintaining its liquidity.

Availability of Assets which are easily convertible into cash• Easily convertible assets are cash or its equivalents-any asset that is

readily convertible into cash. For example, Treasury bills, short-term marketable securities, demand deposits, and time deposits nearing maturity. Liquid assets can be sold quickly without significant loss. Banks should have such assets to meet its demands.

Access to Money market and financial resources• Money market is a place where banks can raise short-term funds. The

money market instruments comprise call money (overnight), notice money (up to fourteen days), Treasury Bills (of various maturities), Commercial Paper, (CP) Certificate of Deposits (CD), inter-bank repos, Government dated securities with balance maturity of less than one year, commercial bills and inter-corporate deposits.

Asset Liability Management• Asset Liability Management is concerned with strategic balance sheet

management involving risks caused by changes in interest rates, exchange rates, credit risk and the liquidity position of bank.

• An effective Asset Liability Management technique aims to manage the volume mix, maturity, rate sensitivity, quality and liquidity of assets and liabilities as a whole so as to attain a predetermined acceptable risk/reward ratio.

It refers to the risk that changes in market conditions could adversely impact earnings and/or capital.

Market Risk encompasses exposures associated with changes in interest rates, foreign exchange rates, commodity prices, equity prices, etc.

It implies how sensitive the bank is to these risks. The rating will reflect the overall adequacy of established policies, limits, and the effectiveness of risk optimization strategies.

S- SENSITIVITY TO MARKET RISK