In 1994, the RBI established the Board of Financial Supervision (BFS), which operates as a unit of the RBI. The entire supervisory mechanism was realigned to suit the changing needs of a strong and stable financial system. The supervisory jurisdiction of the BFS was slowly extended to the entire financial system barring the capital market institutions and the insurance sector. Its mandate is to strengthen supervision of the financial system by integrating oversight of the activities of financial services firms.
The BFS has also established a sub-committee to routinely examine auditing practices, quality, and coverage. In 1995, RBI had set up a working group under the chairmanship of Shri S. Padmanabhan to review the banking supervision system. The Committee certain recommendations and based on such suggetions a rating system for domestic and foreign banks based on the international CAMELS model combining financial management and systems and control elements was introduced for the inspection cycle commencing from July 1998.
It recommended that the banks should be rated on a five point scale (A to E) based on th elines of international CAMELS rating model. CAMELS evaluates banks on the following six parameters :
- Capital Adequacy :Capital adequacy is measured by the ratio of capital to risk-weighted assets (CRAR). A sound capital base strengthens confidence of depositors
- Asset Quality : One of the indicators for asset quality is the ratio of non-performing loans to total loans (GNPA). The gross non-performing loans to gross advances ratio is more indicative of the quality of credit decisions made by bankers. Higher GNPA is indicative of poor credit decision-making.
- Management : The ratio of non-interest expenditures to total assets (MGNT) can be one of the measures to assess the working of the management. . This variable, which includes a variety of expenses, such as payroll, workers compensation and training investment, reflects the management policy stance.
- Earnings : It can be measured as the the return on asset ratio.
- Liquidity : Cash maintained by the banks and balances with central bank, to total asset ratio (LQD) is an indicator of bank’s liquidity. In general, banks with a larger volume of liquid assets are perceived safe, since these assets would allow banks to meet unexpected withdrawals.
Systems and Control Each of the above six parameters are weighted on a scale of 1 to 100 and contains number of sub-parameters with individual weightages.