[Federal Register: July 18, 1996 (Volume 61, Number 139)]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
FEDERAL FINANCIAL INSTITUTIONS EXAMINATION COUNCIL
Uniform Financial Institutions Rating System
AGENCY: Federal Financial Institutions Examination Council.
ACTION: Notice and request for comment.
SUMMARY: The Federal Financial Institutions Examination Council (FFIEC)
is requesting comment on proposed changes to the Uniform Financial
institutions Rating System (UFIRS), commonly referred to as the CAMEL
rating system. The term ``financial institutions'' refers to those
insured depository institutions whose primary Federal supervisory
agency is represented on the FFIEC. The agencies comprising the FFIEC
are the Board of Governors of the Federal Reserve System (Board), the
Federal Deposit Insurance Corporation (FDIC), the National Credit Union
Association (NCUA), the Office of the Comptroller of the Currency
(OCC), and the Office of Thrift Supervision (OTS).
The proposed revisions update the rating system to reflect changes
that have occurred in the financial services
industry and in supervisory policies and procedures since the rating
system was first adopted in 1979. The proposed changes include: The
reformatting and clarification of the existing component rating
descriptions; the addition of a sixth rating component addressing
sensitivity to market risks; an increase in emphasis on the quality of
risk management processes in each of the rating components,
particularly in the management component; the addition of language in
composite rating definitions to parallel the proposed changes in
component rating descriptions; and, the explicit identification of the
risk types that are to be considered in assigning component ratings.
After reviewing public comments, the FFIEC intends to make appropriate
additional changes to the revised UFIRS and adopt a final rating
The FFIEC notes that some agency regulations currently use an
institution's UFIRS or CAMEL rating in determining an institution's
status under those regulations. The agencies may consider amending
those regulations to incorporate any changes made to the UFIRS system.
DATES: Comments must be received by September 16, 1996.
ADDRESSES: Comments should be sent to Joe M. Cleaver, Executive
Secretary, Federal Financial Institutions Examination Council, 2100
Pennsylvania Avenue NW., Suite 200, Washington, DC 20037, or by
facsimile transmission to (202) 634-6556.
FOR FURTHER INFORMATION CONTACT:
OCC: Lawrence W. (Bill) Morris, National Bank Examiner, Office of Chief
National Bank Examiner, (202) 874-5350, Office of the Comptroller of
the Currency, 250 E Street SW., Washington, DC 20219.
FRB: Kevin Bertsch, Supervisory Financial Analyst, (202) 452-5265, or
Constance Powell, Supervisory Financial Analyst, (202) 452-3506,
Division of Banking Supervision and Regulation, Board of Governors of
the Federal Reserve System. For the hearing impaired only,
Telecommunication Device for the Deaf (TDD), Dorothea Thompson, (202)
452-3544, Board of Governors of the Federal Reserve System, 20th and C
Streets NW., Washington, DC 20551.
FDIC: Daniel M. Gautsch, Examination Specialist, (202) 898-6912, Office
of Policy, Division of Supervision. For legal issues, Linda L. Stamp,
Counsel, (202) 898-7310, Supervision and Legislation Branch, Federal
Deposit Insurance Corporation, 550 17th Street NW., Washington, DC
OTS: William J. Magrini, Senior Project Manager, (202) 906-5744,
Supervision Policy, Office of Thrift Supervision, 1700 G Street NW.,
Washington, DC 20552.
The UFIRS is an internal supervisory rating system used by the
Federal supervisory agencies for evaluating the soundness of financial
institutions on a uniform basis and for identifying those institutions
requiring special supervisory attention or concern. The UFIRS was
adopted in 1979 and is commonly referred to as the CAMEL rating system.
Under the UFIRS, each financial institution is assigned a composite
rating based on an evaluation and rating of five essential components
of an institution's financial condition and operations. These component
factors address the adequacy of capital, the quality of assets, the
capability of management, the quality and level of earnings, and the
adequacy of liquidity. Both the composite and the component ratings are
assigned on a 1 to 5 numerical scale. A 1 indicates the strongest
performance and management practices, and the least degree of
supervisory concern, while a 5 indicates the weakest performance and
management practices and, therefore, the highest degree of supervisory
The composite rating reflects an institution's overall financial
condition, compliance with laws and regulations, and management
capability. The composite ratings are used by the Federal supervisory
agencies to monitor aggregate trends in the overall soundness of
The rating system also provides a means for the Federal supervisory
agencies to monitor, for various statistical and supervisory purposes,
the types and severity of problems that institutions may be
experiencing. This monitoring is possible since the composite rating
assigned under UFIRS is based on the ratings of several essential
aspects of a financial institution's condition and operations. For
example, liquidity is one of the aspects of an institution's operations
that is assigned a component rating. Thus, UFIRS allows the Federal
supervisory agencies to readily identify all institutions that are
experiencing a liquidity problem, to gauge the severity of the problem,
and to determine the level of supervisory concern that may be
UFIRS has proven to be an effective means for the Federal
supervisory agencies to determine the safety and soundness of financial
institutions. A number of changes, however, have occurred in the
financial services industry and in supervisory policies and procedures
since the rating system was first adopted. The FFIEC's Task Force on
Supervision has reviewed the existing rating system in light of these
industry trends. The Task Force has concluded that the current UFIRS
framework continues to provide an effective vehicle for summarizing
conclusions about the soundness of financial institutions. As a result,
the FFIEC proposes to retain the basic rating framework, and the
revised rating system will continue to assign a composite rating based
on an evaluation and rating of essential components of an institution's
financial condition and operations. However, the FFIEC proposes certain
enhancements to the rating system.
Discussion of Proposed Changes to the Rating System
1. Structure and Format
The FFIEC proposes to enhance and clarify the component rating
descriptions by reformatting each component into three distinct
sections. These sections are: (a) An introductory paragraph discussing
in general terms the areas to be considered when rating each component;
(b) a bullet-style listing of the specific evaluation factors to be
considered when assigning the component rating; and, (c) a brief
qualitative description of the five rating grades that can be assigned
to a particular component.
2. Component for Sensitivity to Market Risks
The FFIEC proposes to adopt a sixth rating component addressing
sensitivity to market risks. This component would include interest rate
risk, to which every institution is subject, price risk, and foreign
In recent years, financial institutions have increased their
holdings of complicated on- and off-balance sheet instruments, such as
structured notes and collateralized mortgaged obligations (CMOs), that
are sensitive to changes in interest rates. In addition, the increase
in competitive pressures has constrained, in some cases, institutions'
abilities to advantageously price loans and deposits. Thus, there is a
growing need for financial institutions to monitor and manage their
interest rate risk, as well as for the Federal supervisory agencies to
monitor the degree of this risk. In addition, for those institutions
that have substantial trading
operations or large foreign positions, there is an increased
susceptibility to price and foreign exchange risks that also must be
closely monitored by the Federal supervisory agencies.
Under the current UFIRS, these market risks are considered within a
number of components. For example, interest rate risk is considered
when evaluating the earnings component since this risk can have a
direct effect on future earnings. Interest rate risk is also considered
when evaluating the liquidity component since interest rate risk is a
factor of an institution's overall asset/liability management
practices. Under the revised rating system, certain aspects of an
institution's sensitivity to market risks would continue to be
considered when evaluating these other components. However, the
conclusions on an institution's sensitivity to interest rate, price,
and foreign exchange risks would be summarized under the new component
in recognition of the impact these risks can have on an institution's
overall risk profile.
3. Risk Management
The FFIEC is proposing that the revised rating system reflect an
increase in emphasis on risk management processes. The Federal
supervisory agencies currently consider the quality of risk management
processes in applying the UFIRS, particularly in the management
component. Changes in the financial services industry, however, have
broadened the range of financial products offered by institutions and
accelerated the pace of transactions. These trends reinforce the
importance of institutions having sound risk management processes.
Accordingly, the revised rating system would contain language in each
of the components emphasizing the consideration of processes of
identify, measure, monitor, and control risks.
4. Composite Rating Definitions
The FFIEC is proposing changes in the composite rating definitions
to parallel the changes in the component rating descriptions. Under the
FFIEC's proposal, the revised composite rating definitions would
contain an explicit reference to the quality of overall risk management
practices. The basic context of the existing composite rating
definitions is being retained. The composite rating would continue to
be based on a careful evaluation of an institution's managerial,
operational, financial, and compliance performance.
5. Identification of Risk Types
The FFIEC is proposing that the types of risks associated with each
of the component ratings be explicitly identified. For example, the
proposed rating description for asset quality notes that a primary
consideration in assigning the component rating is an assessment of
credit risk associated with loans, investments, other real estate
owned, and certain off-balance sheet transactions. However, all other
risks affecting the quality of assets, including, but not limited to,
operational, market, reputation, strategic, and compliance risks, also
would be considered.
Request for Comments
The FFIEC requests comment on the proposed changes to the rating
system. In addition, the FFIEC invites comments on the following
1. Does the proposed, revised rating system capture the essential
aspects of a financial institution's condition, compliance with laws
and regulations, and overall operating soundness? If not, what
additional or different components should be considered?
2. Does the proposed management component rating adequately
represent an assessment of the quality of the board of directors' and
management's oversight regarding an institution's operating
performance, risk management practices, and internal controls? If not,
what other factors should be considered when rating management?
Proposed Text of the Uniform Financial Institutions Rating System
Uniform Financial Institutions \1\ Rating System
The Uniform Financial Institutions Rating System (UFIRS) was
adopted by the Federal Financial Institutions Examination Council
(FFIEC) on November 13, 1979. Over the years, the UFIRS has proven to
be an effective internal supervisory tool for evaluating the soundness
of financial institutions on a uniform basis and for identifying those
institutions requiring special attention or concern. A number of
changes, however, have occurred in the banking industry and in the
Federal supervisory agencies' policies and procedures which have
prompted a review and revision of the 1979 rating system. The revisions
to UFIRS include the addition of a sixth component addressing
sensitivity to market risks; the explicit reference to the quality of
risk management processes in the management component; and the
identification of risk elements within the composite and component
\1\ For purposes of this rating system, the term financial
institution refers to those insured depository institutions whose
primary Federal supervisory agency is represented on the Federal
Financial Institutions Examination Council (FFIEC). The agencies
comprising the FFIEC are the Board of Governors of the Federal
Reserve System, the Federal Deposit Insurance Corporation, the
National Credit Union Administration, the Office of the Comptroller
of the Currency, and the Office of Thrift Supervision. The term
financial institution includes Federally supervised commercial
banks, savings and loan associations, mutual savings banks and
The UFIRS takes into consideration certain financial, managerial,
and compliance factors that are common to all institutions. Under this
system, the supervisory agencies endeavor to ensure that all financial
institutions are evaluated in a comprehensive and uniform manner, and
that supervisory attention is appropriately focused on the financial
institutions exhibiting financial and operational weaknesses or adverse
The UFIRS also serves as a useful vehicle for identifying problem
or deteriorating financial institutions, as well as for categorizing
institutions with deficiencies in particular component areas. Further,
the rating system assists Congress in following safety and soundness
trends and in assessing the aggregate strength and soundness of the
financial industry. As such, the UFIRS assists the agencies in
fulfilling their collective mission of maintaining stability and public
confidence in the nation's financial system.
Under the UFIRS, each financial institution is assigned a composite
rating based on an evaluation and rating of six essential components of
an institution's financial condition and operations. These component
factors address the adequacy of capital, the quality of assets, the
capability of management, the quality and level of earnings, the
adequacy of liquidity, and the sensitivity to market risks.
Composite and component ratings are assigned based on a 1 to 5
numerical scale. A 1 indicates the highest rating, strongest
performance and risk management practices, and least degree of
supervisory concern, while a 5 indicates the lowest rating, weakest
performance and risk management practices and, therefore, the highest
degree of supervisory concern.
The composite rating generally bears a close relationship to the
component ratings assigned. Each component rating is based on a
qualitative analysis of the factors comprising that component and its
interrelationship with the other components. When assigning a composite
rating, some components may be given more weight than others
depending on the situation at the institution. In general, assignment
of a composite rating may incorporate any factor that bears
significantly on the overall condition and soundness of the financial
institution. Therefore, the composite rating is not derived by
computing an arithmetic average of the component ratings.
The ability of management to respond to changing circumstances and
to address the risks that may arise from changing business conditions,
or the initiation of new activities or products, is an important factor
in evaluating a financial institution's overall risk profile and the
level of supervisory attention warranted. For this reason, the
management component is given special consideration when assigning a
The following two sections contain the composite rating
definitions, and the descriptions and definitions for the six component
Composite ratings are based on a careful evaluation of an
institution's managerial, operational, financial, and compliance
performance. The six key components used to assess an institution's
financial condition and operations are: capital adequacy, asset
quality, management capability, earnings quantity and quality, the
adequacy of liquidity, and sensitivity to market risks. The rating
scale ranges from 1 to 5, with a rating of 1 indicating the strongest
performance and risk management practices, and the level of least
supervisory concern. A 5 rating indicates the most critically deficient
level of performance, the weakest risk management practices, and the
greatest supervisory concern. The composite ratings are defined as
Financial institutions in this group are sound in every respect; as
such, all components are rated 1 or 2. Any weakness is minor and can be
handled in a routine manner by management. Substantial compliance with
laws and regulations is noted. These financial institutions are more
capable of withstanding the vagaries of business conditions and are
resistant to outside influences such as economic instability in their
trade area. As a result, these financial institutions exhibit the
strongest performance and risk management practices and give no cause
for supervisory concern.
Financial institutions in this group are fundamentally sound. For a
financial institution to receive this rating, normally no component
rating should be more severe than 3. Only modest weaknesses are present
and are well within management's capabilities and willingness to
correct. These financial institutions are stable and are capable of
withstanding business fluctuations. These financial institutions are in
substantial compliance with laws and regulations and there are no
material supervisory concerns. Overall risk management practices are
satisfactory. As a result, the supervisory response is informal and
Financial institutions in this group exhibit some degree of
supervisory concern in one or more of the component areas. These
financial institutions exhibit a combination of weaknesses that may
range from moderate to severe. Risk management practices may be less
than satisfactory. The concerns, however, are not of the magnitude to
cause a component to be rated more severely than 4.
Financial institutions in this group generally are less capable of
withstanding business fluctuations; are more vulnerable to outside
influences than those institutions rated a composite 1 or 2; and,
management may lack the ability or willingness to effectively address
weaknesses within appropriate time frames. Additionally, these
financial institutions may be in significant noncompliance with laws
and regulations. These financial institutions are a supervisory concern
and require more than normal supervision, which may include formal or
informal enforcement actions. Failure appears unlikely, however, given
the overall strength and financial capacity of these institutions.
Financial institutions in this group are in an unsafe and unsound
condition. These are serious financial or managerial deficiencies that
result in unsatisfactory performance. The problems range from severe to
critically deficient. Risk management practices are generally
unacceptable. The weaknesses and problems are not being satisfactorily
addressed or resolved by management. There may be significant
noncompliance with laws and regulations. Financial institutions in this
group generally are not capable of withstanding business fluctuations.
Close supervisory attention is required, which means, in most cases,
formal enforcement action is necessary to address the problems.
Institutions in this group pose a risk to the deposit insurance fund.
Failure is a distinct possibility if the problems and weaknesses are
not satisfactorily addressed and resolved.
Financial institutions in this group are in an extremely unsafe and
unsound condition, exhibit a critically deficient performance, often
contain the weakest risk management practices, and are of the greatest
supervisory concern. The volume and severity of problems is beyond
management's ability or willingness to control or correct. Immediate
outside financial or other assistance is needed in order for the
financial institution to be viable. Continuous close supervisory
attention is warranted. Institutions in this group pose a significant
risk to the deposit insurance fund. Failure is highly probable and the
least-cost resolution alternatives are being considered by the
Each of the component rating descriptions is divided into three
sections: an introductory paragraph; a list of the principal evaluation
factors that relate to that component; and, a brief description of each
numerical rating for that component. Some of the evaluation factors are
reiterated under one or more of the other components to reinforce the
interrelationship between components.
A financial institution is expected to maintain capital
commensurate with its existing and potential risk exposures and the
ability of management to identify, measure, monitor, and control these
exposures. The effect of credit, market and other risks on the
financial condition of an institution should be considered when
evaluating the adequacy of capital. The types and quantity of risk
inherent in an institution's activities will determine the extent of
which it may be necessary to maintain capital at levels above required
regulatory minimums to properly reflect the potentially adverse
consequences that these risks may have on the institution's capital.
The capital adequacy of an institution is rated based on an
The level and quality of capital and the overall financial
condition of the institution.
The nature and extent of risks to the organization.
The ability of management to identify, measure, monitor,
and control risk and address emerging needs for additional capital.
The nature, trend, and volume of problem assets, and the
adequacy of allowances for loan and lease losses and other valuation
Balance sheet composition, including the nature and amount
of intangible assets, market risk, concentration risk, and risks
associated with nontraditional activities.
Risk exposure represented by off-balance sheet activities.
The quality and strength of earnings, and the
reasonableness of dividends.
Prospects and plans for growth, as well as past experience
in managing growth.
Access to capital markets and other sources of capital.
Compliance with applicable laws, regulations, and
supervisory guidelines, including plans for maintaining adequate
capital or correcting other deficiencies.
1. A rating of 1 indicates a strong capital level that is more than
adequate to support an institution's risk profile.
2. A rating of 2 indicates a satisfactory capital level given the
financial institution's risk exposure and the quality of its risk
3. A rating of 3 indicates a less than satisfactory level of
capital that does not fully support the institution's risk profile. The
rating indicates a need for improvement, even if the institution's
capital level exceeds minimum regulatory and statutory requirements.
4. A rating of 4 indicates a deficient level of capital. In light
of the level of risk exposure, viability of the institution may be
threatened. Assistance from shareholders or other external sources of
financial support is required.
5. A rating of 5 indicates a critically deficient level of capital
such that the institution's viability is threatened. Immediate
assistance from shareholders or other external sources of financial
support is required.
The asset quality rating reflects the quantity of existing and
potential credit risk associated with the loan and investment
portfolios, other real estate owned, and 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 salability of an institution's
assets, including, but not limited to, operating, market, reputation,
strategic, or compliance risks should also be considered.
The asset quality of a financial institution is rated based on an
The adequacy of underwriting standards and appropriateness
of risk identification practices.
The level, distribution, severity, and trend of classified
assets, nonaccrual and restructured loans, delinquent loans, and
The adequacy of the allowance for loan and lease losses
and other asset valuation reserves.
The exposure to off-balance sheet transactions, such as
unfunded commitments, commercial and standby letters of credit, and
lines of credit.
The volume, diversification, and quality of the loan and
The extent of securities underwriting activities and
exposure to counterparties in trading activities.
The existence of asset concentrations.
The adequacy of loan and investment policies, procedures,
The ability of management to properly administer its
assets, including the timely identification and collection of problem
The adequacy of internal controls and management
Compliance with applicable laws and regulations.
1. A rating of 1 indicates strong asset quality and credit
administration practices without either significant weaknesses or risk
exposure. Asset quality in such institutions is of minimal supervisory
2. A rating of 2 indicates satisfactory asset quality and credit
administration practices. The level and severity of classifications,
other weaknesses, and risks warrant a limited level of supervisory
3. A rating of 3 is assigned when asset quality or credit
administration practices are less than satisfactory. Trends may be
stable or indicate deterioration in asset quality or an increase in
risk exposure. The level and severity of classified assets, other
weaknesses, and risks require an elevated level of supervisory concern.
There is generally a need to improve credit administration and risk
4. A rating of 4 is assigned to financial institutions with
deficient asset quality or credit administration practices. The levels
of risk and problem assets are significant, inadequately controlled,
and subject the financial institution to potential losses in excess of
a reasonable limit that, if left unchecked, may threaten its viability.
5. A rating of 5 represents critically deficient asset quality or
credit administration practices that present an imminent threat to the
The capability of the board of directors and management to
identify, measure, monitor, and control the risks of an institution's
activities and to ensure a financial institution's safe, sound, and
efficient operation in compliance with applicable laws and regulations
is reflected in this rating. Depending on the nature and scope of an
institution's activities, management practices may need to address some
or all of the following risks: credit, market, operating or
transaction, reputation, strategic, compliance, legal, liquidity, and
other risks. Sound management practices are demonstrated by: active
oversight by the board of directors and management; competent
personnel; adequate policies, processes and controls addressing areas
of an institution's operations; and effective risk monitoring and
management information systems. This rating should reflect the board's
and management's ability as it applies to all aspects of banking
operations as well as other financial service activities in which the
institution may be involved.
The performance of management and the board of directors and the
quality of risk management is rated based upon an assessment of:
The level and quality of oversight and support of
institution activities by the board of directors and management.
The ability of the board of directors and management to
plan for, and respond to, changing circumstances, and address risks
that may arise from changing business conditions or the initiation of
new activities or products.
The adequacy of, and conformance with, internal policies
and controls addressing the operations and risks of significant
The accuracy, timeliness, and effectiveness of management
information and risk monitoring systems.
The adequacy of audits and internal controls to: promote
effective operations and reliable financial and regulatory reporting;
safeguard assets; and ensure compliance with laws, regulations, and
Compliance with laws and regulations.
Responsiveness to recommendations from auditors and
Management depth and succession.
The extent that the board of directors and management is
affected by, or susceptible to, dominant influence or concentration of
Reasonableness of compensation policies and avoidance of
Demonstrated willingness to serve the legitimate banking
needs of the community.
The overall performance of the institution and the level
of risk to which it is exposed.
1. A rating of 1 indicates strong performance by management and the
board of directors and strong risk management practices. All
significant risks are consistently and effectively identified,
measured, monitored, and controlled. Management and the board have
demonstrated the ability to promptly and successfully address existing
and potential problems and risks.
2. A rating of 2 indicates satisfactory management and board
performance and risk management practices. Minor weakness may exist,
but are not material to the safety and soundness of the institution and
are being addressed. In general, significant risks and problems are
effectively identified, measured, monitored, and controlled.
3. A rating of 3 indicates management and board performance or risk
management practices that need improvement. Performance or risk
management practices are less than satisfactory given the nature of an
institution's activities. The capabilities of management and the board
of directors may be insufficient for the type, size, or condition of
the institution. Problems and significant risks may be inadequately
identified, measured, monitored, or controlled.
4. A rating of 4 indicates deficient management and board
performance or risk management practices. Risk management practices are
inadequate considering the institution's activities, or the level of
problems and risk exposure is excessive. Problems and significant risks
are inadequately identified, measured, monitored, or controlled and
require immediate action by the board and management to preserve the
soundness of the institution. Replacing or strengthening of management
or the board may be necessary.
5. A rating of 5 indicates critically deficient management and
board performance or risk management practices. Management and the
board of directors have not demonstrated the ability to correct
problems and implement appropriate risk management practices. Problems
and significant risks are inadequately identified, measured, monitored,
or controlled and now threaten the continued viability of the
institution. Replacing or strengthening of management or the board of
directors is necessary.
This rating reflects not only the quantity of earnings, but also
factors that may affect the sustainability or quality of earnings. The
quantity as well as the quality of earnings can be affected by
excessive or inadequately managed credit risk, that may result in loan
losses and require additions to the allowance for loan and lease
losses, or high levels of market risk, that may unduly expose an
institution's earnings to volatility in interest rates. The quality of
earnings may also be diminished by undue reliance on extraordinary
gains, nonrecurring events, or favorable tax effects. Future earnings
may be adversely affected by: an inability to forecast or control
funding and operating expenses; improperly executed or ill-advised
business strategies; or poorly managed or uncontrolled exposure to
The rating of an institution's earnings will be based on an
The level of earnings, including trends and stability.
The ability to provide for adequate capital through
The quality and sources of earnings.
The level of expenses in relation to operations.
The adequacy of the budgeting systems, forecasting
processes, and management information systems in general.
The exposure to credit risk and the adequacy of the
allowance for loan and lease losses and other valuation allowance
The exposure to market risks such as interest rate,
foreign exchange, and price risks.
The level of compliance with applicable laws and
1. A rating of 1 indicates earnings that are strong. Earnings are
sufficient to support operations and maintain an adequate level of
capital after consideration is given to risks and other factors
affecting the quality and quantity of earnings.
2. A rating of 2 indicates earnings that are satisfactory. However,
earnings that are relatively static, or even experiencing a slight
decline, may receive a 2 rating provided the institution's level of
earnings is adequate in view of the assessment factors listed above.
3. A rating of 3 should be accorded to earnings that need to be
improved in order to fully support operations and provide for the
accretion of capital in relation to the financial institution's
4. A rating of 4 indicates earnings are deficient to support
operations and retain an appropriate capital level. Institutions so
rated may be characterized by erratic fluctuations in net income or net
interest margin, the development of a significant negative trend,
nominal earnings, unsustainable earnings, intermittent losses or a
substantive drop in earnings from the previous year.
5. A rating of 5 indicates earnings performance that is critically
deficient. A financial institution with earnings rated 5 is
experiencing losses that represent a distinct threat to its viability
through the erosion of capital.
In evaluating a financial institution's liquidity position and
risk, consideration should be given to current and prospective sources
of liquidity compared to funding needs, as well as to the adequacy of
funds management practices. In general, funds management practices
should ensure that an institution is able to maintain a level of
liquidity sufficient to meet its financial obligations in a timely
manner and to fulfill the legitimate credit needs of its community.
Practices should reflect the ability of the institution to manage
unplanned changes in funding sources, as well as react to changes in
market conditions that affect the ability to quickly liquidate assets
with minimal loss. In addition, funds management practices should
ensure that liquidity is not maintained at a high cost, or through
undue reliance on funding sources that may not be available in times of
financial stress or adverse changes in market conditions.
Liquidity is rated based on a review and assessment of:
The adequacy of liquidity sources compared to present and
future needs and the ability of the institution to meet liquidity needs
without adversely affecting operations or condition.
The availability of assets readily convertible to cash
without undue loss.
Access to money markets and other sources of funding.
The level of diversification of funding sources, both on-
and off-balance sheet.
The degree of reliance on short-term, volatile sources of
funds, including borrowings and brokered deposits.
The trend and stability of deposits.
The ability to securitize and sell certain pools of
The competence of management to properly identify,
measure, monitor and control the institution's liquidity position,
including the effectiveness of funds management strategies, liquidity
policies, management information systems, and contingency funding
Compliance with applicable laws and regulations.
1. A rating of 1 indicates a strong liquidity position and well-
developed funds management practices after consideration of risk and
other factors. The institution has reliable access to a sufficient
volume of liquidity to meet present and anticipated liquidity needs.
Access to external sources of funds is on favorable terms.
2. A rating of 2 indicates satisfactory levels of liquidity and
risks, but modest weaknesses may be evident in quantitative measures of
liquidity or in funds management practices given risk exposures.
3. A rating of 3 denotes liquidity and risk levels or funds
management practices in need of improvement. Institutions rated 3 for
liquidity may lack ready access to funds on reasonable terms and may
evidence significant weaknesses in funds management practices given
4. A rating of 4 represents a deficient liquidity and risk position
for current and anticipated needs and inadequate funds management
practices. Institutions so rated may not be able to obtain funds from
traditional funding sources to meet risk exposures.
5. A rating of 5 indicates a liquidity and risk position so
critically deficient that the continued viability of the institution is
threatened. Institutions rated 5 for liquidity require immediate
external financial assistance to meet maturing obligations and other
Sensitivity to Market Risks
The sensitivity to market risks component reflects the degree to
which changes in interest rates, foreign exchange rates, or commodity
or equity prices can affect a financial institution's assets, earnings,
liabilities and capital values. The capacity of management to identify,
measure, monitor and control market risk exposure is also a factor that
should be considered. Market risks encompass interest rate risk, price
risk, and foreign exchange risk. The primary element considered in
evaluating market risks is the sensitivity of assets, liabilities, off-
balance sheet commitments, and earnings to variability in interest
rates. This vulnerability is measured by potential changes in earnings
or economic value of capital under an appropriate range of economic
scenarios. When significant to an institution, consideration should
also be given to the price risk related to trading and investment
portfolios. If applicable, the foreign exchange risk to assets,
earnings, and capital should also be considered because of the periodic
revaluation of financial positions denominated in foreign currencies
into U.S. dollar equivalents.
Market risks are rated based on an assessment of the following, as
The sensitivity of the financial institutions's net
earnings or the economic value of its capital to changes in interest
rates under varying scenarios and stress environments.
The volume, composition, and volatility of any foreign
exchange or other trading positions taken by the financial
The actual or potential volatility of earnings or capital
because of any change in market valuation of trading portfolios or
The ability of management to identify, measure, monitor
and control exposure to interest rate risk, as well as price and
foreign exchange risk where applicable and material to an institution.
1. A rating of 1 indicates minimal exposure to interest rate, price
or foreign exchange risk. Institutions rated 1 have limited exposure to
interest rate and other market risks and have strong management systems
in place to identify, measure, monitor and control these risks.
2. A rating of 2 is indicative of moderate and controlled exposure
to interest rate, price or foreign exchange risk. Management systems
are satisfactory, and ensure that market risks are maintained at an
3. A rating of 3 indicates that one or more elements of this
component are in need of improvement. A 3 rating may reflect an
elevated level of interest rate sensitivity or exposure. It may also
indicate significant foreign exchange or repricing exposures which
subject earnings and capital to a moderate level of volatility.
Management systems for market risks may reflect weaknesses and need
4. A rating of 4 reflects a financial institution that exhibits
exposures to market risks that may erode earnings and threaten
solvency. A 4 rating indicates an inordinate exposure to changes in
interest rates, or to foreign exchange revaluation or other repricing
effects. Management systems for market risks are deficient.
5. A rating of 5 reflects a financial institution with extreme
interest rate, foreign exchange, or price risk exposure constituting a
critical deficiency, and the continued viability of the institution is
[End of proposed text of Uniform Financial Institution Rating System.]
Keith J. Todd,
Assistant Excecutive Secretary, Federal Financial Institutions
[FR Doc. 96-18187 Filed 7-17-96; 8:45 am]
BILLING CODE OCC: 4810-33-M (25%); Board: 6210-01-M (25%); FDIC: 6714-
01-M (25%); OTS: 6720-01-M (25%)