Bank examinations are conducted by regulatory bodies to assess safety and soundness of banks. The primary regulator of nationally chartered banks in the United States is the Office of the Comptroller of the Currency (OCC). The regulator conducts risk-based examinations of community, mid-size, and large banks, as well as of foreign bank branches holding a national charter. The purpose of bank examinations is to assess a bank's overall performance (composite rating), and six CAMELS components:
The composite and individual components are assigned one of the ratings:
- Needs improvement
- Critically deficient
The composite rating is not an arithmetical average of each component, but rather an overall assessment of the bank's performance, which could be driven by one risk area.
CAMELS rating assessment
Capital adequacy is determined based on sufficiency of capital levels in relation to risk levels. Asset Quality rating is determined based on the quality of the loan portfolio and other credit risk bearing assets, the amount of credit risk exposure, and the quality of credit administration practices. Management rating is based on assessment of the quality of board oversight and management supervision of bank activities. Earnings performance is assessed based earnings ability to support bank operations and maintain adequate capital and reserve levels. The rating considers the level, trend, and quality of earnings. Liquidity rating is based on availability of sufficient liquid sources to support current and anticipated funding needs as well as the adequacy of liquidity risk management practices. Sensitivity to market risk is assessed based on how well management controls interest rate, price, and market risks. The rating considers the quantity of risk and the adequacy of risk management practices.
Frequency of bank examinations
The Federal Deposit Insurance Corporation Improvement Act of 1991 established examination cycles for full scope examinations, with an outside limit of 18 months. The length of the examination cycle varies depending on bank rating and size (total assets). Banks in troubled condition are subject to more frequent examinations. The frequency of bank examinations also increases during a financial crisis as more supervisory oversight is needed during troubled times to ensure the safety and soundness of the financial systems
Bank examinations vs. audits
Regulatory bank examinations are different from audits; however, studies have shown that bank examinations contribute to discovery of financial reporting errors and accounting errors. Both the risk of financial misstatements and regulatory oversight increase when financial performance deteriorates or when banks report substandard performance. In troubled times, supervisory attention is enhanced to ensure a speedy return of the institution to a safe and sound condition This dynamic allows bank examinations to act like a control function in troubled times. Examiners rely on the Call Reports filed by banks to assess the institutions’ financial performance. Examinations test the accuracy of the Call Reports, which allows regulators to uncover reporting errors in financial reporting. Thus, bank examinations may lead to restatements of financial results if the errors are material
- Office of the Comptroller of the Currency, (2018) Comptroller’s Handbook. Version 1.0. Introduction, Component Ratings, s.68-75.
- Gunther, J., Moore R., (2003), Journal of Financial Intermediation 12.2 (2003), Loss underreporting and the auditing role of bank exams, nr 2, s.153-177.
- Hirtle, B., Lopez, J., (1999).Supervisory information and the frequency of bank examinations, Robustness Checks, s.13,16.
- Examination Process. (2018)
- Examination process. (2018)
- Hirtle, Lopez. (1999)
- Gunther, Moore. (2002)
Author: Daniel Gaura