Bank Examination

What Is a Bank Examination?

A bank examination is an evaluation of the financial wellbeing and versatility of a bank. Bank examinations are principally worried about the strength of the bank's balance sheet. Nonetheless, they likewise incorporate a survey of its regulatory compliance and internal controls.

In the United States, examinations of national banks are carried out by the Office of the Comptroller of the Currency (OCC), while examinations of state-contracted banks are carried out by the Federal Deposit Insurance Corporation (FDIC). For bank holding companies, examinations are carried out by the Federal Reserve.

How Bank Examinations Work

The interaction for directing bank examinations depends on the supposed CAMELS Rating System, which is an abbreviation illustrating the six major areas of examination. These comprise of examinations of the bank's capital adequacy, asset quality, management, earnings, liquidity, and sensitivity to systemic risk.

In light of these six qualities, banks are assigned a rating on a scale of 1 to 5. Each bank will receive a separate rating for every category, alongside an overall outcome. A score of 1 shows an extremely positive outcome, while 5 demonstrates an exceptionally weak outcome. In the event that a bank scores 4 or 5 on its overall survey, it will be put on a special watchlist for additional examination by regulators.

The capital adequacy criteria connects with the bank's tier one and tier two capital, and whether these funds are adequate to support its banking operations under conditions of stress. In like manner, the asset quality condition connects with questions, for example, whether the bank's loan portfolio is adequately diversified, and whether its loss provisions are in accordance with industry standards.

Concerning the management criteria, regulators will need to guarantee that the bank's executive team have a reasonable operational strategy and comprehension of their association's unique risks, as well as a robust protocol for guaranteeing legal and regulatory compliance. As to the earnings criteria, regulators will analyze the earnings quality of the bank, and whether those earnings seem adequately stable to support the bank would it be advisable for it go under strain.

Ultimately, the liquidity and sensitivity criteria relate to the bank's level of stability in the face of expected shocks to the financial system. Concerning, regulators will measure the bank's ability to meet its financial obligations, utilizing liquidity tests, for example, the current ratio, acid test, quick ratio, and cash ratio.

While assessing the bank's sensitivity to systemic risk, regulators will frequently utilize complex financial models that recreate the bank's financial performance subject to different likely adverse changes in financial markets. Instances of such changes incorporate rising interest rates, increased loan default rates, declines in the value of investment holdings, and defaults by derivative counterparties.

Real World Example of a Bank Examination

Dana is an investor who routinely surveys the examination aftereffects of major banks. As part of his investment screening process, he peruses the latest bank examination for a national bank called XYZ Financial.

In summing up the outcomes from the examination, Dana notes that XYZ received a CAMELS score of 5 in the asset quality category. Fascinated, he dug further to discover that XYZ's loan portfolio is exceptionally packed in a particular sector which is currently facing [disruption](/troublesome innovation) from new entrants.

Given the vulnerability in that industry sector, the regulators raised worries concerning whether XYZ's [debtors](/account holder) might not be able to repay their obligations. In that scenario, XYZ could face higher than normal loss rates on its loan portfolio, calling into question its profitability, liquidity, and capital reserves.

With this data close by, Dana chooses to keep away from XYZ Financial until there is less vulnerability encompassing the quality of its loan portfolio.

Features

• They are led by regulatory and legislative institutions like the OCC, the FDIC, and the Federal Reserve.
• Bank examinations are evaluations of the financial strength of banks.
• Bank examinations utilize a six-part analysis intended to measure the quantitative and qualitative strength of the banks being referred to.