[Federal Register Volume 61, Number 139 (Thursday, July 18, 1996)]
[Notices]
[Pages 37472-37478]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 96-18187]


=======================================================================
-----------------------------------------------------------------------

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

[[Page 37473]]

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 
system.
    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 
20429.
OTS: William J. Magrini, Senior Project Manager, (202) 906-5744, 
Supervision Policy, Office of Thrift Supervision, 1700 G Street NW., 
Washington, DC 20552.

SUPPLEMENTARY INFORMATION:

Background Information

    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 
concern.
    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 
financial institutions.
    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 
warranted.
    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 
exchange risk.
    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

[[Page 37474]]

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 
questions:
    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

Introduction
    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 
rating descriptions.
---------------------------------------------------------------------------

    \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 
credit unions.
---------------------------------------------------------------------------

    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 
trends.
    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.
Overview
    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

[[Page 37475]]

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 
composite rating.
    The following two sections contain the composite rating 
definitions, and the descriptions and definitions for the six component 
ratings.

Composite Ratings

    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 
follows:

Composite 1

    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.

Composite 2

    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 
limited.

Composite 3

    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.

Composite 4

    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.

Composite 5

    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 
appropriate agencies.

Component Ratings

    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.

Capital Adequacy

    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 
assessment of:
     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.

[[Page 37476]]

     The nature, trend, and volume of problem assets, and the 
adequacy of allowances for loan and lease losses and other valuation 
reserves.
     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.

Ratings

    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 
management practices.
    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.

Asset Quality

    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 
assessment of:
     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 
nonperforming assets.
     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 
investment portfolios.
     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, 
and practices.
     The ability of management to properly administer its 
assets, including the timely identification and collection of problem 
assets.
     The adequacy of internal controls and management 
information systems.
     Compliance with applicable laws and regulations.

Ratings

    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 
concern.
    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 
attention.
    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 
management practices.
    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 
institution's viability.

Management

    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 
activities.
     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 
internal policies.

[[Page 37477]]

     Compliance with laws and regulations.
     Responsiveness to recommendations from auditors and 
supervisory authorities.
     Management depth and succession.
     The extent that the board of directors and management is 
affected by, or susceptible to, dominant influence or concentration of 
authority.
     Reasonableness of compensation policies and avoidance of 
self-dealing.
     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.

Ratings

    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.

Earnings

    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 
other risks.
    The rating of an institution's earnings will be based on an 
assessment of:
     The level of earnings, including trends and stability.
     The ability to provide for adequate capital through 
retained earnings.
     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 
accounts.
     The exposure to market risks such as interest rate, 
foreign exchange, and price risks.
     The level of compliance with applicable laws and 
regulations.

Ratings

    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 
inherent risks.
    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.

Liquidity

    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.

[[Page 37478]]

     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 
assets.
     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 
plans.
     Compliance with applicable laws and regulations.

Ratings

    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 
risk exposures.
    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 
liquidity needs.

Sensitivity to Market Risks

    The sensitivity to market risks component reflects the degree to 
which changes in interest rates, foreign exhchange 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 assement of the following, as 
appropriate:
     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 
institutions.
     The actual or potential volatility of earnings or capital 
because of any change in market valuation of trading portfolios or 
financial instruments.
     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.

Ratings

    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 
acceptable level.
    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 
improvement.
    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 
threatened.

[End of proposed text of Uniform Financial Institution Rating System.]
Keith J. Todd,
Assistant Excecutive Secretary, Federal Financial Institutions 
Examination Council.
[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%)