Time To Decouple The 'M' From CAMEL?

Is it time to decouple the "M" in CAMEL ratings from the other components of CAMEL?

In 2010, the National Credit Union Administration (NCUA) Office of the Inspector General (OIG) issued a "Capping Report" summarizing 10 material loss reviews (MLRs) on credit union failures during the height of the economic crisis, 2008-2010. One of the main conclusions of the report (unsurprisingly) was that credit union management's actions contributed to every failure.

Since 2010, material loss reviews of credit union failures have also indicated that management's actions led to the failures. Because of this, of management-related findings in healthy credit unions and the increased congressional and legislative scrutiny on corporate governance in all financial institutions, regulators have been paying extra close attention to the Management component of CAMEL.

As all who work in credit union regulation or operations know, the CAMEL ratings system is used by regulators to evaluate the safety and soundness of credit unions. CAMEL is designed to take into account and reflect all significant financial, operational and management factors examiners use in their evaluation of a credit union's performance and risk profile. This system, adopted by the credit union regulators in 1987 (a similar rating system has been used in banking since 1979), is based upon five critical elements of a credit union's operations: (C) Capital Adequacy, (A) Asset Quality, (M) Management, (E) Earnings and (L) Asset/Liability Management.

Regulators also employ the risk-based methodology to assess a credit union's condition and determine the CAMEL rating. In this approach, the following risk categories are considered: Credit, Interest Rate, Liquidity, Transaction, Compliance, Strategic and Reputation.


What We're Hearing

A credit union's performance with respect to most elements of the CAMEL is often the result of decisions made by the credit union's directors and officers. Consequently, examiner findings and conclusions in regard to the other four elements of the CAMEL rating system are often the major determinants of the management rating.

We're hearing from some that this method of evaluating management is not as accurate an assessment as once thought. Should regulators be more often looking at "M" in CAMEL in its own right rather than merely as a distillation of all other components of the CAMEL?

Lessons learned from both healthy credit unions that deteriorated rapidly and from troubled credit unions that were able to stabilize their operations tell us that the "M" in CAMEL must be at least partially decoupled from the other components of the rating, rather than being treated as a by-product of the overall perceived condition of the credit union.

Sometimes, credit unions with weak growth have solid management while at other times, credit unions with strong growth have management in need of development. Some well-run credit unions were confronted by a unique confluence of events, the perfect storm, that while perhaps not unforeseeable in the strictest sense, was for all practical purposes the equivalent of the hundred year flood. In those cases, we have seen management react swiftly, decisively, and effectively to confront, contain and mitigate losses. Yes, the credit unions suffered, but ultimately the reaction of the management in conjunction with supervisory action, saved institutions that might otherwise have been lost.

Can a "strong" credit union have less-than-stellar management? Could a "weak" credit union have good management? Should the examiners attempt to make that assessment? How those questions are answered could have far reaching implications for the future evolution of the CAMEL rating system and credit union supervision.


Questions Being Asked By Regulators

One possible answer lies in the increasing shift toward a forward-looking assessment of the institution's risk management programs to truly assess the capabilities of management. In other words, regulators are evaluating the strength of the controls that are present relative to the amount of risk the institution undertakes in its activities. In short, regulators are employing an enterprise wide risk management perspective to examinations. In shifting to this perspective, regulators are asking the following questions as they look at the credit unions they supervise:

* Does the credit union have effective board oversight and corporate governance practices, policies and procedures?

* Are the board and management forward-looking and active participants in managing risk?

* Does management ensure that appropriate policies and limits exist and are understood, reviewed, and approved by the board?

* Is management fully prepared to address risks emanating from new products and changing market conditions?

As part of this perspective, examiners are also evaluating common weaknesses in a credit union's risk framework, asking such questions as, does the board put too much emphasis on return on assets without considering risk factors? Also, regulators are particularly looking at a credit union's compensation plans: do these plans incent long-term growth or short-term returns?

As you can see from the questions above, at the foundation of sound credit union management is active oversight by the credit union boards. As such, directors must understand the major risks that impact their credit union.

As for the "M" in CAMEL, perhaps a new perspective will help identify troubles before they become insurmountable, while also allowing management the time they need to turn around a dire situation. Perhaps, as has been suggested by some, decoupling the Management rating from the other components of CAMEL will ultimately lead to a more efficient, safe and sound system.



Mary Martha Fortney is the president and CEO of the National Association of State Credit Union Supervisors (NASCUS). She can be reached at marymartha@nascus.org or (703) 528-8688.