Financial Institutions
Financial institutions are rated from acquired market data for the purpose of evaluating an institution's safety and soundness. This is done by evaluating the various types of risk that are associated with financial institutions. Insured financial institutions use the CAMELS rating system which is a well-recognized international rating system. Bank supervisory authorities use six factors that are represented by CAMELS acronym. Each financial institution is assessed and evaluated and it is then assigned a score on a scale according to the six factors. According to this rating system, a score of one is considered to be the best while a rating of five is considered to be the worst.
Financial Institutions
CAMELS rating system is an international recognized rating system that bank authorities use for the purpose of rating financial institutions. Bank supervisory authorities use six factors that are represented by CAMELS acronym. Each financial institution is assessed and evaluated and then is assigned a score on a scale according to the six factors. According to this rating system, a score of one is considered to be the best while a rating of five is considered to be the worst (Federal Deposit Insurance Corporation, 2018). Wells Fargo Bank Limited was started in 1985 and it has been an FDIC-insured bank. As of December 31st, 2017, Wells Fargo Bank had earned a full five stars for safety meaning it exhibited a superior condition (Wells Fargo Bank Limited, 2017). The beginning of 2018 was however different for Wells Fargo since there were news that its performance had been downgraded to a three. This is not good news according to the size and type of the institution because it means that the board of directors or the management maybe insufficient for the condition of the institution.
Rating of Three for Wells Fargo Bank
For Wells Fargo Bank, a rating of three is not a rate to brag about since with this type of rating the management is likely to face an enforcement action. This is because any insured institution must comply with regulations that pertain to risk. This is done through evaluation of capital trend analysis which also helps determine an institution's capital adequacy. With a rating of three Wells Fargo might find difficulties meeting all its obligations towards its customers without ceasing its operations and hence why it may require to face an enforcement plan. Earnings in a bank are determined by how profitable a bank is which also affects its safety. Earnings increase the capital buffer of an institution or in some cases earnings are used to deal with problematic loans which make the bank more resilient.
Risks in Financial Institutions
One of the main objectives that the management of financial institutions has had is to increase returns. As a result, increase in returns usually comes at the cost of increased risk such as credit risk, operational risk, market risk, liquidity risk among others (McGraw-Hill/Irwin, 2015). Credit risk arises when the promised cash flows in form of securities and loans held by the financial institution fail to be paid in full. This is the reason as to why financial institutions go through the process of screening and monitoring loan applicants to ensure that only the creditworthy applicants receive loans. Increase in liability withdrawals may drive a financial institution to liquidate assets at lower prices leading to a type of risk called liquidity risk. Although liability holders generally have withdrawals from day-to-day and hence predictable, some large withdrawals by liability holders results to liquidity problems (McGraw-Hill/Irwin, 2015).
On the other hand, changes in interest rates, exchange rates and changes in other asset prices during in trading assets and liabilities give rise to market risk. Market risk is closely related to interest rate risk is derived from volatile interest rates leading to a mismatch of an institution's assets and liabilities.
Conclusion
Financial institutions are rated from acquired market data for the purpose of evaluating an institution's safety and soundness. This is done by evaluating the various types of risk that are associated with financial institutions. Insured financial institutions use the CAMELS rating system which is a well-recognized international rating system.
References
Federal Deposit Insurance Corporation. (2018, August 1st). Retrieved from Federal Deposit Insurance Corporation: https://www.fdic.gov/bank/analytical/banking/br17n1full.pdf
McGraw-Hill/Irwin. (2015). Risk management and type of risk faced by financial institution. New York: The McGraw-Hill Companies,2015.
Wells Fargo Bank Limited. (2017, December 31st). Wells Fargo Bank Limited. Retrieved from Annual Report: https://www.bankrate.com/banks/wells-fargo-bank-ltd/167565/
