Bank Ratings: What They Are and How They Work

A bank rating is a grade—letter, number, or composite score—assigned to banks and thrift institutions to communicate their financial safety, soundness, and credit risk. Ratings help consumers, investors, and regulators understand a bank’s ability to meet obligations and withstand economic stress, and they guide bank management on areas needing improvement.

Who issues bank ratings

• Regulatory agencies (e.g., FDIC, federal/state bank supervisors) evaluate safety and soundness and assign supervisory ratings. These exams are typically updated regularly.
• Credit rating agencies (e.g., S&P, Moody’s, Fitch) assess creditworthiness and the ability to pay debt obligations on time. Their ratings focus on default risk for bondholders and other creditors.

Regulatory and credit ratings serve different audiences and purposes: regulators emphasize depositor protection and compliance, while credit agencies focus on debt repayment risk.

The CAMELS framework

Many regulators use the CAMELS acronym to evaluate banks. Each letter represents a key area of supervision:

• Capital adequacy: Size and quality of capital relative to risks and regulatory requirements.
• Asset quality: Credit risk in loans and investments; portfolio diversification and loss exposure.
• Management: Quality of governance, risk management, strategy, and responsiveness to changing conditions.
• Earnings: Profitability and sustainability of income sources, including interest margin and fee revenue.
• Liquidity: Ability to meet short-term obligations and customer withdrawals using readily marketable assets.
• Sensitivity to market risk: Exposure to interest rates, commodity prices, and other market movements.

Supervisory rating scale (example: FDIC)

Regulators commonly use a 1–5 scale for composite safety-and-soundness ratings:
– 1 — Sound in all respects; strong fundamentals and risk management.
– 2 — Fundamentally sound with only moderate weaknesses.
– 3 — Moderate to severe weaknesses; requires heightened supervision.
– 4 — Unsafe and unsound practices; serious financial or managerial problems; failure possible.
– 5 — Critically deficient and at high risk of failure; immediate supervisory concern.

Note: CAMELS composite ratings are typically confidential supervisory information and not publicly disclosed for individual banks.

How credit ratings work (brief example)

Credit rating agencies use letter-grade systems (e.g., AA, A, BBB) plus modifiers. For short-term ratings they use separate symbols (e.g., F1). Higher grades indicate lower default risk and stronger capacity to meet obligations. A “+” or “-” shows relative strength within a category. Because methodologies differ, it’s useful to consult multiple agencies.

Why ratings matter

• For depositors and customers: they provide a signal of a bank’s financial health.
• For investors and creditors: they indicate default risk and influence borrowing costs.
• For markets: they support transparency and help allocate capital efficiently.

Limitations and cautions

• Ratings are opinions based on available data and are forward-looking, not guarantees. Highly rated institutions can still deteriorate.
• Methodologies vary; no single rating is definitive. Use ratings alongside financial statements, regulatory actions, capital ratios, and news about asset quality or liquidity.
• Supervisory (CAMELS) ratings may not be publicly available; credit ratings and financial disclosures are commonly used by the public.

Practical tips for using bank ratings

• Check multiple credit rating agencies for a fuller picture.
• Review a bank’s reported capital ratios, nonperforming loan trends, and liquidity metrics.
• Watch for regulatory actions, enforcement orders, or public supervisory findings.
• For investment decisions, combine ratings with balance-sheet analysis and macroeconomic context.

Key takeaways

• Bank ratings summarize safety, soundness, and credit risk and are issued by regulators and private rating agencies.
• CAMELS evaluates capital, assets, management, earnings, liquidity, and sensitivity.
• Ratings are useful but imperfect—use them together with financial metrics and supervisory information when evaluating a bank.