CAMELS: Holier Than Cows

India, as usual, is rejecting the ways and regulations of the West in favour of internal and customary Banking regulations. Currently, India is regulated by a CAMELS system which grades banks based on their reliability, compliance with regulations, and probability of default. (See article)

The problems with this system become apparent when examining the Reserve Bank of India, equivalent to the Bank of Canada or Federal Reserve, and their measurement methods. The banks within India are being assessed by a corporation that answers only to their own country. It is difficult to assign quantitative values based on the qualitative information being used to classify each bank as being either Composite 1 rating, down to Composite 5 rating. Composite 1 rating would classify the bank as sounds, safe, and reliable in their investments and deposits, and the safety and soundness of the bank decreases with the increased number, leaving Composite 5 rating used to classify a bank which is unsound, unsafe, and unreliable in their loans, with a high rate of default. Because these classifications are assigned within the country, there is no international standard with which to standardize them.

Basel III is a system that would apply internationally. It works to hold every bank within its jurisdiction to the same quantitative standards. Basel III sets percentage rates based on loan risk and total assets. Basel III removes the opportunity for asymmetrical information in the global financial market.
As it stands, CAMELS regulations, within any given country, reduces asymmetrical information, in the form of moral hazard, by holding each bank accountable to the same national standards. India is arguing that they should maintain this method of regulation, because they see the problem of moral hazard as remedied. If the banks within India are kept to the same standard, and all of their banking information is shared, the problem of moral hazard is solved.

Unfortunately, this does not provide any solution to the international problem of moral hazard. Basel III does. Basel III maintains consistent standards for all banks, and has a strict implication system which does not allow for differing classification standards within any nation. The regulators, such as the Reserve Bank of India, would now answer to a system which supersedes their classification structure, which would disallow for any asymmetrical information on the global financial market.

So, not only would the moral hazard issue within the country be resolved, because the Reserve Bank of India would still be regulating the classifications, but on an international scale, all regulators would be answering to the same banking reserve structure. The report made on India’s position, regarding the CAMELS to Basel III debate, was largely misguided, as the writer failed to see the bigger picture. Too much focus was made on an East versus West basis, and not enough was spent on the global economic picture. It’s global interaction on the financial markets that will increase the stability of every country’s economic standing, including their GDP.

Jaci MacKendrick
Nicole Hanbury
Rhonda Sandve
Michael Daigle
James Trujillo
Christie Aquino