Why regulators’ confidential bank ratings should not be public information

The failure of three multibillion-dollar regional banks in the first half of 2023 has understandably resulted in a great deal of concern and debate in Congress and among the public. 

Those failures stemmed from the management and directors of those banks engaging in unsafe and unsound banking practices. State and federal bank regulators, while having every tool needed at their disposal, did not properly supervise those banks, in terms of promptly ordering them to cease and desist their risky activities.

One criticism of the regulators that has been leveled, however, is highly objectionable. Some argue that a sure-fire solution to the problem is to increase depositor discipline by publicly disclosing the currently confidential “CAMELS” (capital adequacy, asset quality, management, earnings, liquidity and interest-rate sensitivity) ratings issued by bank regulators.  

The CAMEL rating system (the predecessor to the current CAMELS system, which added interest-rate sensitivity) was developed by the Federal Deposit Insurance Corporation, the Comptroller of the Currency and the Federal Reserve when I was chairman of the Federal Deposit Insurance Corporation.

The CAMEL system’s purpose was to provide a uniform way for the agencies to express their view of the condition of each bank based on the results of regulatory examinations. The quality of each factor in the rating system was rated 1 through 5 — with 5 being the worst — and the bank was also given a composite rating on the same scale. 

A 1-rated bank has no significant issues of concern to the regulators, a 2-rated bank is considered good, a 3-rated bank has problems that need attention, a 4-rated bank has significant problems that need immediate attention and a 5-rated bank has roughly a 50-50 chance of failing and needs immediate remediation.

The regulators provide the bank and its directors with the bank’s CAMELS rating, answer any questions they might have and discuss the remediation efforts expected of the bank. The discussion is usually quite forceful for banks rated 4 or 5. In the early years of the system during the 1980s, there were some 3,000 bank and thrift failures and thousands of additional banks and thrifts rated 3 or worse on the regulators’ problem bank list.

The regulators knew that making the rating public would immediately impose substantial market discipline on 3, 4, and 5-rated banks. But after much discussion, this notion was strongly rejected. 

The CAMELS rating, as the opinion of bank regulators, is not necessarily correct. Due to the substantial complexity and judgment involved in determining a rating, and the damage it could cause to the bank if made public, it would place enormous pressure on examiners, likely causing them to rate banks better than their instincts were telling them. This would be particularly true in the case of larger banks. In addition, publicly disclosing the ratings of all banks could lead to a catastrophic loss of confidence and widespread public panic.

Rather, the solution to this conundrum was, and still is, to disclose publicly the facts about the banks (including the existence of any enforcement actions) that led the examiners to their rating, but not disclose the ratings themselves. Moreover, we decided not to disclose identifying information about customers of banks to maintain their privacy.

Regulators rightly believe that they can help turn around troubled banks, given the time to do so. Announcing publicly the CAMELS ratings would significantly accelerate the time a poorly rated bank would have to implement corrective actions and greatly increase the failure rate. A large percentage of the banks remediate their problems after discussing their rating and don’t fail. Indeed, roughly half of the 5-rated banks ultimately recover.

In sum, the CAMELS rating system has improved bank supervision substantially and brought more uniformity and objectivity to the process. Those who would make the ratings public are simply wrong. It would lead to a significant increase in depositor stress and avoidable panics, more bank failures, much higher costs to the FDIC and the banking industry and a less competitive banking system. 

We got it right when we developed the system — let’s not change course now.

William M. Isaac, former chairman of the FDIC & Fifth Third Bancorp, is chairman of Secura/Isaac Group, a consultancy to financial institutions globally. The views expressed are his alone and do not necessarily reflect the views of any firm with which he is or has been associated.