Bank condition is a
random variableused to represent the probability of failureof a bank. The true probability of failure is unknown to depositors as well as regulators. Even the bank managers themselves who manage the risky asset portfolio of the bank might not have an accurate information about the probability of failure.
Notice that the estimation of the bank managers are the closest to the true probability of failure, then comes the evaluation of bank regulators and finally that of the investors.
CAMELS ratingsin U.S. are intended to reflect the evaluation of regulators and supervisors about bank condition. These evaluations are not publicly released but only given to the bank managers. Banks pay deposit insurance premium to the FDICbased on their rating. A 1 or 2 rating bank do not pay a premium since it is considered to be safe. This is ironic, given the fact that one-third of the 1037 banks that failed between 1984 and 1992 have had a 1 or 2 rating (deemed very safe) only two years prior to their failure.
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