`CAEL’ Ratings and its Correlation to Pricing Stocks— An Analysis of Indian Banks

The objective of this paper is to assess the relationship between the CAMEL ratings and the bank stock performance. The viability of the banks has been analyzed on the basis of the Off-site Supervisory Exam Model—CAMEL Model (C for Capital Adequacy, A for Asset Quality, E for Earnings, L for Liquidity). The M for Management has not been considered in this paper because all Public Sector Banks, (PSBs) are government regulated, and also because all other four components—C, A, E and L—reflect management quality. The remaining four components have been analyzed and rated to judge the composite rating. Part A of the study analyzes the interbank performance by determining their CAEL composite score. Part B of the study assesses the relation between the banks’ composite CAMEL ratings with the banks’ stock performance. The paper finds that the Off-site Supervisory Exam Model, CAMEL, is related to the banks’ stock performance in the capital market. The private supervisory information gathered by bank examiners in the form of CAMEL ratings does filter into the financial markets, in spite of the fact that they are confidential and not disclosed to the public. The findings of this study will be important in the context of the banking reforms being undertaken, especially, the government’s plan to consolidate the banking industry, i.e., future bank mergers and acquisitions. On the basis of our findings, the paper argues the disclosure of the bank supervisory information like CAMEL ratings, to facilitate correct pricing of the bank stock.