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.

Over the past decade, bank regulators have introduced a number of measures to link the regulation of commercial banks to the level of risk and financial viability of these banks. Risk-based capital requirements and risk-based deposit insurance premia are two prominent examples. Most recently, the regulators have augmented bank exam CAMEL rating model (early warning, off-site surveillance model) to include explicit examiner assessment of the banks’ ability to manage its performance. Due to the nature of banking, and the important role that banks play in the economy (i.e., capital formation), banks are and should be more closely regulated than any other type of economic unit in the economy. In this context, the early warning off-site surveillance CAMEL model reflects the likelihood of both financial distress and regulatory intervention.

Bank supervisors use both on-site examination and off-site surveillance to analyze and identify the financial viability of banks. The most useful tool for identifying problem banks is on-site examination, in which the examiners travel to a bank and review all aspects of its safety and soundness. On-site examination is, however, both costly and burdensome: Costly to supervisors because of its labor-intensive nature and burdensome to bankers because of the intrusion in their day-to-day operations.