How to Evaluate the Health of Your Financial Institution
(Originally published as an article within ECCU’s former e-publication, Ministry Banking Today.)
In the November issue of Ministry Banking Today (MBT), we urged you to monitor the health of your financial institution. Here, we talk about what information to look for and how to find it.
In case we didn’t convince you last month, let’s quickly recap the importance of evaluating the health of your financial institution:
- Safety and security of deposits. (Even if you have less than $250,000, you would undoubtedly experience challenges should your bank or credit union fail. If you have more than $250,000, it is that much more important to monitor the health of your financial institution.)
- Maximize the impact of your ministry funds.
- Instill confidence in your donors.
What am I looking for?
An easy acronym to help you understand the financial data you’re evaluating is CAMEL:
- Capital: Check to be sure capital is commensurate with the nature and extent of risk to the institution and the ability of management to identify, measure, monitor, and control these risks.
- Asset quality: Asset quality is based on factors such as the quality of loan underwriting and investment strategies; adherence to sound policies, practices, and internal controls; the adequacy of the allowance for loan losses; and the proper management of risks. These factors will reveal the existing and potential credit risk associated with loan and investment portfolios.
- Management: The ability of management to respond to changing business conditions, or initiate new activities or products, is an important factor in evaluating a financial institution’s overall risk profile.
- Earnings: Ask about the adequacy of current and future earnings to fund capital in light of the institution’s current and prospective financial and operational risk exposure, potential changes in economic climate, and strategic plans.
- Liquidity: What are the current and prospective sources of liquidity compared to funding needs? Asset-liability management (ALM) practices should ensure the institution is able to maintain liquidity sufficient to meet financial obligations in a timely manner and to meet loan demands.
Understanding these five critical elements will give you a clearer picture of the health and stability of your financial institution.
How do I find these figures?
First and foremost, contact your bank or credit union directly to get the data you need to make a thorough assessment. Ask questions. Get clarification. Get a pulse on their confidence and understanding of their own financial health. In addition to those conversations, do some secondary research. Here are some resources to consider:
- The National Credit Union Administration’s (NCUA) website which includes 5,300 Statement of Financial Condition reports—comprehensive financial reports filed quarterly by credit unions
- The Federal Deposit Insurance Corporation’s (FDIC) website, databases, and reports
- Peer data and comparisons, such as bank ratings
Speaking of bank ratings...
Bank ratings, when done properly, can help you evaluate the health of a financial institution.
First, you need to understand how they work. Rating companies gather publicly available information about financial institutions and use it to calculate ratios that compare various aspects of the financial information. These ratios are used to assign subjective ratings based on data that the rating companies deem important.
But some bank ratings do not fully reflect the true financial health of some institutions. Ratio analysis can be done without taking into account important indicators or information unique to a specific financial institution.
Even bank rating companies agree that their analysis alone should not define the stability of a financial institution. Bankrate, for example, gives this disclaimer:
“In connection with banking decisions, businesses and consumers are advised to evaluate independently all financial institutions, consider other information—including the strength of the financial institution's management—and to contact financial institutions individually to seek answers to their questions. Bankrate’s rating information should not be relied upon exclusively in making banking decisions.”
A great way to use ratings is as talking points to guide your conversation with your financial institution. For more information on evaluating bank ratings and determining the health of your financial institution, stay tuned for the January issue of MBT.