Review of Quantitative Finance and Accounting, 19: 247–260, 2002
2002 Kluwer Academic Publishers. Manufactured in The Netherlands.
The Changing Relationship Between CAMEL
Ratings and Bank Soundness during the
Indonesian Banking Crisis
I GDE MADE SADGUNA
Bank of Indonesia
J. KENTON ZUMWALT
Abstract. During the recent Southeast Asian ﬁnancial crisis, numerous banks failed quickly and unexpectedly.
This study uses a unique data set provided by Bank Indonesia to examine the changing ﬁnancial soundness of
Indonesian banks during this crisis. Bank Indonesia’s non-public CAMEL ratings data allow the use of a continuous
bank soundness measure rather than ordinal measures. In addition, panel data regression procedures that allow for
the identiﬁcation of the appropriate statistical model are used.
We argue the nature of the risks facing the Indonesian banking community calls for the addition of a systemic
risk component to the Indonesian ranking system. The empirical results show that during Indonesia’s stable
economic periods, four of the ﬁve traditional CAMEL components provide insights into the ﬁnancial soundness
of Indonesian banks. However, during Indonesia’s crisis period, the relationships between ﬁnancial characteristics
and CAMEL ratings deteriorate and only one of the traditional CAMEL components—earnings—objectively
discriminates among the ratings. The panel data results indicate systemic economy-wide forces must be explicitly
considered by the rating system.
Key words: bank soundness, ﬁnancial crisis, CAMEL ratings, Indonesia
JEL Classiﬁcation: G21, G28
The allocation of scarce ﬁnancial resources is a central issue in ﬁnancial economics. Its
importance became particularly evident during the recent ﬁnancial crisis in Southeast Asia.
In the years leading up to the crisis, most Southeast Asian economies were character-
ized by strong growth, low inﬂation, budget surpluses, low unemployment and declining
Address correspondence to: Dr. Dominic Gasbarro, School of Commerce, Murdoch University, Murdoch, Western
Australia, Australia 6150. Tel.: 61-8-9360-2126.