Property Valuations & Banks

Property Valuations & Banks
By V. Leeladhar, Chairman Indian Banks Association
The Institute of valuers conducted the R. Doreswamy memorial lecture which was given
by Sri. V. Leeladhar, Chairman Indian Banks Association and M.D. Union Bank, here in
Bangalore. Following are the excerpts of from the lecture :
“ I am glad to be given an opportunity to be in the midst of and to address professionals
whose services are utilized by Banks, Financial Institutions, Central and State Undertakings
on a regular basis. It is particularly gratifying to be invited to deliver the annual Doreswamy
Memorial Lecture this year.
The Financial Sector and the Banking Industry of this country has seen major changes in
the last fifteen years or so. The entire exercise has been oriented towards making the
industry capable of effectively functioning in a market driven economy. Issues relating to
social objectives were substantially achieved by nationalised banks in ally in the two
decades. Liberalizations brought with it competition in the form of the entry of new
generation private sector banks and the expansion of the operation of foreign banks.
Subsequently, Public Sector Banks were accorded permission to raise capital from the
public and encouraged to reduce their dependence on capital from the Government.
These and other developments aimed at minimizing control over the Banking industry
coupled with the advent of technology on a large scale in banking operations, has
transformed the Banking Industry.
At the operational level, these changes call for a shift in objectives, strategies methods of
conducting business and attitudinal re orientation – all of them resulting in a more
professional approach. This will also require banks to operate in a framework that will
encourage interaction with and learning from professionals bodies that have a bearing on
the industry. Among these, professionals in the field of valuation are of vital importance.
The Economy
Before I deal with the relationship between the Banking Industry and organisations such
as the Institution of Valuers and its members. I will briefly cover a few important aspects of
the economy and some of the more significant developments in the Banking industry in
the recent past.
The Indian economy has displayed many positive features of late. Industrial activity saw
some revival while inflation rate remained controlled. Foreign exchange levels touched
record levels. Our country becomes a creditor to IMF. Exports showed a strong growth
bucking the international trend.
On the monetary front, effective steps were taken by RBI to ensure stability and orderliness
in domestic money, debt and forex markets. Interest rates declined in all segments in
response to monetary policy. Public debt management was strengthened through
prepayment of high cost debt, swaps between centre and state and so on. Bountiful
monsoons this years have brightened prospects. Earlier estimates of 6% growth in real
GDP have been revised with a growth rate of 8% being a distinct possibility. Inflation rate
is expected to stabilize between 5% to 5.5%. Coming to infrastructure, rapid progress is
seen in the road sector. Efficiency at the ports has increased with the turn around waiting
time for ships being drastically cut. Growth is burgeoning in the telecom sector with falling
tariff and increased traffic.
REFORM PROCESS
I will now spend a few moments covering the changes brought about in the Banking
industry as a result of the reform process. Banks have been given greater freedom to
determine interest rates on deposits and advances. Prudential norms have been adopted.
Capital adequacy, Asset Classification and Income Recognition standards and provisioning
measures have been introduced. Public sector banks have been encouraged to access
the market and Government holdings in these banks have been reduced. Banks have
also been given more freedom in opening and swapping of branches.
From the point of view of players in the market, new private sector banks and foreign
banks have been allowed to expand their operations. Banks have also been permitted to
open Offshore Banking units in special economic zones. Simultaneously, Banks have
now been permitted to enter new areas of financial services such as insurance, credit
cards, leasing, gold bullion and factoring. New institutions have been set up such as
National Securities Depositories Ltd., Central Depositories Services Ltd., Clearing
Corporation of India, Credit Information Bureau of India Ltd. SARFAESI Act has been
passed and Asset Reconstruction Companies have made an appearance.
Banks have made massive investments in technology. Centralized funds management
system, structured financial messaging solutions, negotiated dealing system and Real
time Gross settlement are all measures introduced to enhance efficiency and bring about
transparency in financial communication and settlements in the country.
The very meaning of Priority Sector has undergone a change with it being expanded to
include Food Processing, Software upto Rs. 1 crore, Housing above Rs. 10 lakh and
investment in SEBI approved venture capital funds. The industry has also seen new
instruments for greater flexibility and better management of risk such as Interest rate
swap, Cross Currency Forward Contracts, Liquidity Adjustment Facility Rate Agreements
and the like.
RBI guidelines for Risk Management Systems are in place. Committees in Banks address
Credit Risk, Market Risk and Operational Risk. Risk based supervision has also been
introduced by RBI. The Banking industry is striving to benchmark and achieve best practices
on par with international standards. With regard to capital markets, our country has one of
the most transparent systems in the world. Online trading is available, dematerialization
services are offered, retail trading in Government securities introduced and we are moving
towards T+1 settlement by April 2004.
SOME CONCERNS OF THE BANKING INDUSTRY
In the backdrop of the upsurge of the economy and a carefully orchestrated reform process
there are rising expectations from the Banking industry. This sector will play a vital role in
the country’s emergence on the global financial scene. It is therefore, incumbent upon the
industry to raise its levels of professionalism and efficiency.
These are some of the concerns of the Banking industry.
• In the backdrop of a declining interest rate scenario, customers of banks such as the
corporate sector have access to cheaper sources of financing. As such their
dependence on the banking sector for credit requirements is on the decline.
• This is reflected in the figures pertaining to interest income of Banks. The share of
interest income of Banks declined from 50% in the year 1997 to a level below 40% in
the year 2003.
• Another major concern for Banks has been the rapidly increasing levels of Non-
Performing Assets or NPAs. Though the percentage of NPAs the Gross Advances of
Banks Dropped from 14% in the year 2000 to 9.4% in the year 2003, the gross figure
has increased from Rs. 53,033 crores in the year 2000 to Rs. 54,086 crores in the year
2003.
As a consequence of these concerns, priorities of Banks are as under.
• Retail lending with particular emphasis on housing has become a thrust area for Banks.
• Reduction of NPAs and the monitoring of Standard Advances to ensure that they do
not turn into NPA are major priorities for Banks today.
With regard to concerns and thrust areas of Banks, Valuers have a major role to play.
THE ROLE OF VALUERS IN THE FUTURE OF BANKING
In the process of addressing these concerns, the Banking Industry will have to strategize
as under :
• To ensure that funds are deployed through a credit appraisal, delivery and monitoring
system so that they continue to generate income during the currency of the advance.
• To identify new markets and sectors where healthy loan assets can be created.
• To recover Non Performing Assets.
CREDIT APPRAISAL STAGE
Most advances of the Bank are made against collateral security usually in the form of
mortgaged landed property or plant and machinery. These collateral securities are to be
valued at various stages of the periodicity of the advance. At the time the advance is
being appraised proper valuation is essential to ensure that the risks related to the advance
are property assessed and that the interest rates are fixed in a scientific manner.
Prudent practices would dictate that the collateral security be valued from three points of
view :
1. To assess the value of the property for purpose of fixing the quantum to be lent.
2. To assess the value of the property as the realizable market value.
3. To assess the value of the property as would be available in a distress sale.
In all these cases, professional and scientific valuation would aid the Banks to improve
their performance as lending institutions.
SOME PROBLEMS FACED BY BANKS.
Unfortunately some of the experiences of Banks with regard to valuation of securities
particularly landed property are not very encouraging. In many cases the valuation of the
property is obtained at the time when the project is being appraised or the loan proposal
is being appraised for sanction. A certain value is fixed to the property, which prima facie
appears to be in order. There are instances where for a variety of reasons the advance
turns NPA within a short while sometimes within the space of a year and a half. At the time
when the recovery process is initiated there are a few options available to Banks.
The property can be brought to sale by filing of suit, the borrower can be persuaded to
settle the dues or the Bank can make a certain amount of sacrifice in terms of the interest
or the principal amount of the advance. In order to decide the strategy the realizable value
of the mortgaged property has to be ascertained. At that time it is sometimes found that
within the period of just one year or eighteen months the value of the mortgaged property
has dropped dramatically sometimes by as high a percentages 50%. This is a major
problem facing banks and the search for the reason throws up a number of possibilities.
I would only appeal to institutions such as yours to devise methods by which either through
sharing information or by formulating given standards for having properties valued, such
instances are brought to the bare minimum.
THE SINGAPORE SURVEY
As you are aware the valuation profession in Singapore is structured along similar lines
as those in the UK, USW and Australia. The range of valuation service offered is wide
covering statutory valuations which are governed by statutes and legislation, to non statutory
valuations which include all the different types of properties for various purposes. Of the
latter the majority of valuation assignments received are that of residential properties for
mortgage loans. Since this is the bulk of private sector valuation work, it is natural there is
some element of competition for such assignments. Since there was anecdotal evidence
of Valuers succumbing to client pressure in order to retain clients, it was thought that a
survey could be conducted to study “Client Pressure if Residential Valuations” on those
providing valuation services to clients.
This study was also thought of due to certain empirical evidence from the united States
and New Zealand. The survey was carried out by selecting Valuers at random from 47
firms registered with the Singapore institute of Surveyors and Valuers (SSIV). The response
to the survey was 72%. Among the respondents were principals and partners of the firms,
directors and managers of the valuation department and valuation officers.
The survey findings are reported under four main headings : experience with client pressure,
sources of client pressure, type of client threats or coercion and awareness of other Valuers
complying with and succumbing to client demands.
EXPERIENCE WITH CLIENT PRESSURE
The respondents were asked to agree or disagree with the statement that “Valuers are
sometimes pressured by clients to modify their appraisal values.” It is interesting to note
that 85% of the respondents agreed with the statement.
The second question sought the respondents view on the level of client pressure they had
experienced over the years. The majority said that pressure was the same over the last
ten years. The third question as to whether clients had insisted that they modify their
estimates was answered in the affirmative by 76% of the respondents.
Therefore it appears that client pressure is pervasive in appraisal industry based on the
results of this survey.
SOURCES OF CLIENT PRESSURE
With regard to sources of client pressure the groups identified by the respondents were
developers, finance companies, housing and development boards, insurance companies
and private individuals.
TYPES OF THREAT OR COERCION
The major type of threats or coercion appeared to be the threat of withdrawing assignments
from the firm and giving them to another firm or the threat of reducing assignments in the
future.
AWARENESS OF OTHER VALUERS COMPLYING WITH CLIENTS DEMANDS
With regard to this field of the questionnaire 85% of the respondents affirmed that they
suspected valuers in the industry are complying with demands from clients.
The survey concludes that the problem is pervasive in the industry in Singapore with a
majority of the respondents stating that being too rigid in this regard could only lead to
loss of business. It is therefore evident that there is a similar problem in most countries.
OTHER WAYS IN WHICH VALUERS CAN POSITIVELY IMPACT BANKING INDUSTRY
There are a number of ways in which Valuers can help the Banking industry. First and
foremost, it would benefit Banks a great deal if some guidelines could be framed with the
help of Valuers with regard to how valuation proposals could be referred to Valuers. A list
of Do’s and Don’ts could be drawn on which could act as a check list to Bankers. Another
area in which Banks would be benefited would be if some guidelines were drawn about
the briefing that would help appraiser and Valuers to make their assessments more accurate
and professional. If this briefing is made uniform. Banks would benefit a great deal.
Another area is addressing the knowledge gap that exists in the Banking industry with
regards to the pitfalls that could arise in lending against landed property. data pertaining
to local conditions laws and other guidelines may not be easily available with bankers.
As asset Recovery Companies (ARC) become established in the days ahead the role of
the valuer swill become critical. Since the present system envisages a securitisation process
that primarily depends on the value of the security, the role of the Valuer will be vital. It is
not an exaggeration to say that it will be a vital component of the success of ARCs. Basel
Accord and Risk Management.
Looking to the future, your profession will have two other vital roles to play in conjunction
with the Banking industry. Today that industry is moving towards working in a global setting.
We are already committed to meeting the requirements of the Basel Accord. This will call
for Valuers to be able to assess properties and other securities benchmarked to international
standards. Knowledge of conditions obtaining in other countries might become necessary.
At the time of the initial rounds of discussions of the Basel Accord the chairman of the
working Group dealing with valuation issues was John Rich who was also Chairman at
the time of the Royal Institution of Chartered Surveyors, London, His words are worth
recalling :
“In an increasingly global economy, there will be a need to establish principles of valuation
that are uniformly understood and accepted everywhere. The role of the Basel initiative
will be considerably enhanced through the use of recognized valuation standards.”
The banking industry will also be greatly empowered if risk models could be worked out
by associations such as yours with regard to lending’s based on various securities. If
models can be worked out based on demographics, social and economic factors, it will
certainly make the Banker more efficient in his ability to assess risk. It will also have a
bearing on the pricing of loans and advances and other products.
CONCLUSION
The Banking industry is critically posed at the present time. It is on the threshold of facing
a number of challenges, not the least of them being the need to perform in the global
arena of Banks. Professional skills of Bankers will have to be capable of competing with
the best available worldwide.
It will be necessary for Bankers to draw on all sources of information and professional
expertise from many industries and professionals. The profession of the Valuer is one of
the most important ones. Let us work together so that our country will be a force to reckon
with in the international economic arena.