Absence of standard guideline for collateral valuation

Asset valuation is a survey of generally fixed assets like land and building or machinery or equipment. It gives a lender an independent review and confirmation of the property's value and features or significant defects that could affect the property's value as a collateral of loan facility. It is not only important from security perspective of bank's lending but also for keeping provision against the risk weighted assets of a bank.

Asset-backed lending is a common phenomenon all over the world including Bangladesh. Currently, there is no government agency or single independent professional institution to regulate asset valuation procedure of organisations that are fully involved in such activities in the country. Absence of regulation or guideline and regulatory body can create the risk of overpriced and overestimated security proposition which we have seen in the scams of Hallmark Group, Bismillah Group, etc.

Default loans in Bangladesh stood at Tk 1,113.47 billion as of April this year, said Finance Minister AMA Muhith in parliament in July. In early 2009, the amount was Tk 350 billion. A total number of 202,623 borrowers (individual/corporate) who borrowed from 48 state-owned and private commercial banks, defaulted on their loans until March 2017.

The Asia Pacific Group (APG) in its recent Money Laundering report, prepared after its visit to Bangladesh late last year, referred to the US$ 467 million loan scam of Sonali Bank (discovered in 2012), fraud involving US$ 337 million of BASIC Bank between 2010 and 2012, and embezzlement of US$ 51 million from Janata Bank. Just imagine if the collateral against a substantial portion of those loans was found overestimated by third-party valuation firms and should banks be left with no option but to liquidate mortgaged assets to recover its money, it would have not only been immense loss for the banks but a catastrophe for the whole economy as well.

In a Bangladesh Institute of Bank Management (BIBM) research titled 'Credit Operations of Banks' published in April this year, it was found that 59.27 per cent of advances of all banks were secured by real estate in 2016, which was 58.30 per cent in the previous year. Private commercial banks gave the highest segment of loans against real estate at 63.66 per cent in 2016. This clearly emphasises the importance of appropriate asset valuation in the financial industry's risk management.

Banks provide loan facilities to competent borrowers in mainly three forms: 1) unsecured loans, i.e., credit facilities with no collateral; 2) partially secured loans, i.e., a loan facility where a portion of the total limit to the customer is secured by registered mortgage or cash security; and 3) secured loans, a debt facility fully secured by the same or higher value registered mortgage land or cash equivalent collateral. In general, small loans are unsecured or partially secured but when banks take large exposure with clients, the logical preferred method of financing is secured loan.

VALUING A FIXED COLLATERAL: It is imperative for banks to ensure that the value of the collateral is at least equivalent to the credit exposure that it is undertaking on a specific client to safeguard the bank's interest in case the borrower defaults. If the borrower defaults and there is no possible way to recover bank's (its depositors') money, the rule of the land allows the bank to sell off the collateral and recover its investment. Since this is the existential threat in banking business, determining the accurate and justified value of the underlying property (the collateral) is a crucial part of lending operation for every bank and financial institution.

But valuing a fixed collateral i.e., land property is not a simple task. Value of a land depends on numerous factors. Location of the land, its positioning in the neighbourhood, state of the land, land sale history in the surrounding areas, ownership history of the land, shape of the land, type and state of structures on the land, development activities in the vicinity, proper demarcation of boundary, and so on are the few notable factors in determining a proper value of a land.

Credit exposure on the basis of collateral value becomes even more critical considering the fact that when a bank is forced to liquidate a land asset to recover its investment, the land sale process becomes much more complicated than when an owner sells his or her land in normal circumstances. When a bank sells a property, it has to be done as quickly as possible as the default loan keeps piling up of interest and deferred payment charges. Potential buyers become only handful as many consider such properties as disputed ones. Often, establishing possession of the land becomes a daunting task for the new owners as the actual owners do not cooperate or become outright hostile.

Moreover, bankers are not expert in land or property valuation. That is a specialist job, and generally, banks assign third-party land valuation firms, which specialise in land valuation for assigning proper value to borrower's proposed collateral. Surprisingly, even though accurately valuing of collateral is of utmost importance for any bank, we are yet to see any formalised and uniform guideline from regulatory authorities on how and in what method a valuation firm should appraise the value of a collateral. Even there is a lack of clear guideline on how to enlist a valuation firm by a bank. Every bank uses its own risk management guidelines and internal vendor assessment criteria for evaluating and enlisting valuation firms. As these guidelines and expertise vary among financial institutions, so does the quality of asset valuation from bank to bank and it leads to mushrooming of valuation firms in our country. With no proper guideline of what is the minimum requirement to be a valuer and existence of lobbying in our culture, adverse selection of valuation companies and consequently, poor judgement of collateral prices are exposing our financial industry to significant credit risk that is overlooked by many.

Credit risks arising from wrong valuation of collateral is a common phenomenon in the financial industry. Over-valuation, shallow or no access road to the property, proper possession of land by the borrower in question and mismatch of land tafsil are common issues found during loan default stage which significantly impair the banks' interest on collection of loan principal. Unfortunately, there is no single regulatory body or law which defines the eligibility of valuation firms or make the valuers liable for misreporting or malpractice.

At present, minimum compliance documents like trade license, Tax Identification Number, VAT Registration, partnership registration (for partnership business) or Memorandum of Association and Article of Association (for limited company) are enough to start a valuation firm in Bangladesh. Other than those, there is no regulation or specification on operation, experience, skill, etc. Any valuation firm with such minimum requirement can start its business as a third party asset valuation company and seek to get enlisted with any bank. It is entirely the review and enlistment process of a bank that determines whether a prudent and worthy valuation firm will get enlisted or not. Now, with our culture of nepotism, political influence and mismanagement, lack of established regulation or unified standards in enlisting a prudent valuation firm that determines the value of the underlying asset upon which a bank's lending exposure is greatly dependent can be detrimental.

However, for valuation of insurance company's assets and claims, third-party valuation firms need to be enlisted with Insurance Development & Regulatory Development Authority (IDRA) in our country. Currently, 138 valuation firms are listed under IDRA. IDRA has the authority to take action or delist any valuation firm, if justified and provable reason is found against.

Before enlistment of a valuation firm by a bank or giving license by the regulatory authority, it should verify the track record, integrity, reputation or activities of the company. Physical visit to the firm premises is a must to get the exact idea or status of the firm's condition on human resource quality, technical aspects and management culture. Regarding the track record, it is imperative to check the valuation criteria and methods of the firm. Also, how the firm has managed or responded when there was any dispute regarding land valuation by any of its clients. The valuation firm should also keep accurate area-wise database of its valuation over the years of property pricing for historical reference check.

Lately, the Bangladesh Bank has taken a laudable initiative to develop a collateral database that will document and store information and details of all properties of borrowers against which loan facilities have been taken from any bank or financial institution. Such a database, similar to Credit Information Bureau (CIB), will enable the banks to check with the central bank before lending money to any borrower against property by being ensured the same asset was not used as security for any existing loan. If valuation details are incorporated in this collateral profiling, banks will also be able to monitor the historical valuation of the land over the years and will be able to take more accurate lending decision for property- backed loans.

Adnan Rashid is Assistant General Manager and Head of Credit (Small Business) at IDLC Finance Limited and Md. Mehedi Hasan is his colleague in the same department.

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