Assessment of Property Valuations by Financial Institutions: Challenges & Recommendations

Financial institutions rely on property valuations to assess the credit worthiness of borrowers offering property as collateral. Accurate valuations are crucial for mitigating risk in case of default, enabling institutions to recover losses by selling the mortgaged property.

While Institutions typically engage professional Valuers, internal credit officers often conduct independent reviews, including site visits and market surveys, intending to ensure accuracy. However, credit officers may lack basic valuation knowledge. They frequently compare formal valuations with informally gathered market data and valuation figures received from the property owner, loan agent, or CA who sourced the credit proposal. This may result in incorrect assessments of valuation assignments.

Take a case, when a valuer estimates a property’s value at ₹100, and a credit officer’s market research suggests values between ₹95 and ₹105, the ₹100 valuation to be deemed acceptable. Conversely, a valuation exceeding ₹105 might be flagged as overvalued.

Similarly, a properly submitted valuation of ₹ 70-80 (based on recorded comparable sales and adjustments for the specific purpose of the valuation) may be considered undervalued.

This can result in Valuers providing figures between ₹95 and ₹105 receiving preferential treatment and securing future valuation work from the financial institution. Conversely, Valuers who adhere to valuation principles, standards and ethic, and thus provide a more accurate value (e.g., ₹70-80 in the example), may be penalized and excluded from future assignments by being labeled as “undervalue.”

Consequently, much of the valuation work for financial institutions relies on hearsay asking prices without applying any valuation principles and corrections for the specific purpose for which the valuation is made.

This practice raises serious concerns about the role and proper use of professional Valuers. If a valuer’s assessment merely aligns with a credit officer’s informal market inquiries or figures provided by the client, loan agent or CA, it is indicative of a convenience value being opined and can lead to an understanding that proper valuation principles and standards have not been applied, nor do they understand the specific purpose of the valuation. In such cases, why not rely solely on the credit officer’s assessment?

Assessing valuation reports based on hearsay, informal market inquiries, and figures gathered from interested parties undermines the entire valuation process. It creates an unfair environment for qualified and experienced Valuers who adhere to professional standards and ethics, leaving them with an understanding that their expertise is disregarded. This practice incentivizes poor valuation practices and ultimately defeats the purpose of obtaining an independent and subjective valuation for secured lending, potentially leading to substantial financial losses due to overvaluation.

These discrepancies often stem from inadequate training and understanding of valuation methodologies among credit officers. They may rely on anecdotal information from neighbours, real estate agents and property owners, failing to grasp the nuances of market value and, crucially, the specific purpose of the valuation – secured lending.

Valuation for secured lending focuses on the realizable value in a foreclosure scenario, which differs significantly from the price a willing buyer and seller might agree upon in a typical transaction (market value). Factors influencing realizable value include property characteristics, surrounding area, demand and supply dynamics, purchasing power, the time and costs required for sale.

Furthermore, the prevalence of “unaccounted “money in local market transactions, while relevant to open market value, is less relevant for forced sale value.

Professional valuation standards emphasize using comparable sales data with appropriate adjustments. This systematic approach minimizes subjective biases and provides a more robust estimate of market value. While credit officers’ market surveys can be valuable, their interpretations must be grounded in sound valuation principles. Simply gathering data points without proper analysis and adjustments can be misleading.

The current practice of credit officers reviewing valuations presents several challenges. Their lack of specialized expertise can lead to inaccurate judgments, potentially jeopardizing the institution’s financial security. This necessitates a more structured and professional approach to valuation review.

Recommendations:

1. Automated Valuation System: Use a central, automated system for all valuation activities and reports. Credit officers should not assign valuations or review reports.

2. Valuer Performance Evaluation: A recognized valuation Institution should evaluate valuer performance, checking reports for quality, adherence to guidelines, and consistency. This helps address any performance issues. Valuers must have a valid Certificate of Practice from a recognized valuation institute for annual renewal.

3. Independent Valuation Review Panel: Banks should establish an independent panel of valuation experts to review reports, ensuring they meet industry standards and are objective. The bank should review 2.5% of each Valuer’s annual work. If the valuer or the bank disagrees with the review, the report goes to the valuation institution for a final decision.

4. Annual RBI Audit of Valuation Work: The RBI should appoint a valuation institute to conduct an annual audit of valuation work across all banks. This audit will ensure adherence to valuation standards and identify best practices.

5. Enhanced Credit Officer Training: Credit officers need better training on valuation principles, methodologies, and rules. Training should cover valuation basics, different methodologies and approaches, the difference between cost, price, and value, and how these vary by purpose. Valuation institutions should provide this training.

6. Standardized Valuation Guidelines: Banks should create clear, standard valuation guidelines. These should detail requirements for comparable data, adjustments, and reporting, and comply with recognized standards. Valuation institutions should help develop and update these guidelines.

7. Transparent Documentation: The valuation review process must be transparent and well-documented. All review comments and justifications for adjustments, along with the valuation institution’s review, should be recorded.

By following these recommendations, especially the involvement of established valuation institutions in reviews, performance evaluations, and training, will significantly improve the accuracy and reliability of property valuations and reduce lending risks for banks.