An opinion piece from Sim Hoy Chhoung, CEO of VTrust Appraisal Co. Ltd.
As the banking sector is growing in order to fuel the mortgage and collateral-based lending industry, so are the potential concerns over the property valuation standards and risk management systems currently in place in the Kingdom’s banking sector. The global financial crisis, which led to real estate bubbles across various countries around the world, offers a good lesson to explain the current concerns.
Industry leaders agree: a risk analysis should be carefully taken into account.
This was the suggestion of Mey Vann, director general of the Department of Financial Industry, Ministry of Economy and Finance, as cited by the Phnom Penh Post on 19 August 2015, one day after the inter-ministerial seminar on “Opportunities and Potential Risks in Developing Cambodia’s Property Sector” at Cambodiana Hotel.
The 2008 global economic crisis, which impacted Asia and Cambodia, offered a lesson that “we must not let happen again,” he said.
But how can we curb the potential risks associated with mortgage and collateral-based lending?
From my experience, compliance to standards and professionalism in property valuation is one of the best ways to help mitigate the risks associated with loan defaults that could potentially lead to a wider market financial crash.
The Royal Institute of Chartered Surveyors (RICS), one of the world’s most well-recognized organizations, representing professionalism and ethics in land, real estate, and construction appraisals, stresses that accurate and professional valuations are vital to a healthy property market and a stable economy, forming the basis of performance analysis, financing decisions, transactional or development advice, dispute resolution and taxation.
However, not all banks in the country comply with valuation best practices and standards. While all would consider property valuation as a crucial part of any risk assessment, not all of them have clearly-defined measures to ensure compliance, often deciding to offer contracts to valuation partners that are not independent, and do not enforce professional and ethical codes of conduct, or lack professional indemnity insurance coverage.
This sentiment has also been echoed elsewhere. While many of the banks seem to forget the potential risks, officials advise that property valuation firms should not be biased or under any influence that could cause an unfounded value inflation or deflation of the subject property.
Kim Vanda, director general of Banking Supervision of National Bank of Cambodia, said, in the same seminar, that the malpractice could potentially pose risks to the banking industry as a whole, adding banks that have in-house valuation units should also use independent valuation firms to ensure that the appraised values of the subject properties are reasonably concrete and consistent.
To ensure a healthy property and banking sector, an understanding of the weaknesses in the valuation process could help.
The Central Bank of Ireland issued the December-2012 study report entitled “Valuation Process in the Banking Crisis – Lessons Learned – Guiding the Future” identifying three overriding areas of primary weaknesses in valuation processes during the boom lending years.
First, a weakness could come from an inaccurate or inappropriate definition of valuation requirements by credit institutions, thus leading to a subsequent inadequate assessment and understanding of valuations.
Second, it could be the result of inadequate valuation processes and standards, or a disregard for adherence to such processes.
Third, the weakness could also be the result of a lack of appreciation of the significance of the valuation document as independent evidence of risk mitigation effectiveness. Many bankers did not fully regard the importance of independent valuations and the valuation reports as a key document underpinning the basis on which they were acquiring the risk.
Besides identifying the overriding areas of weaknesses, the study also highlighted a number of critical issues that credit institutions should pay attention to in the property valuation process – such as the issue of conflict of interest, valuer panel management, and inappropriate use of informal valuations.
In many instances, lenders would accept existing valuations that had been prepared by valuers on behalf of the borrower, not the credit institutions. In this case the study recommends that the valuers’ duty of care is to the credit institutions and this should be emphasized by credit institutions in their written instructions to valuers in accordance with its clearly defined terms of engagement. Valuation reports should always be addressed to the credit institutions that is advancing the loan funds to avoid any complaint or manipulation between valuers and borrowers or owners of the property.
When it comes to valuer panel management, the study identified some weaknesses in credit institutions practices including the appointment of valuers without sufficient qualifications, without any evidence of sufficient professional indemnity insurance, with inadequate or no review of panel members’ performance, or on the basis they are a customer of the bank.
In sum, to create a healthy financial environment, banks should comply with valuation best practices and standards.
Two of the most credible standardized valuation systems advised by the report are the International Valuation Standards, known as the White Book, and the RICS valuation standards, known as the Red Book.
Although the study report seems to stress more on experiences and applications in settings outside of the Kingdom, it does not make any difference since globalization has made almost all the world’s systems into ‘one’ that applies for all and, more importantly, all central banks should be subject to the Basel Committee on Banking Supervision which should incorporate best banking practices into all countries’ standards.
That said, the country’s valuers association is also working to benefit the industry. Cambodian Valuer and Estate Association (CVEA), which represents the country’s valuation and real estate industry, has taken measures to set minimum valuation fee charges for the industry. The minimum fees should help prevent valuation firms from competing on fees, and in turn compromise the quality of the final appraisal.
Sim Hoy Chhoung is the chief executive officer at VTrust Appraisal Co., Ltd. The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of VTrust Appraisal Co., Ltd. nor do they necessarily reflect the views and opinions of Post Property