Why Banks Keep Getting Bad Debts

Two days ago I hitch Mr. Enry's car to home and we talked about Valuation division in Colliers, Valuation companies in Indonesia, and Indonesian Society of Appraisers. Mr. Enry is the Senior Manager in Colliers' Valuation division; he specialized in Machinery Appraisals. He's been doing machinery appraisals over 25 years.

One thing that intrigued me so much is how he explained the relation between valuer/appraisers' professionalism and a bank's non performing loan score. If I can summarize:

• Valuation is the last gate before someone receive money from the bank. Often times, the debtors will do anything to make the loan value higher.
• If the valuer/appraiser lacks in knowledge or experience when making the appraisal, and gives a higher number for the property value, it can hurt banks because they'll give a higher loan than the real collateral value. When the debtors can't pay anymore, it'll become a bad debt/non performing loan.
• The reason why banks keep getting tricked into giving non performing loans by bad debtors, is because they don't know how to value machinery and they compensate that by relying so much on the written evidence; in this case: the invoices. Imagine this:
• I have a printing factory and I want to apply loan to a bank
• I buy new machines at 1.5 Million rupiah and tell my suppliers to write me an invoice of 15 Million rupiah. I'll pay the tax at 10%, that is 1.5 Million rupiah. And get the loan from bank at 80% invoice value, that is 9 Million rupiah. Can you see how much I make money from that? That's right. I get 9-3 = 6 Million rupiah nett just by doing mark up on my invoice.
• And the reason why banks get tricked? Is because they can't tell whether a machine is worth 1.5 Million or 15 Million. And the reason why they can't tell.. is because they don't have a background in machinery, nor in machinery appraisal.
• Machinery appraisals is vastly different with Land & Building valuation/appraisal, because they're different in design. That is, Land & Building has a standard value for this type & that type of building using this and that material. While every machine is constructed differently, consists of different parts, and function differently at varying cost used/revenue generated.
• The theory of machinery appraisal is only one: Replacement cost - depreciation. The challenge is to determine the replacement cost itself; we need to use different formula for different machine types.
• Only appraisers with machinery engineering background with enough experience can determine the fair/closest property value. Even in India, a machinery appraiser is considered qualified after 10 years of apprentice.
• To give you an illustration, a typical factory value is 5% land & building; and the rest is machinery value. Even in complex factory like chemicals, the land & building value is negligible/nonexistent. In new buildings now, with new smart building technology and all, the machinery value already consist of 50% of the total property value (usually only 35%); so a Land & Building appraiser can't work by himself to value this kind of building.
• All right. Now, for the best part. The reason why banks can't seem to choose the right appraisal company to value the machinery, is because we don't have a machinery appraisers association yet; that can provide a certification/standardize the level of service quality. We do have Indonesian Society of Appraisers, but the certification exam is all about land and building. If so, then how can we guarantee that a valuer has the right skill in property valuation/appraisal? How can banks & clients know which company has the best machinery valuation division?

Now that's food for thoughts, and home work to the appraisers society.