Drawing the conclusions from the global financial crisis, the Basel Committee on Banking Supervision (BCBS) published in December 2017 new requirements for the valuation of real estate for lending purposes in the context of the so-called ‘Standardised Credit Risk Assessment Approach’ (SCRA). It reads:
The valuation must be appraised independently using prudently conservative valuation criteria. To ensure that the value of the property is appraised in a prudently conservative manner, the valuation must exclude expectations of price increases and must be adjusted to take into account the potential for the current market price to be significantly above the value that would be sustainable over the life of the loan.
These requirements are part of a new set of international banking supervisory rules known as ‘Basel III Framework’ and apply since 1 January 2023 to large and internationally active banks. All 28 member countries of the BCBS committed to enforce these rules also on a wider set of banks within their jurisdictions.
In the European Union and within the UK, the legislators have decided to transpose the new SCRA valuation rules into law by amending the European Capital Requirements Regulation (CRR) for banks. The new Article 229 CRR reads:
1. b) the value is appraised using prudently conservative valuation criteria which meet all of the following requirements:
(i) the value excludes expectations on price increases;
(ii) the value is adjusted to take into account the potential for the current market price to be significantly above the value that would be sustainable over the life of the loan;
1. c) the value is not higher than a market value for the immovable property where such market value can be determined.
There is almost no guidance yet from a real estate perspective for the determination of this new ‘Prudential Property Value’ from the BCBS, nor from European authorities.
The European Banking Authority (EBA) provided a first indication through its Policy Advice of 2 August 2019 that the Basel III requirements:
- Will no longer allow institutions to solely apply a Market Value concept.
- Would require additional specifications to clarify how a current use of either Market Value or Mortgage Lending Value could be included in the definition of property value.
- Would allow institutions currently using either the Market Value or Mortgage Lending Value concept to continue to do so, provided that the values used as input parameters are adjusted and exclude expectations of price increases.
The valuation profession concluded after a first assessment that Market Value alone, as defined under IVS, will indeed no longer be permissible for the valuation of real estate for lending purposes under the new BCBS definition. It is understood that Prudential Value is a collateral value concept aimed at securing a stable collateral position of a credit institution (mortgage lender) over the longer term, i.e. throughout economic cycles and property market volatilities.
The EU and the Prudential Regulatory Authority in the UK are planning to apply the ‘Basel III Framework’ including Prudential Value to immovable property from the 1st of January 2025 but there is currently no agreed interpretation of the definition, or an agreed valuation methodology for providing a Prudential Value in a real estate context.
The IVSC welcomes the opportunity to engage with relevant authorities and stakeholders in regard to the concept of Prudential Value. As with any new basis of value, it is concerned that if it is enacted prior to an agreed interpretation and approach being agreed across all markets, then these deficiencies will likely lead to a lack of transparency and consistency in providing such valuations. These challenges will likely be amplified in markets where there are data challenges.
As a result, the IVSC has engaged with various regulatory authorities on the matter and have received feedback from a number of valuation stakeholders. The IVSC will continue to closely monitor developments around the introduction of Prudential Value and will keep our stakeholders informed of any future developments.
Please send any comments or feedback in relation to this issue to IVSC Standards Director, Alexander Aronsohn: [email protected].