RICS Expert Group on Bank Lending Valuations and the Basel III Accord

In 2017, the Basel Committee on Banking Supervision (BCBS) of the Bank for International Settlements (BIS) produced its report on “Basel III: Finalising post-crisis reforms” (BIS, 2017). Basel Accords from the BIS are for global guidance but most countries around the world use them as a basis for regulating financial markets. BIS are monitoring the implementation of the Basel III standards, and this indicates significant progress. RCAP on timeliness: Basel III implementation dashboard.

Section 10, Paragraphs 59-75 are devoted to the real estate exposures of lenders relating to residential, commercial, and land acquisition, development and construction. Paragraph 60 refers to the “prudent value” of real estate in the context of applying different risk weights to various assets.

“Prudent value of property: the property must be valued according to the criteria in paragraph 62 for determining the value in the loan to value (LTV) ratio. Moreover, the value of the property must not depend materially on the performance of the borrower.” (BIS, 2017, para. 60)

Paragraph 62 states: “Value of the property: 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. National supervisors should provide guidance, setting out prudent valuation criteria where such guidance does not already exist under national law. If a market value can be determined, the valuation should not be higher than the market value…” (BIS, 2017, para. 62).

Over the past few years, a number of jurisdictions have consulted on the implementation of Basel III within their credit regulations and directives (for example the EU and the UK). Those two consultations resulted in different stances being taken regarding the real estate valuation criteria set out above. Owing to perceived difficulties in implementing prudent valuation criteria for real estate valuation, the UK has decided to retain the status quo and largely maintain consistency with existing criteria, whilst the EU have decided to press ahead and adopt prudent valuation criteria for real estate valuation as part of its own approach to Basel 3.1 implementation.  

RICS was already taking a significant role with some Government departments, financial institutions, academic departments and real estate organisations in discussions regarding the role of real estate in general and valuations in particular in response to the global financial crisis. This included supporting the investigations into the potential of long-term sustainable valuations to support existing valuation definitions and methods such as Market Value and (within Europe) Mortgage Lending Value. This was well in advance of the publication of 2017 criteria from the BIS.

Current RICS standards and guidance on bank lending valuations, although addressing both market value and mortgage lending value, does not refer to the issues raised by the developing partial and variable adoption of the Basel III prudently conservative valuation criteria at a global level. It is therefore timely to review the guidance in this area and RICS has set up an expert group to develop a Professional Standard, which will address the issues surrounding the implementation of prudently conservative valuation criteria globally as well as updating current standards and guidance on bank lending valuations. It includes membership from across the various regions, including the US, Australasia, Asia and Europe, and from the real estate lending, investment and valuation disciplines. 

In addition to assessing the different possible concepts and definitions across the bank lending valuation and their relationship with market value, the Standard will set out findings on regional and national variations with the adoption of Basel III criteria. The global nature of the Standard means that it will major on principles, but various methodologies have been suggested for adjusting market values for longer-term perspectives or prudently conservative Basel III criteria. These methodologies will be appraised.

RICS has supported the general findings of most research outcomes addressing both long-term value and Basel III prudently conservative criteria which suggest that these approaches should be applied at a market level and should not form part of the valuation of individual property assets. They are based in market analysis. It supports the view that market value is the appropriate valuation basis to be applied at the individual property asset level and that post-crisis reforms, including those addressing the appraisal of property prices, should be aimed at assessing the risks of lenders being over-exposed in the event of cyclical property market downturns. 

The expert group is to be chaired by Professor Emeritus Neil Crosby (MRICS), formerly Professor of Real Estate at the University of Reading in the UK, lead author of the current RICS Europe Professional Standard on Bank Lending Valuations (Bank lending valuations and mortgage lending value). It is planned to have a draft for consultation by the late spring/early summer with final publication later this year.

For further information about this project please contact Jonthan Fothergill, Senior Specialist, Valuation and Investment Advisory at: jfothergill@rics.org.