EBA guidelines on loan origination and monitoring: How to ensure compliance for residential property valuations before time runs out

In recent years, the European banking and financial services sector has witnessed a regulatory evolution with the introduction in May 2020 of the European Banking Authority's (EBA) guidelines on loan origination and monitoring. A key response to the European Council’s Action Plan on non-performing loans (NPLs), these guidelines hold particular significance for residential property valuation, impacting various aspects of the loan origination and monitoring process. Reflecting recent supervisory priorities, they bring a fundamental shift in the sector's approach to credit risk management, credit granting, and credit decision-making processes.

With the guidelines coming into effect on June 30, 2024, the deadline for compliance and application of the guidelines draws closer, making it all the more crucial for credit institutions and competent authorities in Europe to understand exactly which action plan and initiatives need to be implemented to enhance internal governance arrangements, credit risk assessment frameworks and data infrastructures.

EBA guidelines on loan origination and monitoring: what are the requirements for residential property valuations?

The EBA guidelines on loan origination and monitoring cover the whole loan lifecycle, providing recommendations on topics ranging from borrowers’ creditworthiness assessment to consumer protection or anti-money laundering (AML) and counter-terrorist financing policies. In this article, we focus mainly on the recommendations related to property valuations, outlined in chapter 7 of the guidelines: "Valuation of immovable and movable property".

For the valuation of properties, the EBA guidelines aim for a regulatory shift towards a more sophisticated, data-driven approach and a stronger integration of sustainability considerations throughout the loan lifecycle. However, adjusting valuation processes accordingly for millions of properties presents a significant challenge: human-based property appraisals are not only time-consuming but also economically unfeasible.

1. Increased use of advanced statistical models in property valuation processes: What should it look like?

To empower European banks to adopt a more detailed and rigorous approach towards evaluating properties for lending purposes, the guidelines advocate for the use of advanced statistical models (ASMs) as a solution. These models offer a cost-effective alternative to traditional appraisal methods — by leveraging ASMs, banks can streamline the valuation process, reduce costs, and improve efficiency. ASMs can also provide more accurate and nuanced valuations, aligning with the guidelines' emphasis on detailed evaluation and sustainability considerations.

At what stage of the loan lifecycle should banks in Europe leverage ASMs for property valuation?

The EBA Guidelines outline a nuanced strategy for valuing immovable assets, distinguishing between the initial origination phase and subsequent monitoring and revaluation phases.

A. Loan origination procedures: On-site valuations, desktop valuations allowed in some cases

For loan origination procedures, the guidelines advise that all properties used as collateral be evaluated by a professional valuer. This evaluation should entail a physical inspection of the property, encompassing both its internal and external features (refer to paragraph 209). However, in established real estate markets, residential property valuation may be conducted using an advanced statistical model to support a desktop valuation, as mentioned in paragraph 210.

B. Monitoring and revaluation for existing loans: Advancing towards more automation

The guidelines suggest using ASMs to assist in ongoing property monitoring and revaluation, with the valuer remaining responsible for the accuracy of the valuation. This phase is important for banks to ensure that property values remain appropriate over time, requiring regular reassessments as part of the monitoring framework to keep up with changes in the market and in property conditions.

What are the specific requirements when leveraging ASMs for property valuation?

In section 7.4 and particularly in paragraph 237, the European Banking Authority provides additional guidance on what criteria advanced statistical models should meet. Among those criteria:

• They should be benchmarked against up-to-date transaction prices, ensuring their reliability and accuracy;

• They should provide insights and metrics on properties and locations at a sufficient level of granularity (e.g. postcode level);

• They should be based on a sufficiently large and representative sample of high-quality, up-to-date data.

Additionally, acknowledging the influence of market conditions on property values, the guidelines require ASMs to incorporate assessments of liquidity and broader market dynamics, as mentioned in paragraph 213.d: “[...] a description of the location of the collateral, the local market conditions and the liquidity”.

Leveraging ASMs for property valuation: the importance of documentation

Last but not least, model interpretability is crucial. In paragraph 238, the EBA establishes that institutions are responsible for the appropriateness and performance of the models used in valuations, with the valuer remaining responsible for the valuation derived from an ASM. This requires banks to thoroughly understand and document the methodology, input data, and assumptions of the models they use in their credit-granting process. It mandates that documentation of these models be kept up-to-date, underscoring the essential role of rigorous documentation in ensuring accountability and regulatory compliance.

2. Incorporating sustainability into lending practices: What does the EBA recommend?

In paragraphs 57 and 208 of the guidelines, the EBA mandates the integration of ESG and sustainability considerations into the loan origination and monitoring processes.

Paragraph 208 states that “institutions should take into account ESG factors affecting the value of the collateral, for example, the energy efficiency of buildings”. This approach recognises the importance of considering not only the financial viability of loans but also their environmental and social implications.

Paragraph 57 highlights the importance of banks considering the broader impacts of climate change and environmental factors on property valuation. This means that banks are tasked with evaluating the sustainability profile of a property and assessing the potential climate-related risks, such as flooding or extreme weather events.

By integrating sustainability considerations into the loan origination and monitoring processes, banks can better identify and manage environmental risks, enhance the resilience of their loan portfolios, and contribute to broader sustainability objectives.

Act now: Why compliance with the EBA guidelines on loan origination and monitoring spells competitive advantage

The application date for the EBA guidelines on loan origination and monitoring is swiftly approaching — banks are expected to update their monitoring processes and infrastructure by June 2024. With limited time remaining, banks must act swiftly to meet regulatory requirements and avoid potential penalties, legal proceedings, and reputational damage.

But beyond the necessity to comply, early adoption and adherence to the EBA guidelines offer banks a competitive advantage in the market. By proactively aligning with regulatory requirements, banks can demonstrate their commitment to transparency, accountability, and best practices in property valuation. This not only enhances credibility with customers, investors, and regulatory authorities but also opens doors to new business opportunities and strengthens existing relationships with clients.

Additionally, in a context of rising awareness towards ESG challenges, compliance with sustainability considerations allows banks to contribute to environmental responsibility and sustainable development, further solidifying their position as leaders in responsible banking and enhancing their positive image and brand reputation.

How PriceHubble can help you ensure compliance with the EBA guidelines for property valuations

PriceHubble offers tailored solutions — from desktop valuation tools for loan origination to fully automated systems for ongoing monitoring and revaluation — designed specifically to assist banks in meeting the EBA’s loan origination and monitoring requirements and enhance the efficiency, accuracy, and regulatory compliance of their property valuation processes.

PriceHubble's AVMs, characterised by their sophisticated statistical underpinnings, are poised to meet and exceed the guidelines' requirements, including being trained and benchmarked on actual transactions, incorporating liquidity indicators, and integrating crucial insights on energy performance and climate risks. PriceHubble’s unique capabilities position it as a pivotal partner in the banking sector's shift towards sustainable finance and evolving regulatory requirements.

Contact us to learn more about how we can support you in optimising your loan origination and monitoring processes for residential property:

EBA guidelines: Embracing change for future success

The EBA's guidelines on loan origination and monitoring present a clear challenge, but also a transformative opportunity for banks and financial institutions. By understanding the key insights, recognising the urgency of compliance, and leveraging solutions offered by partners like PriceHubble, banks can not only ensure regulatory adherence but also position themselves for long-term success in a dynamic and evolving market.