The implementation of long-term prudent valuation models across the UK and Mainland Europe for financial regulation purposes

Abstract

ABSTRACT The Basel 3 guidance on bank regulation includes a new definition of real estate valuation which differs from existing bases. Prudently conservative valuation or prudent value includes four criteria which include the exclusion of ‘expectations of price increases’ and it 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’ and ‘If a market value can be determined, the valuation should not be higher than the market value’. Prudent value has synergies with existing post Global Financial Crisis (GFC) debates concerning long-term valuations for commercial real estate bank loan origination and monitoring purposes. This paper outlines the concepts of long-term and prudent values in more detail, reviews the literature on long-term valuation and develops a framework for prudent value. It also puts that literature into a wider perspective on the analysis of market cycles and portfolio disaggregation within performance measurement, and suggests ways in which the property industry could implement the current Basel 3 prudent value proposals.