ECB sounds a warning
Some of the Eurozone’s top banks may be inflating the value of commercial property, possibly masking deterioration of loans to a sector in a downturn, a European Central Bank (ECB) inspection has found.
Commercial property prices fell due to higher borrowing costs and poor demand as firms adjust to post-pandemic realities, with the ECB estimating that prices may have dropped by almost a tenth last year alone.
“The inspection teams found a range of problems in how banks commission or carry out valuations,” the ECB said in a supervision newsletter on Wednesday. “With higher interest rates and lower demand weighing on key segments, borrowers are more likely to face debt servicing challenges.”
Some banks use inappropriate definitions of market value and some do not face the reality that the market is in a sharp downturn, suggesting some collateral backing loans may be worth less than assumed, it said.
ECB inspectors found in 2022 and 2023 that some banks based valuations on transaction data from 2021 or earlier, arguing that there were too few more recent deals to adjust valuations.
“No adjustment was made to reflect the market downturn and the very different economic circumstances, not least the increase in inflation and in ECB interest rates,” said the bank, which has been inspecting commercial property exposures.
Some banks also retard market value as the figure they hope to achieve when they are actually in a position to sell, even if transactions could take months or years. However, valuations must be based on economic realities on the reference date and not when the market environment may be more favourable, the ECB argued.
The supervisor objected to banks averaging different valuations. When valuations differ, banks should question the methodology rather than just accept the figure, it said.
Inspectors found some banks not applying higher construction costs to new developments and accepting overly optimistic valuations assuming the highest and best use of the property by the buyer.
2021
inspectors found in 2022 and 2023 that some banks based values on data from 2021 and earlier
2024
it was found that property values some banks stated were not what they were in this year