Real Estate Association: Proposed Amendment to Real Estate Valuation Regulations Makes a Person a Bank's Collateral

According to the Estonian Real Estate Association (EKFL), the draft regulation of the Minister of Finance, which was originally intended to simplify the refinancing of home loans, has become a convenient tool for banks to manipulate collateral during every loan issuance. Accepting the draft in its current form would harm the interests of Estonian consumers and would actually restrict competition in the home loan and consumer credit market.

According to Ingvar Allekand, Vice-Chairman of the EKFL Board, the draft regulation on collateral valuation prepared in the Ministry of Finance in its current form unfortunately does not help achieve the original stated goal – to make home loan refinancing significantly cheaper and easier for Estonian people and to increase competition between banks in home loan issuance.

In its current form, the draft regulation would not only give banks the opportunity to value collateral themselves, but to do so in a significantly simplified manner compared to today's standard practice and without adhering to quality standards. "If real estate valuation becomes concentrated in the hands of large banks on the favorable terms being proposed, then the process loses the view of an impartial outside observer and this further promotes so-called coercion, or dependence, of home loan clients on one specific bank," explains Allekand, describing how what was originally a noble idea is becoming a disservice to home loan borrowers.

According to EKFL information, the original goal of the draft was to simplify consumer real estate collateral loans, or in legal terms, consumer credit refinancing, which is also in the association's view very reasonable. To achieve this goal, the draft provides for the possibility of using a statistical model, or an artificial intelligence-based solution, in the valuation of real estate serving as collateral for consumer credit and gives banks the right to conduct internal valuations in this manner. However, the draft submitted for coordination has instead changed the general arrangement of residential real estate valuation by allowing the use of a statistical model also in the initial issuance of loans. "The current draft increases consumer risks, undermines the principles of responsible lending, and places professional valuers in an unequal position compared to bank valuers," noted Allekand while presenting the results of an analysis commissioned by EKFL.

According to Allekand, what is important is that with such an application of the statistical model, all responsibility remains with the consumer – the bank as a credit provider can justify the result of internal valuation (publicly) with available data and photos provided by the consumer, but also with the legislative system (the regulation), which in this manner permits arriving at incorrect valuation results. "The fact that the draft essentially absolves the credit provider of responsibility for their activities is not in line with the principles of responsible lending," he added.

According to the explanatory memorandum of the draft regulation, one objective of the change is also to increase competition between credit providers, but according to EKFL's analysis, this cannot be achieved in this manner. "Paradoxically quite the opposite – such a change would actually hinder the free movement of loans, as the draft does not take into account the current practice of credit providers," said Allekand. Today's standard practice allows a prospective borrower to use a valuation report to obtain loan offers from different banks. However, the same principle does not apply to internal valuers. Namely, internal valuers do not generally issue valuation reports to consumers that they can take to another bank to obtain an offer. This means that if a consumer initially wants to save on valuation report costs and order a valuation from an internal valuer, but after receiving the report wants to get an alternative loan offer from another bank, they must essentially order a new valuation report and pay for it again. This actually encourages consumers to spend more time and money on valuation reports.

"Of course, the draft has been cleverly omitted from the possibility that a credit applicant could use one bank's internal valuation to obtain a loan offer from another bank," said Allekand. Thus, the planned regulation amendment unfortunately brings results contrary to the goals sought by Bank of Estonia and the Financial Supervision Authority. Although the adoption of artificial intelligence may reduce real estate valuation costs for banks themselves, switching between banks on such a regulated basis will not become easier, faster, or cheaper for consumers.

Allekand emphasized that EKFL is not opposed to the use of statistical models in loan collateral valuation, but initially it makes sense to apply it only in repeated valuation of collateral and in loan refinancing. On the initial acquisition of consumer credit, one must not risk incorrect valuation of collateral, as the consumer bears these risks. "If we do not want to make the already painful bubbles and their bursting on the Estonian real estate market even worse, then the statistical model can be used more widely only after it has proven itself in practice. Among other things, the building registry and other publicly available data must be organized, which are to this day very incomplete, but will significantly affect the value of collateral."

EKFL also submitted specific proposals to the Ministry of Finance and wording variants on how to change the draft text so that the original objective of the draft can be met, while eliminating contradictions with existing regulations and unjustified distinctions among market participants. According to the union's proposals, the regulation should first provide that the same rules apply to both internal and external valuers in real estate valuation (i.e., following established market practice, inspection, qualification requirements). The same rules should apply to both the initial valuation of collateral and the use of a statistical model. Second, it should be stipulated that a statistical model may be used only in repeated valuation of real estate serving as collateral and in loan refinancing. In this case, the use of the model does not require on-site inspection of the property and simplified documentation requirements apply.

The analysis and proposals developed at EKFL concern the draft amendments to the Regulation No. 25 of the Minister of Finance of 15 June 2016 "Requirements for the Valuation of Real Estate Serving as Collateral for a Consumer Credit Agreement Related to Residential Real Estate." The current text of the draft, in EKFL's opinion, is biased in favor of the interests of large banks, fundamentally contradicts both European Union and Estonian law, and is detrimental to consumers and market participants.

Founded in 1994, the Estonian Real Estate Association (EKFL) is an association of business entities engaged in real estate intermediation, development, management, and consulting, which unites Estonian real estate companies that consider it important to provide clients with honest, fast, correct, and professional service. The association's membership includes more than 70 leading Estonian real estate companies.