Recommendation J regarding the rules for the collection and processing of real estate data by banks

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Financial Supervision Authority
Recommendation J regarding the rules for the collection and processing by banks of real estate data Warsaw, September 2012

Introduction
This Recommendation is issued pursuant to Article 137(5) of the Act of 29 August 1997 on Banking Law (consolidated text: Journal of Laws of 2002, No. 72, item 665, as amended) and concerns good practices in the collection and processing by banks of data on the real estate market contained in internal (own) and external (interbank) databases, which support the risk management process related to credit exposures secured by mortgage. In adapting its activities to this Recommendation, a bank takes into account the provisions of law, in particular the Act of 29 August 1997 on Mortgage Bonds and Mortgage Banks (consolidated text: Journal of Laws of 2003, No. 99, item 919, as amended) and the Act of 21 August 1997 on Real Estate Management (consolidated text: Journal of Laws of 2010, No. 102, item 651, as amended).

Taking into account the experiences of recent years, it should be emphasized that from the perspective of the safety of a bank's operations, one of the particularly important issues is a prudent financing policy for transactions in the real estate market, and especially the assessment of the value of real estate collateral. Due to the large share of mortgage-secured credit exposure portfolios in banks' credit portfolios and the extremely important economic significance of this type of exposure, the incorrect or imprudent acceptance by banks of mortgage collateral values may result in the occurrence of significant and difficult-to-predict systemic risk. Therefore, to limit the effects of potential crisis situations, banks should possess as complete knowledge as possible about the real estate market.

For effective risk management related to accepting mortgage collateral established on real estate, banks need reliable and complete information about the real estate market, current and historical data showing changes occurring in this market in both long-term and short-term terms, and especially its cyclicality. These data should take into account the local nature of the real estate market and the long-term nature of changes occurring in it.

Furthermore, the creation and, above all, active use by banks of databases collecting information on the real estate market can be an important factor promoting the development of an efficient (and relatively low-cost) system for banks to obtain long-term financing using debt instruments issued based on mortgage-secured loans. Banks' involvement in the collection and processing of real estate data will increase market transparency and the scope and quality of information that can be obtained, which in turn will facilitate the sale of receivables – their trading – e.g., for the purpose of conducting securitization transactions or using loans as a pool securing the issuance of debt securities. In turn, in the case of the assessment by rating agencies of mortgage-backed securities (mortgage bonds, covered bonds, securitization papers), the quality of the securing portfolio plays an important role, the assessment of which can be made using appropriate qualitative and quantitative data.

Therefore, the systematic collection by banks of information on the real estate market and the creation of databases containing at least the set of data specified in this Recommendation gains even greater significance. Possession by banks of an appropriate set of information will enable a better assessment of the risk associated with the real estate market, which, unlike the capital and foreign exchange markets, has a local character. Consequently, this may facilitate the trading of mortgage-secured receivables. This will stimulate banks to conduct in-depth analyses regarding the financing of investment projects in the real estate market. At the same time, such databases should be appropriate for the activity conducted by the bank, especially its scope, area, scale, type of financed real estate, and in particular the bank's policy in this regard.

Databases should serve primarily to verify the value of accepted collateral in the form of real estate and update it throughout the entire period of the credit agreement. Additionally, with the use of consolidated information in databases, it will be possible to analyze individual local real estate markets, and especially to identify changes occurring in them and the risk associated with specific real estates that serve as collateral for credit exposures.

Parallel to this, using appropriately long time series and based on sufficiently large resources of data on the real estate market, the information contained in databases can be used to assess the risk of changes in the value of real estate collateral (estimating parameters of predictive models for collateral values, determining trends in changes in these collaterals). By better predicting phenomena occurring in the real estate market, it will be possible to effectively manage portfolio risk, monitor the level of collateral value in the portfolio (including monitoring the Loan-to-Value ratio level), and take appropriate preventive actions. In particular, modeling the assessment of the risk of changes in the value of real estate collateral should serve as one of the tools for conducting portfolio risk management policy for mortgage-secured credit exposures. The use by banks of models assessing the risk of changes in the value of real estate collateral may also be useful in the context of widely adopted valuation standards for securing receivables.

Recommendation J complements the principles specified in Recommendation S regarding good practices in managing credit exposures financing real estate and secured by mortgage, and Recommendation T regarding good practices in managing retail credit exposure risk, and thus sets out the minimum criteria for assessing the reliability of databases indicated in Recommendation S. Recommendation J should be applied to all types and categories of real estate that constitute or will constitute the subject of collateral for a credit exposure.

The structure of databases should be based on developed, widely adopted, and harmonized standards for collecting information. An extremely important feature of any reliable database, decisive for its use in assessing and monitoring the value of real estate collateral, is the comparability of the data contained in it. For this reason, the scope and structure of data describing specific types and categories of real estate, with a breakdown of appropriate subcategories, are indicated in the Annex.

The best way to meet the above-mentioned assumption is to maintain, independently of own (internal) databases, a common database for the entire banking sector, systematically fed from both banking sources by all banks involved in mortgage-secured credit exposures, as well as from non-banking sources. Such a database, due to the largest number of information, can become the best source of authoritative, and above all, standardized information about the real estate market, although the use by banks of external databases will require banks to pay attention to the correct selection of data to the bank's activity profile, environment (scaling the database to the bank's business profile), and IT infrastructure.

One of the key elements determining the reliability of databases is the quality of the information sources from which it is fed. The primary source of information on real estate should be data contained in notarial deeds and valuation reports. These reports, after being compared with data recorded in databases, should be verified from the perspective of the realization of the possibility of recovering funds from the collateral (the bank should take into account the collateral value that can be obtained, which is consistent with Recommendation 15, point 4.1.5 of Recommendation S).

It should be noted that there is no single, complete set of information needed to assess and monitor the value of real estate collateral. Information sources are characterized by significant spatial dispersion and diversity in terms of scope and quality.

Among reliable sources, in addition to the aforementioned notarial deeds and valuation reports, the KNF recommends, among others: the register of land and buildings, land and mortgage registers, spatial development plans, information on transaction prices from local markets, statistical studies (e.g., data published by the Central Statistical Office), collections of unit price indicators in construction, catalogs of physical expenditures, technical and project documentation, collections of data on real estate prices and values held by central and local government administrative units. If a bank's internal database is not fed from the above sources, the bank should use external databases in which data from reliable sources are collected. Banks should collect information in databases about:

• transaction prices based on a real estate sale agreement (preliminary and definitive agreement, concluded in the form of a notarial deed);
• the value of real estate disclosed in valuation reports prepared by qualified real estate appraisers;
• the value of mortgage collateral based on the bank's assessment of the value of the real estate collateral.

The second element determining the level of reliability of databases is the volume of currently updated information. Banks should prepare analyses based on a sufficiently large, representative sample built using own data and data from external databases. A bank that does not have its own reliable database should use data from reliable external (interbank) databases.

Recommendation J applies to all banks for which the share of mortgage-secured credit exposures in their own credit portfolios exceeds 10%.
Recommendation J applies mutatis mutandis to branches of credit institutions.

A thorough assessment of the risk of changes in the value of real estate collateral requires the use of models utilizing data accumulated in databases. Reliable, stable, and statistically verified models supporting the process of assessing the risk of changes in the value of real estate collateral will streamline the process of monitoring the risk of portfolios of mortgage-secured credit exposures. Models used to assess the risk of changes in the value of real estate collateral are a separate and independent tool compared to methods used in the assessment and monitoring of the value of real estate collateral, defined for the purposes of the Recommendation in the glossary of terms.

Recommendations 11 and 12 apply to banks for which the share of the portfolio of mortgage-secured credit exposures exceeds 2% of the value of mortgage-secured credit exposures for the entire banking sector in Poland, referred to for the purposes of this Recommendation as significantly engaged. A bank should determine the level of market share once a year, based on data published by the KNF for the entire market. It is particularly important that significantly engaged banks actively participate in the system of external (interbank) information exchange regarding the real estate market.

Due to the safety and stability of bank operations, it is necessary to present, upon request of the Financial Supervision Authority, documentation of models1 along with a description of the rules for their implementation and use, and the methodology used for model construction.
The Authority will verify the documents and materials submitted by banks in terms of form and substance.

Recommendation J applies to all mortgage-secured loans on real estate granted from the date of commencement of the application of Recommendation J. Regardless of this, banks, during the transitional period, i.e., from the moment the KNF adopts the resolution introducing Recommendation J until its application begins, should strive to ensure that data concerning real estate on which mortgage collateral was established meet the criteria specified in Recommendation J. Furthermore, the KNF also expects that banks will update in databases during the transitional period information regarding real estate accepted as mortgage collateral prior to the adoption by the KNF of the resolution introducing Recommendation J.

Regardless of the above-mentioned rules regarding the coverage of a specific group of banks by this Recommendation, depending on the level of engagement in mortgage-secured credit exposures, all banks are encouraged to use databases on the real estate market and the good practices indicated in the Recommendation in this regard.

1 The KNF may assess such models on the basis and in the manner specified in Article 133(2)(1) and (2) of the Act of 29 August 1997 on Banking Law (Journal of Laws of 2002, No. 72, item 665, as amended).

Glossary of Terms

1. Backtesting - the use of historical data to verify models in order to examine the level of conformity of their results with actual observations.
2. Significantly engaged banks – banks in which the share of the portfolio of mortgage-secured credit exposures exceeds 2% of the value of mortgage-secured credit exposures for the entire banking sector.
3. Mortgage-secured exposures – loans and credits secured by a mortgage on real estate.
4. Model monitoring – verification of the effectiveness of the model's operation performed by persons responsible for model construction, usually based on statistical measures.
5. Monitoring of the value of real estate collateral – estimation by a bank of the obtainable value of real estate collateral within the process of monitoring changes in real estate prices accepted as collateral for a given credit exposure, performed at any time during the validity of the credit agreement based on statistical methods or based on real estate market analysis.
6. Assessment of the value of real estate collateral – estimation by a bank of the obtainable value of real estate collateral for a given credit exposure, current at the moment of granting the loan, performed based on statistical methods or based on real estate market analysis.
7. Validation – assessment of the model's operation performed by persons not involved in the model construction process, usually in a more comprehensive manner than within monitoring (e.g., including, in addition to statistical measures, a qualitative assessment).
8. External (interbank) database – an independent of the bank standardized system for collecting and processing data, in which data on the real estate market are systematically collected, including in particular real estate characteristics and information regarding real estate prices and values enabling the conduct of analyses and monitoring of phenomena occurring in the real estate market. Data entered into the database may come from banking sources or reliable non-banking sources.

List of Recommendations
I. Collection of data on the real estate market
Recommendation 1
Incorrect or imprudent acceptance by banks of collateral values in the scope of significant, in terms of value and share, portfolios of mortgage-secured credit exposures may cause the occurrence of systemic risk. Therefore, a necessary element of risk management policy in a bank, enabling the limitation of systemic risk, is the management of risk related to real estate accepted as mortgage collateral. This should be done based on data concerning the real estate market collected in internal (own) or external (interbank) databases.

Recommendation 2
Data collected by banks should allow, to a sufficient extent, for the assessment and monitoring of the value of real estate collateral, the conduct of real estate market analyses, and in the case of significantly engaged banks, for the assessment of the risk of changes in the value of real estate collateral.

Recommendation 3
Significant bank engagement in real estate financing is associated with the need to ensure long-term financing for this area of activity. The creation and active use by banks of databases collecting information on the real estate market should enable the development of a system for banks to obtain long-term financing using debt instruments to build the liquidity position of banks. Banks should analyze in detail the maturity structure of funding sources and adapt it to the maturity structure of assets, diversifying funding sources for activities to limit liquidity risk2.

Recommendation 4
The rules for maintaining and using databases on the real estate market should be specified in the credit risk management policy and described in procedures approved in accordance with the bank's internal rules for implementing internal regulations within a unified risk management system.

II. Creation of databases on the real estate market
Recommendation 5
Databases on the real estate market should contain data allowing for the classification of real estate into groups with a high level of similarity of features influencing their value.

Recommendation 6
It is particularly important that banks actively participate in the system of external (interbank) information exchange regarding the real estate market, creating for this purpose a common external (interbank) database for all banks, fed also from reliable non-banking sources. This database should be systematically fed by all banks covered by this Recommendation.

III. Reliability of databases on the real estate market
Recommendation 7
A bank's database on the real estate market is considered reliable if:

• it is currently fed with information exclusively from sources recognized as reliable, especially those specified in recommendation 1.2.3.
• individual information is collected in a standardized manner,
• high quality of feedback generated within the current use of the database is guaranteed,
• it has a sufficiently large volume of information (historical and current) about individual local real estate markets,
• the IT system supporting the database is characterized by an appropriate level of performance and security, in accordance with good and recognized practice in this regard,
• the accumulated information allows for the assessment and monitoring of the value of real estate collateral and the conduct of analyses and generation of reports concerning both local markets and the entire real estate market,
• it is supported by persons/organizational units with appropriate competencies,
• the bank possesses and applies appropriate procedures, approved in accordance with the bank's internal rules for implementing internal regulations, regulating the use of databases and their recognition as reliable, both with respect to internal and external databases - if used by the bank.

Recommendation 8
A bank should verify the reliability of the databases on the real estate market used once a year. The method of verification, criteria, and persons/organizational units of the bank authorized to conduct it should be specified in appropriate procedures, approved in accordance with the bank's internal rules for implementing internal regulations.

IV. Use of databases on the real estate market
Recommendation 9
A database on the real estate market should allow a bank to assess and monitor the value of real estate collateral for most of the applications analyzed by the bank.

Recommendation 10
A bank should have procedures for assessing and monitoring the value of real estate collateral for which it is not possible to perform assessments based on databases on the real estate market created in accordance with this Recommendation.

Recommendation 11
In the case of a significantly engaged bank, for the proper assessment of the risk of changes in the value of real estate collateral, it is necessary to use statistical models based on data originating from reliable external (interbank) or internal databases.

Recommendation 12
Ensuring the appropriate quality of models for assessing the risk of changes in the value of real estate collateral used by a bank requires that their use and effectiveness be subject to regular verification within monitoring or validation.

I. Collection of data on the real estate market
1.1. Recommendation 1
Incorrect or imprudent acceptance by banks of collateral values in the scope of significant, in terms of value and share, portfolios of mortgage-secured credit exposures may cause the occurrence of systemic risk. Therefore, a necessary element of risk management policy in a bank, enabling the limitation of systemic risk, is the management of risk related to real estate accepted as mortgage collateral. This should be done based on data concerning the real estate market collected in internal (own) or external (interbank) databases.

1.1.1. In order to streamline the credit risk management process, banks are obliged to collect data on the real estate market.
1.1.2. Banks may use internal databases for data collection. However, it is recommended that banks also use jointly created external (interbank) databases, fed also from reliable non-banking sources.
1.1.3. Data collected in external databases should be representative for the entire real estate market in Poland (including data concerning those real estates on which banks establish mortgage collateral) and simultaneously take into account the local nature of this market.
1.1.4. Internal and external databases should meet the reliability criteria specified in Recommendations 7 and 8.

1.2. Recommendation 2
Data collected by banks should allow, to a sufficient extent, for the assessment and monitoring of the value of real estate collateral, the conduct of real estate market analyses, and in the case of significantly engaged banks, for the assessment of the risk of changes in the value of real estate collateral.

1.2.1. In databases on the real estate market, banks should currently collect information about real estate, including its value, from available and obtainable sources, including those recommended in this Recommendation.
1.2.2. Banks should collect in databases on the real estate market reliable, available, and obtainable data, in particular about:

• transaction prices, for which banks assessed the value of real estate based on a real estate sale agreement (preliminary and definitive agreement, concluded in the form of a notarial deed);
• values of real estate disclosed in valuation reports commissioned from a qualified real estate appraiser;
• values of real estate...

2 According to recommendations contained in Recommendation S regarding good practices in managing credit exposures financing real estate and secured by mortgage.