Valuing real estate is as much an art as a science, a characteristic that makes the process a banker's nightmare.

Bankers, after all, are lending against collateral. The value of that collateral determines the risk characteristics of each loan and the price each borrower should be asked to pay.

At issue is the question of how expensive it ought to be for banks to lend against real estate.

One lending cost for banks is the capital "cushion" they are required to hold against each loan they make. Rules that make these cushions smaller for lenders in some countries can give them a competitive advantage.

What has made the issue a pressing one for lenders is a proposal to revamp some of the terms set by the Basle Committee on Banking Supervision for bank loans against commercial real estate.

The committee's rules on bank capital adequacy, launched in 1988, had two key aims; first, to ensure that the world's lenders maintain a cushion of capital to protect them against bankruptcy.

The second aim was to ensure that banking supervisors did not offer their own banks an unfair advantage in lending markets by allowing them to operate under less strict standards than those set by regulators of their competitors.

From the start, lending to commercial real estate has proven to be vexatious. Regulators in some countries, particularly Germany, insisted that mortgage lending was a low-risk activity that should require only half the capital cushion required for other commercial loans.

The European Union has its own directive allowing countries to allocate 50 per cent risk weighting to real estate under certain circumstances.

Those rules, according to Andrew Cherry, head of valuations at property consultants Healey & Baker and a member of the International Valuation Standards Committee (IVSC), may be enshrined in a revamped version of the Basle Accord, set to take effect in 2006.

Under the proposal, banks in countries with a history of satisfactory real estate lending would be able to set aside only 50 per cent of the capital required against their real estate loans, on the condition that loan-to-value ratios not exceed the lower of 50 per cent of the Mortgage Lending Value (MLV) or 60 per cent of the Market Value (MV).

The proposal has generated debate about the meaning of "value" for the purpose of lending.

Broadly speaking, Mr Cherry says, "MLV tries to take out the spikes in rental values". It tries to smooth calculations of future rental income to omit the probable peaks and troughs. At the market peak, he says, the gap between MLV and MV will be at its greatest, and when real estate markets collapse the two will coincide.

But the concept of MLV is controversial. Professors Neil Crosby, Nick French and Melanie Oughton at the University of Reading's Department of Land Management and Development are scathing of MLV.

"The reality is that it (MLV - also known as sustainable value) is just another product of the endless search for a single valuation figure which can give lenders the holy grail of longer-term protection from lender default," they say in a 1999 paper. "This it will fail to do, as all other bases applied so far to lending valuations have done."

MLV, the Reading University professors conclude, is simply a more conservative valuation basis and its predictive qualities are subjective.

Markets may bottom below the forecasted level and there is no way of knowing how they will behave at any future point. The only certainty is that prevailing in the market at a specific time, and that is represented by valuations at MV.

However, John Rich, an independent consultant to the IVSC and formerly head of valuations at property consultants Knight Frank, says the debate is more complex. There may be merit in considering the uses of MLV within the context of bank lending to property, he says.

"A large proportion of work done by valuers is done for banks," Mr Rich says. "MLV may be something that the property industry has to be prepared to offer if the banking industry wants it."

ONE approach to the uses of MLV, he suggests, might be to think of the value of a loan's collateral as falling between two bands of a calculation of the probable peak and trough of market values.

As long as a particular real estate loan's collateral remained within the bands forecasted in an MLV calculation, it should be able to attract the lower risk weighting for capital adequacy.

He says banks increasingly want more sophisticated types of value to be provided, such as probability of default, a category to be applied to loans where interest payments are delinquent. This measure goes hand-in-hand with probable loss on default, an effort to measure the gap between the realisable value of the collateral and the loan outstanding.

Ironically, the European Union's directive, intended to codify the Basle Accord for member states' bank regulators, offers the option of a lower-risk weighting to countries with a good track record in real estate lending.

That list includes Germany, Spain, France, Finland, Luxembourg, Austria, the Netherlands, Denmark and the Republic of Ireland - several of which have had relatively poor track records on bank lending to real estate.

Whatever solution is agreed by banking regulators, one thing is clear: that lenders are requiring increasingly sophisticated measures of concepts such as "worth" and "value" that are still unmet by the valuations profession. There is little to be gained from ignoring this demand.