Living in an uncertain economy with financial instability, makes it harder to bring about secure financial transactions. Indeed, the availability of information regarding the borrower to the lender has been seen as asymmetrical and led to some problems associated with credit risk. Hence the need for security for the lender. In this case, floating charge in particular is an English innovation in security that very well serves both borrower’s and lender’s objectives.
Table of Contents
Introduction
Information asymmetry and credit risk
Security and The Floating Charge
Crystallization / De-crystallization
Evaluating Floating Charge As Security
Conclusion
Research Objectives and Themes
This paper examines the role of the "floating charge" as a critical financial security instrument within the context of information asymmetry between borrowers and lenders. It investigates how this English legal innovation balances the need for lender security with the operational flexibility required by corporate borrowers.
- The mechanics of information asymmetry and its impact on credit risk.
- The definition and legal nature of floating charges in corporate finance.
- The process of crystallization and de-crystallization of security interests.
- Comparative advantages and criticisms of the floating charge in global legal frameworks.
Excerpt from the Book
Security and The Floating Charge
According to Ellinger (2011, p.808), bank customers making loans usually need « to provide 'security' for the loan to improve the bank's chances of repayment ». In this context of debtor and creditor relations, security is to « provide the creditor with a means – through the exercise of proprietary or possessory rights – of obtaining payment, in addition to mere reliance on the debtor's personal liability ». In other words, security's main purpose is to « protect the creditor should the debtor be unable or unwilling to repay ».
The different types of securities are classified under the notion of propriety. A division first takes place between 'proprietary' and possessory securities, which relates to « the legal nature of the arrangement involved ». In the case of proprietary securities, while during the arrangement the debtor's property is still in his possession, the creditor now has proprietary rights over the debtor's property and can therefore seize it in the event of the debtor's default or insolvency.
Summary of Chapters
Introduction: Provides the context of financial uncertainty and introduces the floating charge as an essential English security innovation.
Information asymmetry and credit risk: Explains how information imbalances between lenders and borrowers create market frictions and necessitate formal security measures.
Security and The Floating Charge: Defines the conceptual framework of proprietary securities and describes the unique "hovering" nature of the floating charge.
Crystallization / De-crystallization: Details the transition of a floating charge into a fixed security and the rare mechanism of reverting back to a floating status.
Evaluating Floating Charge As Security: Critically analyzes the benefits and international legal skepticism surrounding the effectiveness of floating charges.
Conclusion: Summarizes the ongoing tension between traditional equity-based law and the need for modern, predictable legislation.
Keywords
Floating Charge, Credit Risk, Information Asymmetry, Financial Intermediaries, Security, Crystallization, Corporate Finance, Proprietary Rights, Debt Securities, Insolvency, Lender, Borrower, Legal Innovation, Equity, Collateral.
Frequently Asked Questions
What is the primary focus of this paper?
The paper explores the role and legal effectiveness of the floating charge as a security instrument in financial transactions, particularly when dealing with information asymmetry.
What are the central themes discussed?
The themes include the necessity of collateral, the economics of information in banking, the distinction between fixed and floating charges, and the historical development of equity law in relation to finance.
What is the main research question or objective?
The objective is to critically discuss how floating charges serve the conflicting objectives of both lenders (seeking security) and borrowers (seeking operational freedom).
Which scientific methods are employed?
The author employs a legal-analytical method, synthesizing established economic theories (such as Akerlof, Spence, and Stiglitz) with legal precedents and academic banking law literature.
What topics are covered in the main body?
The main body covers the theoretical foundations of information asymmetry, the legal classification of proprietary securities, the practical mechanisms of crystallization, and a critical evaluation of the floating charge's security efficacy.
Which keywords best characterize this work?
Key terms include Floating Charge, Credit Risk, Information Asymmetry, Financial Intermediaries, and Proprietary Rights.
How does information asymmetry create a need for the floating charge?
Because lenders cannot fully monitor or predict a borrower's behavior (ex ante adverse selection or ex post moral hazard), they require a flexible security interest that protects their capital while allowing the company to trade freely.
What is the significance of the "crystallization" process?
Crystallization is the turning point where the "floating" security becomes "fixed," effectively seizing control of assets from the borrower in response to financial distress or insolvency.
- Quote paper
- Jennie Robinson (Author), 2015, The importance of security in lending, Munich, GRIN Verlag, https://www.grin.com/document/432709
