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Drivers of Zombie Lending

Paper Session

Sunday, Jan. 5, 2025 10:15 AM - 12:15 PM (PST)

Hilton San Francisco Union Square, Yosemite C
Hosted By: American Economic Association
  • Chair: Viral Acharya, New York University

The Zombie Lending Channel of Monetary Policy

Bruno Albuquerque
,
International Monetary Fund
Chenyu Mao
,
University of Maryland

Abstract

We uncover a new channel—the zombie lending channel—in the transmission of monetary policy to nonfinancial corporates. We find that the financial performance of unviable and unproductive zombie firms is relatively less affected by a contractionary monetary policy because of a more muted tightening in credit conditions. We rationalize this result with a strengthening in evergreening motives when interest rates rise: lenders face incentives to extend loans to zombies to prevent them from defaulting. Policies that strengthen banks’ balance sheets, and limit banks’ incentives to engage in risky behavior may help mitigate zombie lending practices when financial conditions tighten.

Zombie Lending to U.S. Firms

Giovanni Favara
,
Federal Reserve Board
Camelia Minoiu
,
Federal Reserve Bank of Atlanta
Ander Perez-Orive
,
Federal Reserve Board

Abstract

We show that U.S. banks do not engage in zombie lending to firms of deteriorating profitability, irrespective of capital levels and exposure to such firms. In contrast, unregulated financial intermediaries do, originating more and cheaper loans to these firms. We establish these results using supervisory data on firm-bank relationships, syndicated lending data for banks and nonbanks, and an empirical setting with quasi-random shocks to firm profitability. Although credit migrates from banks to nonbanks, zombie firms file for bankruptcy at an elevated rate, suggesting that nonbanks’ zombie lending does not enhance the survival rate of distressed and unprofitable firms.

Zombie Lending and Policy Traps

Viral Acharya
,
New York University
Simone Lenzu
,
New York University
Olivier Wang
,
New York University

Abstract

We build a model with heterogeneous firms and banks to analyze how policy affects credit allocation and long-term economic outcomes. When firms are hit by small negative shocks, conventional monetary policy can restore efficient bank lending and production by lowering interest rates. Large shocks, however, necessitate unconventional policy such as regulatory forbearance towards banks to stabilize the economy. Aggressive accommodation runs the risk of introducing zombie lending and a “diabolical sorting”, whereby low-capitalization banks extend new credit or evergreen existing loans to low-productivity firms. If shocks reduce the profitability gap between healthy and zombie firms, the optimal forbearance policy is non-monotone in the size of the shock. In a dynamic setting, policy aimed at avoiding short-term recessions can be trapped into protracted low rates and excessive forbearance, due to congestion externalities imposed by zombie lending on healthier firms. The resulting economic sclerosis delays the recovery from transitory shocks, and can even lead to permanent output losses.

Credit Market Tightness and Zombie Firms: Theory and Evidence

Masashige Hamano
,
Waseda University
Philip Schnattinger
,
Bank of England
Mototsugu Shintani
,
University of Tokyo
Iichiro Uesugi
,
Hitotsubashi University
Francesco Zanetti
,
University of Oxford

Abstract

We develop a simple model of financial intermediation with search and matching frictions between banks and firms that links credit market tightness --encapsulating the abundance of credit-- to the search and opportunity costs of credit intermediation. Search costs generate lending to unprofitable firms (zombies) and the opportunity costs of searching exert countervailing forces on the incentives for banks and firms to engage in zombie lending, generating an inverted U-shaped relationship between credit market tightness and the share of zombie lending. High bargaining power to firms decreases the opportunity cost of the firm of foregoing credit relationships, reduces the share of zombie firms and increases the efficacy of capital injections to reduce zombie lending.
JEL Classifications
  • E4 - Money and Interest Rates
  • G3 - Corporate Finance and Governance