Zombie Lending and Policy Traps
— October 29, 2021
By Viral Acharya, Simone Lenzu and Olivier Wang
Starting with the seminal studies of Peek and Rosengren (2005) and Caballero et al. (2008) on the Japanese economy, a growing body of research attributes the ineffectiveness of policy in improving long-term economic outcomes to credit misallocation. In particular, weakly capitalised banks use regulatory forbearance to extend new credit or evergreen existing loans to their stressed borrowers, even as healthier firms in the economy experience adverse spillovers from the resulting proliferation of ‘zombie’ firms.
In a recent paper (Acharya et al. 2021), we review the empirical evidence on zombie lending and its real effects, and propose a theoretical framework consistent with this evidence to analyse how policy can affect the efficiency of credit allocation and long-term economic outcomes. A central contribution of our model is to highlight the role played by central bank and regulatory policies in shaping banks’ incentives, and thereby the equilibrium allocation of credit. We focus on the two most important components of policy for bank incentives: the interest rate set by conventional monetary policy; and ‘forbearance policy’, whose generosity captures a host of government guarantees and unconventional policy actions that subsidise bank lending.
Read the full VOXEu article.
Viral Acharya is the C.V. Starr Professor of Economics
Simone Lenzu is an Assistant Professor of Finance
Olivier Wang is an Assistant Professor of Finance