What Is a Zombie Bank?
A zombie bank is an insolvent financial institution that continues to operate due to explicit or implicit government support. These banks possess large amounts of nonperforming assets and are kept afloat to prevent the panic from spreading to healthier banks and igniting a wider financial crisis.
Key Takeaways
- Zombie Bank: An insolvent bank sustained by government intervention.
- Prevention of Panic: Aim to avoid panic affecting healthy banks.
- Coined in 1987: Term first used by Edward Kane referencing the savings and loan crisis.
- Economic Impact: Restoring zombie banks is expensive and inhibits economic growth.
Understanding Zombie Banks
Zombie banks’ balance sheets are burdened with nonperforming assets. Typically, a bank experiencing prolonged losses would declare bankruptcy, leading to asset liquidation to repay debts unless rescued by government bailouts. Zombie banks result from financial repression, where central banks prefer to provide support to these institutions rather than risk widespread financial collapse.
Historically, failing banks were left to declare bankruptcy, but the urge to avert panic and protect healthier institutions led policymakers to intervene and keep problematic banks afloat. This resulted in debates about the optimal timing for government intervention and asset liquidation.
Zombie banks first entered popular discourse during the Savings and Loan Crisis in the U.S. when commercial mortgage losses put many banks at risk. Continued government support turned out to be a costly and ineffective strategy when market rebounds did not materialize.
Economic Consequences
Enabling zombie banks to operate incurs several drawbacks. Reviving these banks can be massively expensive, affecting taxpayers and prolonging economic recovery. Capital invested in these banks stifles more productive economic uses, perpetuating inefficiency and weakening the financial system’s overall integrity.
Real-world Examples
Japan
Following its real estate bubble collapse in 1990, Japan opted not to recapitalize or allow its insolvent banks to fail. Three decades later, Japan’s economy remains hampered by deflationary pressures and encumbered by zombie banks with significant nonperforming loans.
Europe
Post-2008 financial crisis, Europe mirrored Japan’s approach, keeping zombie banks alive to stave off deeper financial fallout. This led to suboptimal lending practices and a significant misallocation of credit resources, hampering economic recovery. Even today, European banks struggle with over $1 trillion in bad loans, raising risks related to debt sustainability.
United States
Post-crisis, U.S. banks underwent rigorous stress tests, compelling weaker institutions to raise capital and offload toxic assets. However, the economy still faces challenges with numerous zombie firms struggling to cover interest expenses relative to earnings, suggesting quantitative easing (QE) might have postponed broader day-of-reckoning scenarios.
Related Terms: Nonperforming Assets, Bankruptcy, Bailouts, Financial Repression, Creative Destruction.
References
- Herold Financial Dictionary. “What Are Zombie Banks?”
- International Banker. “The Spectre of Zombie Banks”.
- European Central Bank. “Are the Pandemic Relief Measures Creating Zombie Firms?”
- The Corporate Law Academy. “The Horde of the European Zombie Banks”.
- Congressional Research Service. "‘Zombie’ Companies: Background and Policy Issues".
