Zombie Prevalence and Bank Health: Exploring Feedback Effects

Clemens Possnig (), Andreea Rotarescu () and Kyungchul Song ()
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Clemens Possnig: School of Economics, University of Waterloo
Andreea Rotarescu: Economics Department, Wake Forest University
Kyungchul Song: Vancouver School of Economics, Univesity of British Columbia

No 26006, Working Papers from University of Waterloo, Department of Economics

Abstract: This paper investigates feedback effects between bank health and zombie firms—financially distressed firms receiving subsidized credit. The literature focuses on how banks create zombies, overlooking zombies’ impact on bank health. Using Spanish firm-bank data (2005-2014), we document a vicious cycle: lower bank capital ratios are associated with higher zombie activity in served industries, while higher zombie prevalence is associated with reduced bank capital. We link this to a previously unexplored mechanism where banks respond appropriately to observable financial distress through higher provisioning, but overlook risks from relationship borrowers receiving subsidized rates. Our findings suggest that this feedback stems not from financial distress alone, but from the combination of distress with interest rate subsidies.

Keywords: Zombie lending; Bank-firm-industry feedback; Capital misallocation; Networks; Cross-sectional dependence (search for similar items in EconPapers)
Pages: 70 pages
Date: 2025-08-04
New Economics Papers: this item is included in nep-fdg
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