What Is a Zombie Bank?

What Is a Zombie Bank?

Let me explain what a zombie bank is: it's an insolvent financial institution that keeps operating only because of explicit or implicit government support. You see, these banks are essentially dead on their feet, but they're propped up to stop panic from infecting healthier parts of the system.

Key Takeaways

Understand that zombie banks survive insolvency through government backing, primarily to maintain stability and prevent broader financial contagion. The term originated with Edward Kane in 1987 during the savings and loan crisis. Reviving these banks can drain hundreds of billions and stifle growth, while also locking investors' capital away from better opportunities.

Understanding Zombie Banks

You need to know that zombie banks carry massive nonperforming assets on their books and are kept alive to shield other banks from fallout. Normally, a bank deep in losses would face bankruptcy, with assets liquidated to cover debts, but governments step in with bailouts instead. These banks emerge from financial repression, where central banks opt to sustain debt-laden entities rather than letting creative destruction play out.

In the past, failing banks were allowed to collapse, but as policymakers realized the panic this caused, they began intervening. Now, debates focus on when to cut off support—perhaps by creating a 'bad bank' to absorb toxic assets. The term 'zombie bank' first appeared in 1987 amid the S&L crisis, where regulators hoped a market rebound would save them, but losses tripled before they acted.

Shutting them down risks widespread fear, yet keeping them going has clear downsides. It costs a fortune to restore health, burdens the economy, traps capital, and supports failing companies instead of healthy ones, ultimately weakening the entire system through resource misallocation.

Zombie Bank Examples

Consider Japan: after its 1990 real estate bubble burst, officials kept insolvent banks afloat rather than recapitalizing or closing them, unlike the U.S. in the S&L era. Nearly three decades later, those banks still hold non-performing loans, trapping Japan in deflation it can't escape.

In Europe, post-2008 crisis, the eurozone repeated this error to avoid Japan's fate. Zombie banks, loaded with toxic debts, lent more to impaired borrowers to hide losses, misallocating credit and slowing recovery. The ECB warns that rising rates could expose these vulnerabilities, with $1 trillion in bad loans lingering.

Now, look at the United States: after the crisis, stricter stress tests forced weak banks to raise capital and shed toxic assets. Yet, according to the BIS, the U.S. has as many zombie firms—where interest exceeds earnings—as Europe, suggesting quantitative easing merely delayed inevitable write-offs.