16 November 2017

OECD: Zombie firms, weak banks and depressed restructuring in Europe

This paper presents robust evidence that zombie firms are more likely to be connected to weak banks. Authors use two different zombie definitions with very similar results, and none of them depends on new lending, but indebtedness, so we account for forbearance.

They then show that the effect of bank health on zombie status is amplified under insolvency regimes that do not unduly inhibit corporate restructuring.

Thus efficient insolvency policies, together with healthier banks, would appear to be important in resolving the zombie problem, thereby raising aggregate productivity growth.

Next, they show that healthy banks foster productivity-enhancing capital reallocation, the process by which productive firms grow relatively more. They also show that about one-third of the negative effects of zombie congestion on the efficiency of reallocation, identified in earlier work, could be attributed to weak banks.

Finally, they offer some evidence on the mechanism behind zombie congestion. The negative zombie effects on reallocation and productivity have been attributed to congestion effects (competition) or the credit crowd-out. However, little is known about the crowd-out channel. Authors provide some evidence of the existence of credit crowd-out, using SAFE. Results are indicative due to the small sample, but they document a modest but statistically significant effect: healthy firms report smaller improvements in access to finance in sectors with a high share of capital tied to zombie firms. This would suggest that zombie congestion works mostly through reduced profits for healthy firms, which reduce expected return on projects, and as a result lead to worse borrowing opportunities.

Set in the broader context of the productivity slowdown and the aftermath of the global financial crisis, which has hurt bank and firm balance sheets, their results can carry important implications. As rising capital misallocation has been shown to be a key driver of the aggregate productivity slowdown (Gopinath et al 2017), while zombie congestion is intimately linked to the other key micro dimensions to the slowdown, such as rising productivity dispersion (Andrews et al 2016) and declining business dynamism (Decker et al. 2016), identifying and correcting the distortions which disrupt the natural market selection mechanism is vital to reviving productivity growth.

The results imply that in order to facilitate the unwinding of the zombie problem, it is essential that bank balance sheets are strong, underlining the need for fast recapitalizations after crises and other measures to reduce NPLs. But strengthening banks is an insufficient policy response while insolvency regimes remain hostile to the orderly restructuring and resolution of weak firms. Thus, in countries with weak banks and weak insolvency regimes, efforts to improve banks’ health should be accompanied by appropriate insolvency reforms to reduce impediments to corporate restructuring. At the same time, countries with strong firms and banks should view the establishment of an efficient insolvency framework as equivalent to a macro-prudential tool, to be used in conjunction with post-crisis recapitalisation.

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