Zombie banks

Topics: Monetary policy, Inflation, Central bank Pages: 5 (1766 words) Published: January 24, 2014
What are ‘zombie banks’
The term ‘zombie bank’ was first introduced by Edward Kane in 1987 to describe a bank that has a negative net worth but still continues to operate. A negative net worth means that the fair value of assets is lower than the total value of liabilities. Zombie banks usually have large amounts of non-performing assets on their balance sheets making them unprofitable. A loan is considered to be a non-performing asset if no principal payments or interest have been paid for 90 days and is therefore seen to be in jeopardy of default. The fair value of an asset that is considered non-performing is considerably reduced. Zombie banks usually continue to operate until their financial situation is resolved or they are run down. How ‘zombie banks’ emerge

Zombie banks usually start emerging when bubbles burst or a recession begins resulting in households and companies defaulting. This will increase the amount of non-performing assets making some banks net worth negative. Normally, a company with a negative net worth would be deemed insolvent. However, in the case of banks, insolvency is often avoided because banks deny and hide their problems making them seemingly solvent or the government doesn’t allow the bank to default. The troubled banks overvalue their toxic assets in order to stay solvent. The management of these banks hopes that over time the situation will resolve itself. Due to similar hopes, this overvaluing is often overlooked by national banking supervisors. In the case that a bank’s insolvency becomes evident, it often will not be allowed to fail by the national government because letting it fail would be very costly and could cause a systemic crisis like in 2008 when Lehman Brothers was allowed to default. To prevent a bank defaulting, financial support is provided either in the form of cash injections, by lending money using non-performing assets as collateral or by buying the non-performing assets for a price often exceeding their fair value in order clean up their balance sheets. How ‘zombie banks’ operate

Simply put, normal healthy banks earn their living by taking in deposits and then lending this money out to creditworthy customers. The deposits are the banks liabilities and the loans given out are banks assets. The bank pays an interest on these deposits and collects interest on the loans they give out. The spread between these interest rates is the banks return. Zombie banks however, tend not to lend out money that they get from central bank or deposits to new creditworthy customers. Instead, zombie banks have incentives to hoard the money, ever-green loans or gamble with the money. Firstly, in order to avoid writing down non-performing assets, zombie banks tend to extend credit to their current close to insolvent customers enabling them to pay the interests on their earlier loans. By keeping these so called ‘’zombie companies’’ alive through this ‘’ever-greening of loans’’, zombie banks try to avoid writing-down these assets. Secondly, zombie banks tend gamble with the money by making risky bets hoping to earn high enough return to cover their losses from writing-down non-performing loans. Thirdly, Zombie banks tend to ‘hoard the money’ meaning that they hold on to the money instead of lending it out. Zombie banks do this because the money provides them liquidity and therefore gives them time to clean up their balance sheets. All in all, zombie banks don’t do what banks are supposed to do. They consume public funds and don’t lend out money and in effect slow down economic growth or recovery. Therefore, zombie banks are a burden on the economy and should be dealt with. Background and government reaction

The Japanese crisis in the 1990’s was caused by 1980’s assets price bubble bursting in 1991. Nikkei stock average however already started declining in 1989 and fell by 60% during the 1990’s (8). Bank of Japan (BOJ) started lowering the interest rate from 4,5% only in 1992....
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