Preventing Zombie Lending

Review of Financial Studies, 27(3), pp 923-956.

49 Pages Posted: 21 Jun 2010 Last revised: 12 Mar 2014

See all articles by Max Bruche

Max Bruche

Humboldt University of Berlin

Gerard Llobet

Centre for Monetary and Financial Studies (CEMFI); Centre for Economic Policy Research (CEPR)

Date Written: October 2012


Because of limited liability, insolvent banks have an incentive to continue lending to insolvent borrowers, in order to hide losses and gamble for resurrection, even though this is socially inefficient. We suggest a scheme that regulators could use to solve this problem. The scheme would induce banks to reveal their bad loans, which can then be dealt with. Bank participation in the proposed scheme would be voluntary. Even though banks have private information on the quantity of bad loans on their balance sheet, the scheme avoids creating windfall gains for bank equity holders. In addition, debt holders can be made to shoulder part of the costs of the scheme as long as the regulator can credibly commit not to bail out a bank whose debt holders do not accept a reduction in the face value of their debt.

Keywords: bank bail-outs, forbearance lending, recapitalizations, asset buybacks, mechanism design

JEL Classification: G21, G28, D86

Suggested Citation

Bruche, Max and Llobet, Gerard, Preventing Zombie Lending (October 2012). Review of Financial Studies, 27(3), pp 923-956., Available at SSRN: or

Max Bruche (Contact Author)

Humboldt University of Berlin ( email )

Spandauer Str. 1
Berlin, D-10099


Gerard Llobet

Centre for Monetary and Financial Studies (CEMFI) ( email )

Casado del Alisal 5
28014 Madrid
34 91 429 0551 (Phone)
34 91 429 1056 (Fax)

Centre for Economic Policy Research (CEPR) ( email )

United Kingdom

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