On Zombie Banks and Recessions after Systemic Banking Crises: Government Intervention Matters

Abstract

Systemic banking crises often continue into recessions with large output losses. In this paper we ask whether the way governments intervene in the financial sector has an impact on the economy's subsequent performance. Our theoretical analysis focuses on bank incentives to manage bad loans. We show that interventions involving bank recapitalizations provide banks with incentives to restructure bad loans and free up resources for new economic activity. When the fundamental problem is undercapitalization of the banking sector, other interventions, such as guarantees on bank liabilities and liquidity support, lead banks to roll over bad loans, tying up resources in distressed firms: they become zombie banks and a drag on economic recovery. We then analyze 68 systemic banking crises from the period 1980-2013, of which 28 are part of the recent global financial crisis, and find that bank recapitalizations substantially reduce recession duration.

Keywords: Financial crises, intervention policies, zombie banks, economic recovery, bank restructuring, bank recapitalization

JEL Classification: E44, E58, G21, G28