76 Pages Posted: 16 Dec 2019 Last revised: 2 Apr 2020
Date Written: November 29, 2019
The secular rise of "zombie" borrowers, insolvent firms sustained by continued extension of credit by complicit banks, has been a source of concern for mature and emerging economies alike. Using supervisory data on the universe of large bank-borrower relationships in India, we introduce a novel method for identifying zombies. We use this classification to test the effect on zombie recognition of two key reforms: an overhaul of the bankruptcy law and a regulatory intervention removing lender discretion in bad loan recognition. Increases in the recognition of zombie accounts as non-performing were modest after the law change but there was a more sizable increase post the regulatory action. We show that the effect of the bankruptcy law was wholly concentrated among well-capitalized private banks; the regulatory action was required for undercapitalized and public-sector banks to respond. Post-intervention results indicate that lending has been reallocated to large, healthy borrowers. Overall, our results suggest that regulatory action might be necessary, above and beyond bankruptcy reform, to target "zombie" lending in the presence of weak banks and cronyism.
Keywords: NPA, Zombie, Bankruptcy, Bank Regulation, India, Creative Destruction
JEL Classification: F34, G23, G28, G33, K42, O53
Suggested Citation: Suggested Citation