A zombie bank is an insolvent financial institution that manages to function despite being insolvent because of direct or indirect backing from the government. Of course, the government does not keep these banks viable and prop them up for no reason; rather, it does so to stop the crisis from spreading to stronger institutions. This week's entry will focus on learning more about the fascinating phenomena known as zombie banks.
Z Stands for Zombie Banks!
What is a Zombie Bank?
As was previously established, zombie banks are insolvent financial organizations that, in all fairness, ought to be dead and insolvent. Zombie banks are still operating as a result of government bailouts and are characterized by high levels of nonperforming assets on their balance sheets, which would typically cause a bank to go bankrupt and have its assets sold off to pay off as many debts as possible. However, bringing companies back to life completely is considerably harder than simply keeping them afloat; doing so might cost hundreds of billions of dollars, hinder economic progress, and discourage investors from looking for better chances elsewhere.
How are Zombie Banks formed?
Zombie banks are products of financial repression, which is a phrase for policies used by governments to divert money from the private sector to themselves in order to pay off debt. When loans default, capital is dumped, which lowers the value of assets. Sometimes, instead of letting nature take its course and creative destruction do its job, central banks choose to keep debt-ridden banks, firms, and families on life support, creating a zombie bank.
In the past, banks that went bankrupt due to their financial missteps were just left to die. It soon became evident, though, that by doing so, governments were inviting themselves to the unpleasant reality of widespread panic among other financial institutions, which would harm even otherwise sound banks. As a remedy, governments introduced interventive measures to prevent such panic from occurring. It should be noted that the duration in which a government should keep a zombie-bank on life support has become a rather debated topic.
Consequences of Zombie Banks
While keeping troubled banks alive and operational has serious drawbacks as well, data suggests that letting them die naturally through creative destruction causes numerous difficulties as well. As was previously said, bringing banks back to health may be expensive and detrimental to economic progress. Additionally, by failing to liquidate zombie banks, investors' cash is stranded rather than being put to better use. Zombies banks help economic recovery by aiding ailing businesses, not by bolstering strong ones. The consequent misallocation of resources damages the whole financial system by distorting market dynamics.
That’s all for this week’s issue! Thank you for taking the time to read this! As Z is the final letter in the English alphabet, there will not be any further submissions. That being said, we hope that you were able to learn many interesting phenomena that occur in the world of finance along the way!