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. It was lowered step by step to 0. 5% in April 2005 (11). The Japanese government had an unwarranted fear of inflation and wouldn’t therefore engage in additional methods such as quantitative easing in order to increase money supply.
As a result, Japan went into a prolonged period of deflation that lasted for most of the 1990’s. In order to boost demand, the Japanese government took a Keynesian approach and went through 10 fiscal stimulus packages in 1990’s totaling over 100 trillion yen (10). However, this didn’t have the desired effect on demand because of deflation. Consumers were putting-off purchase decisions because prices were falling. The real GDP stagnated and average growth between 1990 and 2001 was only 0. 37% (12). The European debt crisis began in 2009 when rating agency’s downgraded Greek government and bank debt because.
Greece’s government debt reached 113% of GDP. Furthermore, in 2010 Greece’s budget deficit for 2009 was revised from 3. 7% to 12. 7% (13). Since then Greece has received multiple bail-outs and the crisis has spread throughout the Eurozone and many countries like Portugal, Spain, Ireland and Italy have been severely affected. The Eurozone crisis is a combination of sovereign debt, productivity, private debt, asset bubble and banking crisis. Contrary to BOJ in 1990’s, the ECB reacted to the crisis by quickly lowering the interest rate to 1% in May 2009 (14).
Furthermore, the ECB started intervening with the securities market directly in 2010 with the ’Securities Markets Programme’, purchase programme to buy bank-issued covered bonds (2011) and ‘Outright Monetary Transactions’ programme (2012), providing massive amount of liquidity to banks (14). In Europe however, instead of putting together fiscal stimulus packages, the sovereigns have undertaken austerity measures in order to reduce the excessive amounts of sovereign debt. As we can see, reaction to the crisis has been more swift and decisive in the Eurozone compared to Japan.
Additionally, the ECB has been engaging in quantitative easing to increase money supply. As a result, Eurozone has so far avoided deflation that haunted Japan in the 1990’s. In fact, inflation expectations in the Eurozone have remained around 2% (6). Deflation can be very hurtful to economy because it lowers demand and increases the value of liabilities. Deflation Emergence of the zombies After the asset price bubble burst in early 1990’s, the Japanese bank balance sheets started to deteriorate quickly. This was due to an increasing amount of non-performing assets and plummeting stock prices.
Across the Eurozone, one of the biggest problems of national banks has been their exposure to PIIGS sovereign debt (5). This has forced many banks to write-down the value of their assets. However, European zombie banks have started emerging for different reasons in different countries. In Spain, zombie banks have emerged as a result of housing bubble bursting and mass unemployment. Additionally, the Spanish zombies lack a viable business model since because they are heavily reliant on cheap money provided by the ECB to refinance their loans.
In Italy, the main problem for the banks has come from extensive lending to small and medium size companies while productivity on capital investment has been close to zero even before the crisis. Even German banks have problems. Due to lack of profitable investment oppoturnities, German banks have deposited their excess liquidity to the ECB at very low rates while their cost of funding is not free. (3) One of the main differences between the Japanese and European zombie banks has been the rate at which the problems of the banks have been exposed.
Although many Japanese banks should have become insolvent, this didn’t happen for a number of reasons. Firstly, Japanese banks were under political pressure to not write-down non-performing assets. The politicians among the bank managers were hoping that in time asset prices would start rising again and corporations would turn profitable. Therefore the financial supervisors were lenient on the banks and in effect ‘turned a blind eye’ to asset overpricing done by the banks. Secondly, in order to avoid writing-off non-performing, zombie banks engaged in ‘ever-greening’ of loans to zombie corporations.
By doing this they kept these zombie corporations alive. Thirdly, the lack of corporate governance in Japanese corporate meant that owners of a bank didn’t interfere with the banks practices. Additionally, Japanese corporate culture and structure in the 1990’s put emphasis on life-long employment and therefore companies didn’t lay-off workers although their productivity had dropped significantly. However, these zombie corporations were kept on life support by the banks through ever-greening of loans.
This with the subsidies given to zombie corporations through fiscal stimulus packages resulted in very low unemployment rates from the asset price bubble bursting in 1991 until 1997 when finally the financial crisis materialized (12). Employment rate only reached 3. 5 % at its peak in 1996 (9). This meant that ordinary households were not defaulting as has been the case in Europe. In Europe the problems of the banks were exposed much faster than in Japan. This is partly because the banks were heavily exposed to sovereigns that were on the brink of default. This automatically raised questions about the banks health.
Secondly . The Euro-zone’s unemployment rate as a whole peaked 12. 2% in October 2013 while in countries like Spain and Greece the unemployment rate peaked at 27. 2% and 27. 5% respectively (9). As a result, the European banks have been forced to write-down the non-performing loans from mortgages exposing their problems much faster than was the case in Japan. http://www. project-syndicate. org/commentary/europe-s-zombie-banks-and-the-curr ent-recession-by-daniel-gros http://www. nber. org/chapters/c0092. pdf http://mises. org/daily/1099 http://www. grips. ac. jp/teacher/oono/hp/lecture_J/lec13.
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