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Preventing Zombie Lending

Max Bruche¹; Gerard Llobet^1,2

¹ City, University of London · ² Centro de Estudios Monetarios y Financieros

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 scheme would be voluntary. Even though banks have private information on the quantity of bad loans on their balance sheets, the scheme avoids creating windfall gains for bank equity holders. In addition, some losses can be imposed on debt holders.

DOI

10.1093/rfs/hht064

Volume

27 (3)

Pages

923-956

Language

en

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BibTeX

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