Zombie-lending during the pandemic in India: Did the Central Bank reduce credit misallocation concerns of forbearance?

During the COVID-19 pandemic, the Reserve Bank of India (RBI) undertook a policy mix approach to maintain financial stability in the Indian banking system. RBI recapitalized the banks and infused liquidity through accommodative monetary policies combined with temporary forbearance policies of restructuring loans to boost credit growth and support economic expansion. With a focus on zombie lending, we examine the effectiveness of this policy mix in bank lending channels during the pandemic. We find banks have extended credit growth to the non-financial listed firms. Broadly, we obtain little evidence of credit misallocation to these firms through zombie lending. Subsequently, we observe a decline in zombie lending to manufacturing and small and medium enterprises. However, our result shows a significant increase in zombie lending towards high rent-seeking industries. We witness that zombie lending does not crowd out healthy lending through the bank and industry congestion channels. The results of our study have significant implications for policymakers. Specifically, our findings suggest that accommodative monetary policy reduces credit misallocation concerns of forbearance. In the absence of monetary policy support, forbearance alone may exacerbate adverse effects.