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The Unholy Trinity: Regulatory Forbearance, Government-Owned Banks And Zombie Firms

Author

Listed:
  • Anusha Chari

    (Kenan-Flagler Business School, University of North Carolina)

  • Lakshita Jain

    (University of North Carolina at Chapel Hill)

  • Nirupama Kulkarni

    (Centre for Advanced Financial Research and Learning (CAFRAL))

Abstract

Asset quality forbearance to alleviate loans under crisis-induced liquidity stress adversely impacts the allocative efficiency of credit. Bank-firm-matched data from India reveal that government-owned banks increased lending to firms facing solvency pressures relative to private banks. Zombie lending crowded out productive lending, especially in industries and bank portfolios with high proportions of failing firms, controlling for demand-side factors. Reduced loan loss provisioning requirements facilitated regulatory arbitrage by banks through asset-risk reclassification, hiding true asset quality. Forbearance manifested fiscal dominance allowing the sovereign to postpone costly recapitalization— an implicit subsidy that facilitated the buildup of stressed assets in the banking system.

Suggested Citation

  • Anusha Chari & Lakshita Jain & Nirupama Kulkarni, 2023. "The Unholy Trinity: Regulatory Forbearance, Government-Owned Banks And Zombie Firms," Working Papers 022279, Centre for Advanced Financial Research and Learning (CAFRAL).
    • Handle: RePEc:ris:cafral:022279
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    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • H8 - Public Economics - - Miscellaneous Issues
    • E65 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook - - - Studies of Particular Policy Episodes
    • E6 - Macroeconomics and Monetary Economics - - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook
    • H6 - Public Economics - - National Budget, Deficit, and Debt
    • G2 - Financial Economics - - Financial Institutions and Services

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