Zombies are stalking Europe — zombie banks that are solvent in name only. The phenomenon is not new. Zombies weighed down Japan for almost 20 years after a real estate bust. They are usually born of financial panics, when loans go bad, capital flees and the value of assets tumbles. There are no good choices when zombie banks are on the march. Shutting them down can cause further panic. Restoring them to health can require hundreds of billions of dollars. But letting them fester can cripple an economy for years, because zombies don’t make the loans healthy businesses need to grow and consumers need to spend. No place has been cozier for zombies since the 2008 global financial crisis than Europe, and no economy has taken longer to recover.
Europe has been slow and piecemeal in its approach to troubled banks. Lenders in Greece face the specter of their fourth cash infusion as the economy wobbles and deposits flow out. In Italy, repeated attempts to relieve banks of soured loans have failed to restore trust. On July 4, the Italian government injected 5.4 billion euros ($6.1 billion) and became the majority owner of the country's fourth-largest lender as part of its ongoing efforts to keep a zombie alive. The previous month, it provided 17 billion euros to make the acquisition of two failed banks by a larger rival possible. In contrast, Spain refused to provide any state funds when it killed off its own zombie with the forced sale of failing Banco Popular Espanol SA. Spain's earlier refusal to deal with its crippled banks helped fuel Europe's sovereign debt crisis between 2010 and 2012, along with ailing banks in Ireland and Portugal. Even after multiple rescues and capital injections, almost a fifth of 130 banks failed a European Central Bank stress test in 2014. In an effort to coordinate the response, the ECB was given the job of the central banking regulator. In October 2016, the International Monetary Fund said European banks with more than $8 trillion in assets were still so weak they remain vulnerable even if economic growth picks up.
One thing about old-fashioned bank runs — when they killed banks they stayed dead. The panics that followed, however, could bring down healthy banks as well, so tools for supporting banks grew up, most notably deposit insurance. Those developments brought with them a thorny question — when to pull the plug. The term “zombie banks” was coined by Edward J. Kane of Boston College in 1987 to refer to U.S. savings and loans institutions that had essentially been wiped out by commercial-mortgage losses but were allowed to stay in business, as regulators put off the pain of shutting them down in the hope that a market rebound would make them whole. By the time they gave up and cleaned up the mess, the losses of the zombies had tripled. In Japan, zombie banks propped up zombie companies rather than write down their loans, while the banks themselves were kept alive through “regulatory forbearance” — a tacit agreement by the government to pretend that their bad loans were still worth something, an approach that kept the markets calm but contributed to a “lost decade” of economic stagnation. The prime example of a tough approach is Sweden, which in the 1990s responded to a financial crisis by nationalizing its ailing banks — and quickly rebounded.
"These institutions have very distorted incentives, just as the zombies do in the horror movies," Edward J. Kane.
After the 2008 crisis, the U.S. pumped $300 billion into its banks, but it also conducted stress tests that were more rigorous than Europe’s and forced low-scoring banks to raise private capital. In Europe, countries from Germany to Spain plugged holes in their banks and failed year after year to force losses and recapitalizations as the U.S. had. As a result, European lenders still sit on more than $1 trillion of dud loans, which don’t earn them any money and prevent them from making new loans that the region’s economy needs desperately to grow. Critics of Europe’s approach point to its double-dip recession and an unemployment rate stuck near a record high. U.S. banks have slowly sold off toxic legacy assets, with the help of recovering prices as well as the near zero percent interest rates maintained by the Federal Reserve since the crisis. While that has enabled them to return to profitability and build capital, it could have hidden costs: There’s a risk that the cheap money that the Fed pumped into the economy may have fueled a new bubble — one that could start the cycle all over again.
The Reference Shelf
- Europe's addiction to bailing out banks was explored in this Bloomberg View column.
- Excerpt from the 2011 book Zombie Banks: How Broken Banks and Debtor Nations Are Crippling the Global Economy by Yalman Onaran.
- The New York Times calls the ECB “zombie hunter.”
- The Economist highlights the blight of the living dead.
- Bloomberg News article on German zombies.
- QuickTake on Stress Tests.
First published Jan. 14, 2014
To contact the editor responsible for this QuickTake:
Leah Harrison at email@example.com