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VoxEU Column Financial Regulation and Banking Macroeconomic policy

Corporate debt and business dynamism in emerging Europe

After years of rising indebtedness and the Covid-19 pandemic, financially weak firms are constraining business dynamism across emerging Europe. This fourth in series of five columns looks at zombie lending and its economic implications. Zombie lending – the evergreening of cheap loans to unviable firms – turns out to be especially prevalent when banks are undercapitalised or state-owned and where insolvency frameworks are weak. Zombie firms create negative spillovers for healthy companies (which experience lower investment, revenues, and employment) and these effects are especially pronounced along the value chain.

The majority of businesses across the European Bank for Reconstruction and Development (EBRD) regions suffered large negative cash flow shocks following the Covid-19 outbreak. In response, almost half of all countries in the EBRD regions introduced some form of emergency insolvency legislation. Many countries also suspended, at least temporarily, the obligation to file for insolvency. This gave affected companies more time to carry out fundamental restructuring or to delay their dissolution in the case of de facto insolvency. Thanks to the scale and speed of the policy response, firms’ default rates are now at all-time lows. Yet, the downside of this development is that the creative destruction process typically observed in a recession has not (yet) materialised. Indeed, across much of emerging Europe, both insolvencies and the registration of new businesses saw sharp falls after the onset of the pandemic. While new business registrations have since returned to pre-pandemic levels, insolvencies have fallen even further (Figure 1).

We estimate that around 20% to 25% of all firms in emerging Europe are currently financially vulnerable. Just over a quarter of those vulnerable firms – or around 5% of all firms by total assets – can be classified as true zombies: firms that are in distress but avoid default thanks to their continued access to cheap funding and forbearance from their lenders (Laeven et al. 2020, Acharya et al. 2022). Access to cheap credit is what sets these zombie firms apart from other financially vulnerable firms: implicit subsidisation is at the core of zombie lending.

Our analysis shows that across emerging Europe, undercapitalised and state-owned banks are much more likely to lend to zombie firms. Such zombie lending is also more prevalent in countries with less efficient insolvency regimes – for instance, where creditors’ expected recovery rates on distressed assets are lower, where the start of insolvency proceedings takes a long time, and where creditors’ participation in insolvency proceedings is limited.

Figure 1 While new business registrations have recovered, firm exit rates remain subdued

Figure 1 While new business registrations have recovered, firm exit rates remain subdued

Source: Eurostat and authors’ calculations.
Note: Data for the EBRD regions cover Bulgaria, Croatia, Estonia, Hungary, Latvia, Lithuania, Poland, Romania and Slovenia. Data for comparators cover Belgium, Denmark, France, Germany, Iceland, Ireland, Italy, Luxembourg, Malta, the Netherlands, Norway, Portugal, and Spain.

Zombie firms distort business operations

The presence of zombie firms can affect peers in the same sector (through horizontal spillovers) and have an impact via supply chains (vertical spillovers). There are two main mechanisms underpinning horizontal spillovers from zombification. First, healthy firms face increased competition from zombies in input and product markets (a ‘congestion effect’). Second, zombie firms can make it harder for financially healthy firms to access credit (via a ‘crowding-out effect’) because capital-constrained banks that evergreen loans to zombies have less scope to lend to healthy firms.

The presence of zombie firms appears more harmful to healthy firms than the presence of other (non-zombie) vulnerable firms, especially when it comes to investment and employment. Our estimations indicate that the annual investment rate of a healthy firm is, on average, about 2 percentage points higher than that of a vulnerable firm if it operates in a sector without any zombie firms. This differential drops to 1.4 percentage points when zombie firms account for 20% of the sector on an asset-weighted basis.

Distortions created by zombies and other financially vulnerable firms can also spread vertically along supply chains. Downstream spillovers occur when distortions among suppliers are passed on to businesses that receive inputs from those suppliers. Upstream spillovers occur when credit market and other distortions cause a demand shock for suppliers providing inputs to a firm. The analysis in Chapter 3 of the EBRD's 2022-23 Transition Report (EBRD 2022a) provides strong evidence of such negative spillovers – both downstream and upstream in the supply chain – due to the presence of zombie firms (Figure 2). In fact, when zombie firms account for more than 20% of total assets in either downstream or upstream sectors, this results in negative investment rates and employment growth for affected healthy firms. Importantly, no spillovers arise in the presence of vulnerable firms that are not zombies. This highlights the specific distortionary effect that subsidised credit has on the allocation of economic resources.

Figure 2 Zombie firms negatively affect healthy firms throughout the supply chain

Figure 2 Zombie firms negatively affect healthy firms throughout the supply chain

Source: Bureau van Dijk’s Orbis database, Eurostat, and authors’ calculations.
Note: Bars denote the coefficients that are derived from regressing firms’ annual investment rates and annual employment on an indicator for healthy firms and an interaction variable combining that indicator with the percentages of vulnerable firms and zombies in the relevant country-sector. 95% confidence intervals are shown. Regressions include firm and country-sector-year fixed effects, as well as controls for firms’ assets and stocks of debt.

Policy implications

To prevent zombification, policymakers can take action in four areas: (i) a gradual withdrawal of business support, (ii) strengthening banking supervision, (iii) reforming insolvency resolution mechanisms, and (iv) developing private debt and equity markets.

Withdrawal of support

The withdrawal of government credit guarantees and subsidies needs to be carried out gradually, with loan foreclosures ideally targeting structurally weak firms. Where countries have sufficient fiscal space, continued business support should be fine-tuned to ensure that only solvent and viable firms with temporary liquidity problems receive financial assistance.

Banking supervision

Banking supervisors can support the economic recovery in three main ways. First, they need to ensure that banks provision adequately for losses as it becomes clearer which borrowers are viable and which are not. Second, banks need to have sufficient capacity to monitor the financial health of borrowers and make greater use of expert judgement to identify firms in financial distress. Large-scale on-site inspections of the credit portfolios of several Portuguese banks in 2012 and 2013 made it less likely that those banks would refinance zombie firms, with the banks immediately triggering those firms’ default instead (Bonfim et al. 2022). Third, banks can establish dedicated workout units to resolve distressed loans – which should be independent of loan origination activities, as recommended by the European Banking Authority (EBA 2018). This can prevent conflicts of interest between the team that originates loans and the team that is engaged in corporate recovery.

Reforms to insolvency frameworks

Efficient insolvency frameworks can reduce undercapitalised banks’ incentives to evergreen loans, making insolvency reform a key complement to capital requirements, banking supervision, and the reduction of nonperforming loans (NPLs). Measures to improve the efficiency of insolvency procedures include electronic filing and case management systems, virtual court hearings and creditors’ meetings, and out-of-court or hybrid solutions (Helmersson et al. 2021, EBRD 2022b).

Development of private debt and equity markets

A more efficient insolvency framework will enable all types of creditors – not just banks – to monitor their exposures closely and, where necessary, take steps to close down distressed borrowers or support a formal restructuring of their debts. One emerging source of credit is private debt provided by global private debt funds. Evidence shows that making greater use of private debt markets can help to curb lending to zombie firms when coupled with better-functioning insolvency regimes (Becker and Ivashina 2022). Moreover, as loan support schemes and credit guarantees are phased out, they may need to be complemented or replaced with measures that promote the use of equity or equity-like instruments, such as debt-for-equity swaps in jurisdictions where insolvency law permits it.


Acharya, V, M Crosignani, T Eisert and S Steffen (2022), “Zombie lending: Theoretical, international and historical perspectives”, Annual Review of Financial Economics 14: 21-38.

Becker, B and V Ivashina (2022), “Weak corporate insolvency rules: The missing driver of zombie lending”, AEA Papers and Proceedings 112: 516-520.

Bonfim, D, G Cerqueiro, H Degryse and S Ongena (2022), “On-site inspecting zombie lending”, Management Science, forthcoming.

EBA (2018), Guidelines on management of non-performing and forborne exposures, London, Last accessed on 26 September 2022.

EBRD (2022a), Business Unusual, EBRD Transition Report 2022-23.

EBRD (2022b), EBRD Insolvency Assessment on Reorganisation Procedures, London, Last accessed on 26 September 2022.

Helmersson, T, L Mingarelli, B Mosk, A Pietsch, B Ravanetti, T Shakir and J Wendelborn (2021), “Corporate zombification: Post-pandemic risks in the euro area”, Financial Stability Review, ECB, May.

Laeven, L, G Schepens and I Schnabel (2020), “Zombification in Europe in times of pandemic”,, 11 October.