A deeper concern, however, is that zombie banks may pose risks for medium to long-term growth if they engage in the so-called “evergreening” of loans, which is often discussed with reference to Japan.3 The collapse of the Japanese stock and real estate markets in the early 1990s led to severe losses for Japan’s non-financial corporations, a large number of which became unable to service their bank loans.
If banks had decided to call in non-performing loans, they would have been forced to write off existing capital. The fear of falling below the regulatory capital standards gave them the perverse incentive to continue extending credit to insolvent borrowers, gambling on the hope that the firms would recover or that the government would bail them out.