This time, zombie borrowing

The 2008 financial crisis has been characterized with subprime mortgages. The current phenomenon is zombie borrowing.

Zombie firms are companies that do not generate enough profits to cover their debt servicing costs and survive primarily by rolling over debt.

According to the Bank for International Settlements (BIS), the share of zombie firms among listed companies doubled from around 6% in the mid-1980s to more than 12% by 2020 (Banerjee & Hofmann, 2020).

The Role of ABCPs in Zombie Financing

Asset-Backed Commercial Paper (ABCP) is a short-term debt instrument that allows non-bank financial institutions (NBFIs) to fund long-term assets—such as corporate bonds, trade receivables, or lease contracts—using short-term liabilities, typically maturing in under 90 days.

ABCPs resemble bank deposits in function but are outside the scope of deposit insurance or traditional banking regulation. They are backed not by government guarantees, but by collateral and private guarantees. That means their stability is fragile and depends heavily on market confidence.

In the context of zombie borrowing, ABCPs act as an indirect funding channel. Non-bank intermediaries buy long-term, often risky corporate debt—including from zombie firms—and fund this by issuing ABCPs to investors. They earn a spread by assuming maturity transformation risk—a classic source of systemic fragility.

Case Study: ABCP Collapse in 2007–2008

During the 2008 global financial crisis, the ABCP market collapsed rapidly, marking the beginning of a shadow bank run. The market shrank from over $1.2 trillion in July 2007 to below $1 trillion by the end of August 2007—a 20% drop in a single month (Covitz, Liang, & Suarez, 2013).

Collapse of the ABCP Market, 2007

• Before the crisis: ABCPs were often backed by subprime mortgage-related securities.

• During the crisis: Investors, unsure of underlying collateral quality, indiscriminately pulled out of the ABCP market.

• After the crisis: Many conduits were forced to liquidate assets at fire-sale prices. This transmitted the financial panic to the real economy, worsening the recession.

Traditional banks—also exposed to subprime losses—were unable to support the ABCP market, leading to systemic liquidity shortages.

Central Bank Intervention in 2020: A Temporary Fix

During the COVID-19 financial shock, central banks reacted swiftly. The U.S. Federal Reserve reintroduced the Commercial Paper Funding Facility (CPFF) and purchased a wide range of short-term debt instruments, including ABCPs. To reduce the stigma and risk associated with these purchases, the U.S. Treasury created a loss-absorbing equity buffer.

This intervention succeeded in preventing another run. However, the real economy—especially the corporate sector—was already weakened. Many firms, especially small and mid-sized enterprises (SMEs), borrowed heavily at low rates just to survive. These are now among the riskiest borrowers.

The Real Problem: A Looming Insolvency Wave

While central banks successfully prevented a liquidity crisis in 2020, the next phase may involve insolvency rather than illiquidity. As interest rates rise and revenues stagnate in many sectors, zombie firms will struggle to refinance. If these firms default in large numbers, the financial intermediaries holding their long-term debt—funded by short-term ABCPs—will be unable to roll over their liabilities. A new wave of shadow bank deleveraging could ensue.

According to S&P Global Ratings (2024), the global corporate default rate increased from 1.8% in early 2022 to over 4.5% in late 2023, with further increases likely in 2025. This marks a significant stress on the quality of collateral underlying many ABCPs.

Systemic Implications and Policy Recommendations

The fragility introduced by zombie borrowing through shadow markets like ABCPs carries wide systemic risks. If ignored, the financial system could suffer another crisis—this time, triggered not by consumer leverage or subprime mortgages, but by insolvent businesses kept afloat by unsustainable borrowing.

Policy recommendations:

1. Enhanced ABCP regulation: Increase disclosure requirements on collateral composition and origin.

2. Stress-testing non-banks: Include ABCP conduits and their guarantees in macroprudential supervision.

3. Exit strategy for central banks: Design a path to unwind emergency facilities without destabilizing the market.

4. Zombification metrics: Use ICR-based and productivity-based metrics to monitor zombie firm prevalence (Banerjee & Hofmann, 2020).

Conclusion

The financial system has evolved in response to past crises, but new vulnerabilities have emerged in parallel. ABCPs now represent a hidden fragility—not because of poor design per se, but because they fund a growing population of zombie borrowers. If central banks and regulators do not act preemptively, the maturity mismatches and opaque exposures of these instruments could once again bring the financial system to the brink. This time, the danger is not subprime households—but undead businesses.

References

• Armour, J., Awrey, D., Davies, P., Enriques, L., Gordon, J., Mayer, C., & Payne, J. (1999). Principles of Financial Regulation. Oxford University Press, pp. 275–289.

• Banerjee, R., & Hofmann, B. (2020). Corporate zombies: Anatomy and life cycle. BIS Working Paper No. 882. https://www.bis.org/publ/work882.pdf

• Bernanke, B. S. (2007). The Subprime Mortgage Market. Speech at the Federal Reserve Bank of Chicago’s 43rd Annual Conference on Bank Structure and Competition.

• Covitz, D., Liang, N., & Suarez, G. (2013). The evolution of a financial crisis: Collapse of the asset‐backed commercial paper market. Journal of Finance, 68(3), 815–848.

• Mayer, C., Pence, K., & Sherlund, S. M. (2009). The rise in mortgage defaults. Journal of Economic Perspectives, 23(1), 27–50.

• S&P Global Ratings (2024). Global Corporate Default Update. https://www.spglobal.com