Bank Specialization and Zombie Lending

We study whether banks internalize congestion externalities when lending to zombie firms. We conjecture that banks should be better informed about the presence of zombie firms and the congestion externalities that such firms exert on healthy borrowers in industries where banks are specialized and show that banks' credit supply to zombie firms relates negatively to their industry specialization. This relation is stronger when congestion externalities are likely to have stronger adverse effects, namely when zombie firms take a higher fraction of resources in the industry or when the industry is geographically more concentrated. Additionally, this relation is weaker in industries with higher asset specificity as zombie firms' default (and potential asset fire sales) could reduce healthy borrowers' collateral value.