Zombie Firms, Evergreening, and Insolvency: Recalibrating India’s Credit and Regulatory Architecture

[Megha and Aarusha are students at Gujarat National Law University and Indian Institute of Management, Rohtak, respectively.]

Economists have sounded the alarm on the “zombification” of corporations, companies surviving only through perpetual refinancing because they cannot cover interest costs from profits over time. The term zombie firms originated in Japan’s prolonged economic stagnation that is known as the Lost Decade (1991-2001). In response to the collapse of asset prices and the pressure of maintaining regulatory capital thresholds, financial institutions refrained from recognizing loan losses and instead extended further credit to insolvent borrowers, thereby perpetuating the existence of unviable firms and contributing to widespread misallocation of capital.

Zombie firms are the financially distressed companies and manage to avoid their immediate defaults by covering their debts due to the continuous support by the lenders like investors, banks or the government. Despite being economically unviable, these firms avoid formal defaults through bailouts, evergreening of loans, regulatory forbearance or investor support, often by incentives within the financial system.

A widely used empirical proxy defines zombie firms as:

• Listed firms aged ≥10 years;

• With an interest coverage ratio (ICR) < 1 for three consecutive years; and

• Not in high-growth industries (to exclude young, high-investment startups).

  
  

It is important to distinguish between distressed firms and zombie firms, as the latter are in a more advanced stage of financial unviability, making recovery increasingly difficult. While liquidity problems are short-term and temporary, solvency issues indicate an inability to meet long-term debt obligations. The COVID-19 crisis is an example where many firms faced liquidity problems, but those already struggling financially before the pandemic may have seen these issues evolve into insolvency. Zombie firms, characterized by declining return on assets (ROA), investment, and employment growth, alongside increasing leverage, show that their struggles go beyond short-term liquidity issues and stem from deep-rooted economic problems.

In 2015, the Reserve Bank of India launched its Asset Quality Review (AQR), a comprehensive forensic review of banks' loan books, to bring all 90-day plus overdue exposures under non-performing assets (NPAs) category, putting an end to the practice of "evergreening" through short-term rollover and window-dressing. The AQR was launched for large exposures first and subsequently for small accounts, bringing uniform classification norms to all banks and shutting off regulatory forbearance loopholes.

The short-term effects saw reported NPAs swell, as banks provisioned for hidden bad loans. In an effort to strengthen balance sheets, the government provided capital injections to government-owned banks under the Indradhanush Scheme, pumping in INR 70,000 crore in August 2015 and subsequently another INR 2,11,000 crore through recap bonds and budget support. At the same time, the RBI imposed stricter provisioning norms and activated its Prompt Corrective Action framework, capping dividend payouts, branch growth, and executive compensation for banks that had crossed capital or asset-quality thresholds.

In the longer term, India's banking industry experienced a sustained cleaning: scheduled commercial banks' gross NPAs came down from a peak of 11.18% in March 2018 to 3.9% as of March 2023, with the provision coverage ratio rising over 90%, reflecting improved buffers and cleaner loan books. By June 2024, public sector banks' gross NPA ratios came down to 3.32%, from 14.58% in March 2018, reflecting ongoing resolution efforts.

The Insolvency and Bankruptcy Code 2016 (IBC) is the focal legislation for managing large stressed accounts by shifting power from promoters to creditors and enforcing tight timelines. Over 30,000 default cases worth INR 13.78 lakh crore were settled prior to admission up to December 2024, reflecting the achievement of the Code in avoiding procrastination of insolvency triggers.

On 12 February 2018, the RBI had circulated a directive making exposures of over INR 2,000 crore subject to a resolution plan within 180 days from the date of default, eliminating all earlier restructuring programs and mandating IBC referral in case of non-compliance. This anti-zombification measure looked to starve to death non-viable companies, which were estimated to represent 10% of corporate debt due to evergreening. Yet, in Dharani Sugars and Chemicals Limited v. Union of India, the Supreme Court declared the circular ultra vires and held that the RBI had exceeded its powers. In response, on 7 June 2019, the RBI circulated a modified circular restoring lender flexibility while keeping mandatory early default reporting and IBC referral for large outstanding accounts.

In May 2025, after the Supreme Court's reversal of JSW Steel–BPSL takeover, regulators launched another review of IBC regulations to strengthen timelines, increase transparency, and uphold creditor responsibility, emphasizing India's ongoing enforcement over forbearance orientation.

Case Studies

Jet Airways ceased all operations on 18 April 2019, due to severe financial distress and entered insolvency proceedings on 22 June 2019, with outstanding liabilities of approximately INR 9,000 crore owed to lenders, operational creditors, and employees. Despite initial investor interest, including from existing stakeholder Etihad Airways, no credible equity infusion materialized. Creditors eventually faced a haircut of nearly 90%, reflecting a significant loss in enterprise value. Notably, despite being functionally defunct, Jet Airways' equity continued trading on stock exchanges, exemplifying zombie-like market behaviour where fundamentally insolvent companies persist through speculation and delayed resolution.

The insolvency of DHFL, one of India’s largest housing finance NBFCs, was initiated by the RBI in December 2019 under Section 227 of the IBC, after it defaulted on repayments totaling INR 92,700 crore. Earlier restructuring efforts under the RBI’s inter-creditor agreement failed due to lack of consensus among stakeholders, including mutual funds and depositors. The delayed IBC admission, coupled with parallel litigations, led to value erosion and reflected broader systemic risks. The case underscores how coordination failures and late-stage interventions can undermine the resolution process and investor confidence in large NBFC defaults.

Despite being financially defunct, both companies remained active in markets, highlighting systemic inefficiencies that allow such entities to survive artificially, distort capital allocation, and erode investor confidence.

Legal and Economic Consequences of Evergreening in India

In India, evergreening, rolling over of loans or extension of fresh credit to stressed companies at the maturity, creates a perception of solvency while concealing underlying asset quality, violating both RBI's restructuring goal as well as insolvency norms. Banks "extend and pretend" by classifying stress using internal accounts or loan buybacks, ignoring prudential norms on classification and provisioning. It facilitates regulatory arbitrage: restructured exposures are still regarded as performing, evading provisioning costs and maintaining support for capital ratios. Likewise, it protects short-term profitability, postponing credit loss recognition until economic revival or regulatory pressure forces disclosures.

Spotting these distortions, the RBI's 2015 Asset Quality Review mandated honest recognition of NPA, compelling banks to write off hidden bad loans and restrict evergreening under its "no extension without viability" philosophy. From 2018, new lending to a stressed borrower is treated as restructuring and subject to outright downgrade unless tough revival conditions are met. Concurrently, the IBC compels banks to initiate resolution against large defaulters within specified timelines, replacing existing promoters if needed. Risk-based supervision and "prompt corrective action" mechanisms also deter evergreening by undercapitalized lenders.

Macro-economically, zombie evergreening misallocates labour and capital, driving out healthy firms, stifling Schumpeterian creative destruction, and dulling monetary policy transmission, as interest rate increases do not entail evergreen credit. They also distort competition, allowing inefficient firms to undercut healthy entrants and stifle innovation. Only by putting in place transparent NPA standards, speedy insolvency proceedings, and incentive-congruent bank regulation can India ensure credit fuels real growth and not the "undead".

Detailed Policy Recommendations

Enhance insolvency schedules and powers

• Statutory sunset on restructuring: Modifying the IBC to limit allowed restructuring to 180 days with no extension after a one-time 90-day grace period to prevent endless roll-overs.

• Trigger of insolvency automatically: Implement in Companies Act 2013 that any SMA-2 classification (90+ days past due) necessitate IBC filing for exposures ≥INR 500 crore within 30 days.

• Promoter-change requirement: Make resolution plans mandatory to have equity dilution of existing promoters by at least 51% in case of negative ICR for 3 years in succession.

  
  

Realign bank incentives and capital rules

• Risk-weight penalties: Impose higher Basel-compliant risk weights (200%+) on ICR <1 corporate loans for ≥3 years to deter evergreen lending.

• Countercyclical buffers: Allow the RBI to activate Countercyclical Capital Buffer during credit booms, especially when exposures to zombies are more than 10% of corporate loans.

• Viability audit mandate: Require banks to order independent turnaround audits prior to any loan rollover to stressed companies.

  
  

Strengthen judicial and regulatory coordination

• Fast-track benches: Establish specialized NCLT/NCLAT benches for high-value cases (>₹1,000 crore) to meet the 330-day IBC timeline.

• Clarity of creditor consortium: Codify cross-class cram-down provisions and voting majorities to avoid holdouts, as recommended by OECD.

• Information transparency: Require timely reporting of restructuring and SMA status through the CRILC platform to encourage market discipline

Conclusion

Zombie companies drain capital from healthy firms and undermine policy tools. India's shift toward strict enforcement is beginning to bear fruit, but ongoing vigilance, strict identification of NPs, strong insolvency procedures, and a strong banking culture are required to prevent credit from pushing zombies rather than innovation.