Korea's Zombie Firms Hold Back Growth as Weak Companies Stay Alive

The companies surviving while investment stalls

South Korea could have had 2.8 percent more domestic investment and GDP 0.4 percentage point higher between 2022 and 2024 if weak companies had left the market and healthier businesses had taken their place, according to Bank of Korea estimates. Instead, firms at high risk accounted for 3.8 percent of businesses, while the exit rate was just 0.4 percent.

The central bank identifies the prolonged survival of marginal companies as a central cause of Korea's declining economic dynamism since the 1990s. Businesses with little prospect of recovery continue to absorb credit, workers and market space, making it harder for more productive companies and new entrants to grow.

The problem predates COVID-19. Between 2014 and 2019, about 4 percent of firms were in the high risk category, yet only 2 percent exited, roughly half the expected rate. The Bank of Korea estimates that replacing weak companies with healthier ones during those years would have lifted domestic investment by 3.3 percent and raised GDP by 0.5 percentage point.

Emergency loans, lender support and public programs helped prevent bankruptcies, layoffs and financial instability during successive crises. The difficulty is what happens after the immediate danger passes. Support that keeps an otherwise viable business operating can also keep an unviable company alive for years.

As of November 12, 2025, Korea's challenge is to draw that line more effectively. The central bank's diagnosis calls for faster restructuring, healthier banks and an industrial policy that protects the business ecosystem rather than the survival of individual companies. Research on smaller firms also points to a complication: some businesses with weak finances continue to produce useful research and patents.

How successive crises weakened renewal

South Korea's growth slowed after the 1997 Asian financial crisis, the 2008 global financial crisis and the 2020 pandemic. The Bank of Korea contrasts that pattern with the recovery after the oil shock of the 1970s, when output rose above its previous trend.

Firm exits remained unusually low through the later shocks. Emergency credit lines, public support and regulatory forbearance helped distressed businesses continue operating. Regulatory forbearance means allowing financial institutions or borrowers more time or flexibility instead of immediately enforcing the usual requirements.

Authorities sought to prevent thousands of business failures from causing a credit crunch, mass unemployment and wider financial instability. Those interventions softened the immediate damage. Their longer cost was a weaker process of replacing struggling companies with businesses able to make better use of money and labor.

Korea and the United States both experienced a decline in business creation during the 2008 crisis and the 2020 shock. Their exit patterns diverged. Exits rose in the United States, clearing space for new companies during recovery. Korean exits stayed muted and even declined during the pandemic.

The main dates show how the growth problem overlaps with rising demographic pressure:

• 1970s: Korea's recovery after the oil shock lifted output above its previous trend.
• 1997: The Asian financial crisis was followed by a downshift in growth.
• 2008: The global financial crisis reduced business creation in Korea and the United States, while their exit patterns diverged.
• 2014 to 2019: About 4 percent of Korean firms were high risk, while 2 percent exited.
• 2017: Korea's working age population began shrinking.
• 2020: The pandemic brought another growth shock, and Korean firm exits declined.
• 2022 to 2024: High risk firms accounted for 3.8 percent of businesses, while exits were 0.4 percent.

What makes a company a zombie firm?

Zombie firms are companies that have lost economic viability but remain in business with help from creditors or the state. Many carry heavy debts, repeatedly lose money or depend on subsidized credit, loan guarantees and tax relief.

A common financial test is an interest coverage ratio below one for three consecutive years. The ratio compares operating profit with interest expenses. A result below one means that the money a company earns from its operations is insufficient to pay the interest on its borrowing.

Banks can keep these borrowers alive by rolling over loans, replacing debt that is coming due with renewed lending. A bank with a weak balance sheet may prefer that approach because acknowledging that a borrower cannot repay would force it to recognize a loss.

Very low interest rates and abundant credit provide another lifeline. Cheap refinancing allows businesses to continue projects that would otherwise be closed. Research across the Organisation for Economic Co-operation and Development links the crowding created by zombie firms to fragile banks and slow insolvency procedures, the processes used to restructure or close companies unable to pay their debts.

A recent global dataset also finds higher shares of zombie firms where macroprudential rules are weak, insolvency systems are ineffective and credit is cheap. Macroprudential rules are safeguards intended to limit risks across the financial system, including excessive borrowing.

Why weak firms hold healthier businesses back

Zombie firms compete for resources even when they generate low returns. Credit, skilled workers and management time remain tied to established businesses, while stronger companies and new entrants struggle to obtain what they need to expand.

Weak incumbents also retain market share and productive capacity. New methods spread more slowly when stronger firms must wait for customers, workers or equipment to become available. Investment by healthy companies falls, and job creation slows.

Economists describe the replacement of less productive businesses by stronger ones as creative destruction. The phrase refers to an economy renewing itself through business closures, new companies and changes in how goods and services are produced. When that renewal stalls, the economy's capacity to grow over time falls.

The Bank of Korea examined about 2,200 firms subject to external audits to estimate their probability of exiting. Large corporations in the top 0.1 percent, roughly two dozen companies, continued investing through the global financial crisis. Most other businesses stagnated or reduced investment.

The central bank concludes that weak profitability explains the investment slowdown better than a shortage of credit. Public programs and lender support often supplemented liquidity, meaning the money available to meet immediate payments.

Companies in the high risk group had worse profitability and debt ratios than firms that actually exited, yet they had better liquidity. That combination fits a pattern in which lenders and public policies keep companies supplied with cash despite poor business prospects. The resulting pressure extends beyond the supported firms to investment and productivity across the corporate sector.

When crisis support becomes prolonged dependence

Korean authorities have repeatedly used loans, guarantees and regulatory protections to preserve stability during shocks. Such support can be justified when a sudden loss of revenue threatens businesses that could recover once conditions improve.

The difficulty arises when firms needing major restructuring or liquidation continue operating after the emergency. They still compete for money and labor with younger, more productive rivals, while the wider economy receives less investment from the resources committed to them.

International studies of quantitative easing and prolonged low interest rates describe how easy refinancing can encourage investment in projects with poor returns. Quantitative easing involves central bank asset purchases that increase the availability of money and credit. Banks may also refinance weak borrowers to postpone recognizing loans that are no longer being repaid properly.

Research on China after its 2008 stimulus found that politically connected firms were more likely to become zombies when industries targeted for support received large assistance. Korea's institutions differ, but the mechanism is relevant: generous support without careful targeting can prolong the lives of weak firms and slow the movement of resources to stronger businesses.

Pandemic assistance prevented a wave of failures around the world. In economies with slow insolvency systems and fragile bank balance sheets, that survival continued after the emergency. Korea's exit rate of 0.4 percent during 2022 to 2024 points to a cleanup process that has not fully begun.

Why the Bank of Korea looks to Japan

Korea's private sector debt reached about 207 percent of GDP in 2023, close to Japan's peak in the early 1990s. The Bank of Korea has warned that Korea risks repeating parts of Japan's experience after its asset bubble burst.

Korea is also aging faster, and its working age population has been shrinking since 2017. High debt and a declining pool of workers increase the pressure on lenders and policymakers to preserve existing businesses by keeping credit flowing.

Japan's banks and regulators followed that approach during the 1990s. Many unproductive firms remained alive into the 2000s. The Korean central bank calls for tighter control of borrowing through macroprudential rules, quicker corporate restructuring and a stronger insolvency framework.

Global research supports those priorities. Countries with healthier banks and faster restructuring have fewer zombie firms and smaller crowding effects on healthy businesses. Resolving weak borrowers also requires banks strong enough to absorb losses when debts cannot be recovered.

The Bank of Korea's broader message is that industrial policy should protect the ecosystem in which businesses compete and innovate, rather than individual firms. To express the choice facing Korea, it cited Swedish economist Johan Norberg:

A nations rise or fall is not a matter of fate, but of choice.

Some financially weak firms still innovate

A study of Korean small and medium sized enterprises active in research and development complicates the case for relying on financial ratios alone. Firms classified as zombies invested more in research and were more likely to secure patents than their peers.

The effect was strongest in industries with a lower share of zombie firms, a pattern the authors describe as zombie congestion. In those sectors, financially weak innovators faced less crowding from other struggling businesses.

Those companies did not achieve better commercialization rates. Commercialization means turning research or an invention into a product or service that can be sold. Their research effort and technical output were nevertheless real, showing why financial screening can misclassify some innovators.

Policy therefore needs to separate companies with temporary cash problems from those without a viable route back to profitability. The first group can benefit from bridge finance, temporary funding to keep operating, and targeted relief tied to restructuring plans. The second needs an orderly wind down so workers, machinery and credit can move to businesses with better prospects.

Innovation programs also need to examine the quality of research pipelines alongside financial scores, especially for companies at an early stage. A business developing promising technology may require a different assessment from one surviving through repeated loans without a credible recovery plan.

Smaller companies face mounting strain

Banks focused on small and medium sized enterprises have seen loan delinquency rates rise to their highest level since 2010. Delinquency means that borrowers have fallen behind on scheduled payments.

Many small exporters have faced weak demand, higher costs and tariff extensions on products related to steel. Bankruptcies have increased, while surveys show business sentiment well below the neutral level separating positive and negative views.

Gains from the semiconductor cycle have yet to reach many suppliers. A recovery concentrated in a major industry can leave smaller companies under pressure when their own orders and earnings remain weak.

About 18 percent of SMEs were classified as zombies under the interest coverage rule in 2024, the year before the November 2025 assessment. That measure identifies companies whose operating profits have failed to cover interest costs for three consecutive years.

Smaller businesses therefore present two linked policy problems. Some need support to survive a temporary squeeze in demand or costs. Others have prolonged financial weaknesses that require restructuring. The research on patents adds a further consideration: policymakers need to examine what a firm can produce and sell, as well as whether it can currently pay its interest bill.

Restructuring, bank losses and new business finance

Faster insolvency procedures are central to the proposed response. They should resolve cases more quickly, reduce the personal cost of business failure and allow assets to move to stronger owners. Restructuring can preserve a workable business under new terms, while liquidation closes it and releases its assets.

Listed companies also need timely action when they fail audits or meet established triggers involving persistent losses and governance problems. The Korea Exchange has begun tightening delisting rules, and the Financial Supervisory Service has signaled tougher accounting reviews. The share of listed zombie firms remains high, pointing to a need for quicker and more consistent enforcement.

Delisting removes a company's shares from an exchange. Corporate restructuring addresses the business and its debts. Both feature in the proposed cleanup of chronically weak listed companies.

Regulators can also require banks to recognize losses and clear loans that are no longer performing, followed by replenishing bank capital. Recognizing losses makes the cost visible; rebuilding capital gives lenders a stronger base from which to finance viable businesses.

Reducing the tax bias toward debt and expanding equity and venture funding would give young companies alternatives to bank borrowing. Equity funding supplies money in return for an ownership stake. Finance raised through markets can help new entrants expand when lending channels favor established borrowers.

Making room for growth while protecting workers

The state can support growth by concentrating on public goods and removing bottlenecks rather than shielding particular companies. Easing regulatory barriers can help new industries emerge while preserving Korea's strengths in semiconductors and autos.

Digital infrastructure, data portability and faster testing and certification can lower the cost of innovation. Data portability allows information to move between services or systems. Competition policies that open markets to new players would also make it easier for challengers to win business from incumbents.

Workers face real costs when companies restructure or close. Faster business turnover needs support that helps people move into new jobs rather than leaving them to absorb the losses alone.

Job search assistance, retraining linked to skills employers need and relocation help can shorten unemployment. Wage insurance and portable benefits can protect incomes during transitions. Wage insurance cushions an earnings loss, while portable benefits remain with workers when they change jobs. These measures are part of enabling money and labor to move more quickly without abandoning displaced employees.

Retail investors have meanwhile shifted toward foreign equities as confidence in domestic listings has weakened. Cleaning up chronically weak listed companies, improving disclosure and enforcing rules consistently could help rebuild trust and reduce the Korea discount, the lower valuations attached to Korean shares.

Financial Supervisory Service Governor Lee Bok hyun addressed the cultural side of that challenge at an open forum on revitalizing the stock market. He called for a stronger commitment to investing over longer periods:

There needs to be a broader culture that recognizes and practices the value of long term investing.

His message aligns with the central bank's call for an economy that rewards innovation and patient capital rather than keeping incumbents alive at any cost. Korea's task is to preserve viable businesses, resolve those without a recovery path and help workers and investors through the transition.

Key Points

• The Bank of Korea links slower growth since the 1990s to the prolonged survival of marginal firms after major crises.
• High risk firms accounted for about 4 percent of businesses in 2014 to 2019 and 3.8 percent in 2022 to 2024. Exit rates were 2 percent and 0.4 percent respectively.
• The central bank estimates normal replacement of weak firms would have raised investment by 3.3 percent before the pandemic and 2.8 percent afterward, with GDP gains of 0.5 and 0.4 percentage point.
• Weak banks, cheap refinancing and slow insolvency procedures can keep unviable companies operating and crowd out healthier firms.
• Korea's private sector debt reached about 207 percent of GDP in 2023, while its working age population has been shrinking since 2017.
• Some Korean SMEs classified as zombies produced more research and patents, but did not achieve better commercialization rates.
• About 18 percent of SMEs met the zombie firm interest coverage test in 2024.
• Policy priorities include faster restructuring, stronger banks, targeted support for viable firms, more funding for new businesses and protection for workers changing jobs.