No more free rides for zombie firms: China’s structural monetary policy cleans up the market

This paper investigates the market cleansing effects of China’s structural monetary policy, represented by the Medium-term Lending Facility (MLF). Using a DID framework on firm-level data from 2007 to 2022, we find that the MLF significantly reduces the prevalence of zombie firms. We attribute this outcome to an ‘Opportunity Cost Channel’: by providing banks with low-risk, profitable lending alternatives, the policy increases the opportunity cost for banks to evergreen loans, thereby incentivizing a disciplined credit reallocation from non-viable to healthy enterprises. This cleansing effect is particularly pronounced among large, capital-intensive, and financially dependent firms. Our findings suggest that targeted unconventional monetary policy can effectively restore market discipline and improve resource allocation in emerging economies.