Insolvency Reforms Help Economies Redirect Capital and Boost Growth: ADB

An Asian Development Bank and University of Southampton study finds that insolvency reforms reduce capital misallocation by limiting credit to distressed and zombie firms while improving access to finance for productive businesses, leading to productivity gains of up to 3.5% within five years. The research shows that faster insolvency resolution and higher creditor recovery rates help economies allocate capital more efficiently, boosting investment, growth, and long-term economic resilience.

A new study by the Asian Development Bank (ADB) and the University of Southampton suggests that stronger insolvency laws can play a major role in boosting productivity, improving capital allocation, and supporting economic growth. Analyzing more than 532,000 firms across 22 economies between 2003 and 2024, the researchers found that reforms aimed at speeding up bankruptcy procedures and improving creditor recovery rates helped redirect capital from struggling firms to more productive businesses.

Zombie Firms Are Holding Back Economic Efficiency

The study focuses on distressed and zombie firms, companies that continue operating despite weak sales, high debt levels, and poor profitability. Zombie firms are a more severe category because they keep accumulating debt even when their financial performance remains weak.

Researchers found that the share of distressed and zombie firms has risen over the past two decades, with sharp increases during the global financial crisis and the COVID-19 pandemic. These firms often absorb scarce credit and investment resources that could otherwise support productive companies. As a result, capital becomes trapped in low-performing businesses, reducing overall economic efficiency and slowing productivity growth.

Faster Insolvency Processes Deliver Measurable Results

The research shows that insolvency reforms significantly improved the functioning of bankruptcy systems. Within five years of reform implementation, the average duration of insolvency proceedings fell by more than six months, while creditor recovery rates increased by nearly 30 percent.

These improvements created stronger incentives for lenders to allocate capital more efficiently. Sectors with a high concentration of distressed and zombie firms experienced the biggest benefits after reforms were introduced. The findings suggest that efficient insolvency systems help economies move resources away from weak firms and toward businesses with stronger growth potential.

Productivity Gains Reach Up to 3.5 Percent

One of the study's most important findings is the impact on productivity. The researchers estimate that insolvency reforms generated productivity gains of around 3.5 percent within five years in sectors with average levels of distressed and zombie firms.

The reforms reduced what economists call capital misallocation, a situation where productive firms receive too little funding while less productive firms receive too much. The study found that the main benefits came from improving the distribution of capital across firms rather than changing their debt-equity structures. This indicates that better insolvency systems can enhance economic performance without requiring major increases in overall credit supply.

What It Means for Governments and Development Partners

For governments, the findings highlight insolvency reform as an important economic policy tool rather than just a legal reform. Countries with lengthy bankruptcy procedures and low recovery rates may be limiting investment, productivity, and business dynamism.

The study suggests policymakers should focus on reducing insolvency delays, strengthening creditor rights, expanding restructuring mechanisms, and improving judicial efficiency. Such reforms can help economies recover more quickly from crises and create conditions for sustainable long-term growth.

For international development partners, including multilateral development banks and donor agencies, the findings provide evidence that investments in judicial modernization, insolvency administration, and regulatory reforms can generate substantial economic returns. Supporting these reforms could become an effective way to promote private-sector development and productivity growth in emerging economies.

Winners, Risks, and the Road Ahead

The study finds that insolvency reforms increase pressure on financially weak firms. Debt growth among distressed firms fell by 3.46 percentage points after reforms, while zombie firms experienced a 2.12 percentage point decline. Borrowing costs for these firms also increased by around 26 basis points, making it harder for them to survive through continued debt rollovers.

At the same time, productive but credit-constrained firms benefited significantly. Their borrowing increased by 14.8 percentage points, while investment in fixed assets rose by roughly 32 percent. This indicates that capital released from weak firms was redirected toward businesses with stronger growth prospects.

The researchers conclude that insolvency reforms should be viewed as a key component of economic development strategies. By improving the allocation of capital, reducing zombie lending, and supporting productive investment, stronger insolvency systems can help economies raise productivity, attract investment, and build greater resilience against future economic shocks.