Chinese financial institutions should not use their role in serving the real economy as an excuse to help “zombie companies” and instead must help troubled firms with good fundamentals to ride out short-term difficulties, senior officials said.

In China, the term zombie companies refers to inefficient or loss-making enterprises whose production facilities are outdated and debt is mounting or unmanageable.

Liu Guoqiang, assistant governor of the People’s Bank of China, the central bank, said at the Financial Street Forum 2017 in Beijing on Sept 15: “Financial institutions must reduce funding for so-called zombie companies, lower hidden local government debts and combat speculation in real estate to save financial resources for other parts of the real economy that meet the requirements of China’s supply-side reform, so that we’ll be able to cultivate a new economic structure and a new drive for growth.”

Wang Zhaoxing, vice-chairman of the China Banking Regulatory Commission, the country’s top banking regulator, agreed, saying banks will continue to optimize credit allocation and strongly support reduction of excess capacity.

Wang further said that banks should identify zombie companies and withdraw loans from such companies in an orderly way.

They should also not stop lending to those businesses that have good potential for growth but are experiencing temporary difficulties. Disruption to funding for a potentially good business may increase financial risk or even trigger an outbreak of risk, he said.

The CBRC will further promote and improve the foundation of creditor committees to stabilize financial support for those good businesses that are running into difficulties at the moment, he said.

A creditor committee is defined as a temporary organization set up by at least three banks that are creditors to a company where the latter is unable to repay its large outstanding debt.

The CBRC will also support the banking industry to further reduce corporate leverage by carrying out debt-for-equity swaps as per market forces.

“Regulators will properly control the force and pace of financial regulation so that banking institutions will play a better role in resource allocation and risk management,” Wang said.