The Crowding-In Effects of Local Government Debt in China

Xiaoming Li (), Zheng Liu, Yuchao Peng and Zhiwei Xu ()

No 2024-35, Working Paper Series from Federal Reserve Bank of San Francisco

Abstract: We study how changes in the composition of Chinese local government debt influenced bank risk taking, credit allocation, and local productivity. Using confidential loan-level data and a difference-in-difference identification approach, we show that a debt-to-bond swap program for local governments implemented in 2015 significantly increased bank risk taking through a risk-weighting channel under Basel III capital regulations. The debt swap program converted bank holdings of municipal corporate debt to local government bonds, reducing banks’ risk-weighted assets. Banks responded by lowering credit spreads on loans to privately owned firms (POEs) relative to state-owned enterprises (SOEs), with significantly larger reductions in POE credit spreads in provinces with more outstanding government debt. Furthermore, the credit reallocation toward more productive private firms—a crowding in effect of the debt swap—significantly raised local productivity.

Keywords: Local Government Debt; credit allocation; Bank Risk Taking; misallocation (search for similar items in EconPapers)
JEL-codes: E52 G21 G28 (search for similar items in EconPapers)
Pages: 50
Date: 2024-11-08
New Economics Papers: this item is included in nep-ban, nep-cna and nep-fdg
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DOI: 10.24148/wp2024-35

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