Local Government Debt and Bank Credit Allocation in China

14:00-15:30, Friday, May 12, 2023

I-206, Boxue Building, DUFE

Zhiwei XU is an Associate Professor of Economics HSBC Business School at Peking University. He got his Ph.D. from Hong Kong University of Science and Technology. His research interest includes macro-finance, business cycles, and Chinese economy. His work has been published at AEJ: Macro, Economic Journal, Journal of Economic Theory, Journal of Development Economics, Quantitative Economics, Review of Economic Dynamics, and other leading Chinese journals.

China launched a three-year debt-to-bond swap program in early 2015 that required local governments to replace outstanding debts by local government bonds. Since most of the swapped and newly issued local government bonds were held by commercial banks, the share of local government bonds in commercial bank assets surged from 2015 to 2018.  Under the Basel III capital regulations, local government bonds are considered relatively safe assets with low risk weights. A simple theoretical model shows that an increase in the share of low-risk-weight assets should raise the share of bank lending to risky projects and reduce the credit spread.  Furthermore, the sensitivity of the credit spread to changes in risk weights should increase with the amount of outstanding government debts. Guided by the theory, we study the empirical effects of the debt-swap program on banking lending and credit spreads, using confidential loan-level data from one of China's "Big Five" commercial banks, combined with province-level government debt data and firm-level balance sheet data in China's manufacturing sector.  Consistent with the theory's predictions, we obtain robust empirical evidence that the implementation of the debt-swap program has significantly reduced the credit spread for privately owned firms (POEs) relative to state-owned enterprises (SOEs), and the decline in the credit spread is significantly more pronounced in provinces with larger outstanding government debts.

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