Constraining effects of local government debt on bank loan growth

Abstract

In China's ever-evolving financial landscape, commercial banks are showing an increasing preference for local government bonds, viewing them as steadfast financial instruments. This study explores the complex relationship between banks’ growing preference for local government bonds and the resulting impact on their loan growth trajectories. Using a linear mixed model, empirical findings reveal that as local government debt increases, there is a corresponding slowdown in loan growth. Notably, city commercial banks, which are closely tied to local governmental structures, exhibit a more pronounced response to these fiscal changes compared to their joint-stock counterparts. Furthermore, strong political connections between banks and local governments tend to mitigate this negative relationship.