Local Banks' Stabilization Role: Does Local Government Debt Matter?

This study investigates the role of local small and medium-sized banks in stabilizing the local economy and assesses whether higher levels of local government debt hinder this effect. Using panel data on local small and medium-sized banks and local government debt from 31 Chinese provinces between 2015 and 2021, we find that the lending behavior of local small and medium-sized banks is counter-cyclical in provinces with low levels of local government debt and pro-cyclical in provinces with high levels of local government debt. Notably, our analysis reveals that provinces with higher levels of local government debt exhibit more pro-cyclical behavior in terms of local small and medium-sized bank lending, particularly during economic downturns. This finding suggests that high levels of local government debt impede the stabilizing role of small and medium-sized banks, exacerbating regional economic volatility. Furthermore, we find that the ownership, type, and cross-regional operations of banks have a significant impact on their ability to stabilize the local economy. Overall, our results provide valuable insights into the role of local small and medium-sized banks in promoting economic stability at the regional level.