“Forced” or “Voluntary”? The impact of local government implicit debt on bank risk-taking—based on the perspective of credit resource allocation

We exploit the relationship between local government implicit debt (LGID) and bank risk-taking. Using data from Chinese urban and rural commercial banks from 2011 to 2020, we document that LGID increases bank passive risk-taking but reduces active risk-taking. We further uncover that structural imbalance in credit allocation, declining quality, and decreasing efficiency are the mechanisms by which LGID increases bank risk-taking. Heterogeneous analysis reveals that banks with distinct characteristics and situated in diverse regions exhibit varying effects of LGID on passive and active risk-taking. The debt governance policies have not been particularly effective, as they have not reduced banks’ passive risk-taking but rather dampened their willingness to engage in active risk-taking. Overall, our findings show that LGID is one of the crucial factors that increase bank risk-taking, which gradually removes doubts about the effectiveness of the policy support program for preventing and resolving local government implicit debt risk.