Effect of Local Government Debt on Chinese Urban Commercial Banks’ Ability to Create Liquidity: An Empirical Study

This is the authors' abstract. We don't add key points for this paper.

Post—tax-sharing reform in China, fiscal imbalances drove local governments to borrow heavily. This study uses fixed effects and mediation effect models to show that Chinese urban banks are creating less liquidity because of the increasing local government debt, which crowds out financial resources. The mechanism test indicates that the expanding government debt encourages banks to enter the interbank business, suppressing liquidity creation. Additionally, the suppression effect is strong in urban commercial banks with government majority shareholders and non-listed banks. The findings suggest that local government debt regulation must be improved to reduce its negative impact on liquidity creation.