City commercial banks’ expansion and firm innovation: Evidence from China

This paper examines the impact of city commercial banks (CCBs) on firm innovation in China using a quasi-natural experiment approach, focusing on the period from 1998 to 2008. We differentiate between local city commercial banks (LCBs) and non-local city commercial banks (NLCBs) to explore their distinct effects on firm innovation. Our findings reveal that while the entry of LCBs does not significantly affect innovation, NLCBs promote firm innovation by increasing competition in the local financial market and enhancing access to external financing. Our analysis further decomposes bank market concentration and shows that the pro-innovation effect is driven specifically by non-local banks that introduce effective competition, particularly in markets with high concentration. Additionally, we conduct heterogeneity analyses based on regional economic conditions and firm characteristics, such as financial constraints and ownership structure, to explore the varying effects of NLCB entry. We find that NLCBs have a stronger impact on financially constrained firms and private firms, as well as on regions with higher economic development. Our study highlights the dual role of NLCBs in driving innovation, particularly in capital-intensive industries, and suggests that regional economic capacity and firm characteristics play crucial roles in determining the effectiveness of banking deregulation.