Bank deregulation and the rise of local government debt: Evidence from joint-equity bank entry in China

The rapid growth of government debt worldwide highlights the need to understand its underlying drivers for effective default risk management. However, few studies have explained the expansion from the perspective of financial development. Using joint-equity bank branch entry after bank deregulation as a shock, this study examines the impact of bank deregulation on local government debt in China. We find that joint-equity bank entry leads to a 13.47 % increase in local government debt. This finding remains robust after accounting for the potential influence of the 4-trillion-yuan stimulus and other policy interventions. Mechanism analysis reveals that both an expanded loan supply and rising debt demand drive this effect, with the latter linked to higher expected returns on infrastructure projects due to elevated housing prices post-deregulation. Moreover, we find that increased government borrowing crowds out private manufacturing firms’ investment and employment, highlighting an unintended consequence of government debt expansion.