Policy Distorion in Credit Allocation: Evidence from an Economic Stimulus

This paper examines how bank behavior contributes to capital misallocation from the supply side, leveraging China’s 2008 fiscal stimulus as a quasi-experimental setting. Using proprietary loan-level data from a major state-owned bank, we document systematic credit misallocation favoring state-owned enterprises (SOEs) over private firms. Following the stimulus announcement, the bank reduced interest rates significantly more for SOEs than for comparable private enterprises—a differential reduction of 0.36 standard deviations—despite SOEs exhibiting higher default rates and unchanged credit ratings. We identify the mechanism as a loosening of risk-based pricing: interest rates became less sensitive to internal credit ratings for SOEs. This risk-based pricing misallocation largely relates to the industrial policy in supporting government-preferred industries. Notably, no such distortion appears in bankers’ acceptances, a less-regulated shadow banking activity, suggesting policy intervention—not financial frictions—drives the observed misallocation. Our findings provide direct micro-level evidence on how government directives and industrial policy induce capital misallocation through weakened credit risk management in state-owned banks.