Local Governments' Fiscal Pressure and Bank Credit Resource Allocation Efficiency:Evidence from Chinese City Commercial Banks
ZHU Jigao, YUE Heng, RAO Pingui
Business School, University of International Business and Economics; School of Accountancy, Singapore Management University; School of Management, Jinan University
Summary:
Since China's tax-sharing reform of 1994, local governments have struggled with insufficient fiscal revenue to meet their investment needs. Under the reform, taxes collected from concentrated sources become central taxes, while taxes from scattered and sporadic sources become local taxes. Therefore, the reform led to declining tax revenues and increasing government expenses, increasing the fiscal pressure on local governments (Fu and Zhang, 2007; Li and Zhou, 2009; Zhao et al., 2010). In these circumstances, local governments, motivated by the goal of local economic development, have strong incentives to intervene in financial market resource allocation to make up for their fiscal deficits (Ba et al., 2005). We intend to investigate how fiscal pressure on local governments influences commercial banks' credit investment and what impact this type of government intervention has on credit resource allocation efficiency. To explore these questions, we conduct an empirical analysis using data from Chinese city commercial banks from 2005 to 2015. We choose city commercial banks for two main reasons. First, city commercial banks and local governments are inextricably linked. In China, city commercial banks are local joint-equity commercial banks approved by the State Council and founded on the basis of urban credit cooperatives. China's central bank tasks city commercial banks with providing financial services to promote local economies, facilitate the development of small and medium-sized enterprises, and serve local urban residents. Second, city commercial banks are more appropriate for this research than national commercial banks because local governments are usually able to exert stronger influence on city commercial banks. As a result of the vertical management structure of national commercial banks, their local branches are directly controlled by the head office, and local governments are limited in their ability to persuade these branches to lend to local performance-related projects (Liu, 2013). Most city commercial banks are 75%-owned by local governments or state-owned enterprises. For this reason, local governments can easily control the equity investments and personnel appointment and dismissal decisions of these banks (Xu, 2018). Through empirical analysis, we find that local governments' fiscal pressure significantly determines city commercial banks' credit allocation. When fiscal pressure increases, city commercial banks allocate more credit resources to local state-owned economic sectors. However, this kind of credit resource allocation negatively affects bank performance, resulting in higher non-performing loan ratios and worse accounting performance. Further analysis finds that banks located in provinces with higher fiscal pressure have lower allowance ratios for loan losses and allocate more credit resources to local state-owned economic sectors. This finding suggests that banks use allowances for loan losses as an earnings management tool to deal with regulatory pressure. Unlike existing research, our study uses data manually collected from city commercial banks, which makes our findings on the relationship between local governments and commercial banks more generalizable. Our findings have significance in explaining the channel of local governments' influence on banks' credit resource allocation efficiency. Our study also has significant policy implications. Large-scale borrowing by local governments has brought significant theoretical and practical attention to the issue of financial risk prevention. Our results suggest that local government-related financial risks could arise from both the tournament-based incentive system for local officials in China and the mismatch between local governments' financial and administrative powers. To alleviate the fiscal pressure on local governments and reduce financial risks, it is important to build a well-established debt financing system and improve the financial market for local government bonds. It is even more important to launch a new round of fiscal reforms aimed at balancing the financial and administrative powers of local governments (Liu, 2013) and effectively supervise the promotion of local officials. Furthermore, to improve the performance of commercial banks and ensure that they play a major role in credit resource allocation and better serve the real economy, local governments should intervene less in commercial banks, and the level of marketization should be further improved.
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