1. The Financing of Local Government in China: stimulus loan wanes and shadow banking waxes
Zhiguo He (何治国)
University of Chicago, Booth School of Business; and NBER
joint with Zhuo Chen (Tsinghua PBCSF) and Chun Liu (Tsinghua SEM)

2. Motivation Trust/Entrusted loans : 信托和委托贷款; WMP: 理财产品
Data source: PBOC and China Banking Wealth Management Registration System

3. Summary
China’s local government financing shifts from bank loans in 2009 to a significant fraction of non-bank debt starting 2012
Why do shadow banking activities in China start rampant growth around ?
Hangover effect of 2009 stimulus
Time series and cross-section evidence on local government financing and municipal corporate bonds (城投债)
An angle that helps understand the marketization process of Chinese financial system starting 2012

4. Four-Trillion Stimulus Plan and its financing
Following 2007/08 global crisis, Premier Wen announced the 4T RMB stimulus plan on Nov 2008
Domestic investment (mainly infrastructure) to boost GDP growth
How was it implemented and financed?
Mostly through local governments (Bai, Hsieh and Song, 2016, Brookings)
1 trillion from Beijing; the rest through LGFV (Local Government Financing Vehicles, 政府融资平台)
Mostly in the form of bank loans

5. New bank loan and GDP growth
Data source: PBOC and National Bureau of Statistics

6. Shifting of local government financing (1)
in 2010 China reverted back to its normal credit policy…
2009 Stimulus loan hangover effect
Long-term infrastructure projects need continuing investment
Need to rollover/refinance their three- to five-year bank loans (which are maturing around 2012 to 2014)
Both forces are relevant with similar implications
LGFVs turn to non-bank sources
What are they?

7. Shifting of local government financing (2)
four major debt liabilities
Bank Loans
Municipal Bonds (地方政府债: pre-2015, issued directly by MoF for qualified local government; post-2015, issued by local government at the province level)
Municipal Corporate Bonds (城投债, our focus)
Trust and Entrusted Loans (信托贷款和委托贷款)
other three are non-bank debt; often with implicit bail-out expectation
National Audit office reports on local government debt, on Dec 2010 and June 2013
Worked hard filling out the rest
Bank loan wanes, non-bank debt waxes

8. Composition change of bank and non-bank debt financing

9. Municipal corporate Bond（MCB, 城投债）
Data source: PBOC and Wind

10. Cross-sectional analyses: Evidence from MCB (1)
Core idea
Areas/provinces with more bank-loan-fueled stimulus in should have more shadow banking in
Matters little whether firm (demand) or bank (supply) driven in 2009
We focus on Municipal corporate Bonds
It is more than data availability issue; source of fund versus use of fund
For MCB, we know where the funds go to

11. Cross-sectional analysis: evidence from MCB (2)
What do we do?
Abnormal 2009 Bank loan over GDP at the province level
For each province, (BL/GDP at 2009) – (Average BL/GDP 2004~08)
Abnormal 201X MCB over GDP at the province level over
For each province, (MCB/GDP at 201X) – (Average MCB/GDP 2004~08)
Prediction: the province with larger abnormal 201X MCB/GDP is the one that had higher abnormal 2009 BL/GDP
various relevant controls at provincial level at 201X
GDP growth; (abnormal) fiscal deficit over GDP; (abnormal) fixed asset investment over GDP at 201X; abnormal) land sale over fiscal revenue at 201X; Corruption index at provincial level (Ang, Bai, and Zhou (2016))

12. Regional evidence
2009 Bank Loan v.s MCB: Regional Level

13. Provincial evidence
2009 Bank Loan v.s MCB: Provincial Level

14. Provincial evidence for each year, 2012-2015

15. placebo test on 2008 loans Year-by-year provincial regression 2012
2013
2014
2015
2008 Q1-Q3 BL/GDP
0.07
-0.00
-0.01
-0.06
(0.74)
(-0.01)
(-0.09)
(-0.36)
Adj. R2
-0.02
-0.04
-0.03
Obs 30
2009 BL/GDP
0.11*
0.15***
0.23***
0.18**
(1.68)
(2.73)
(4.72)
(2.74)
0.01
-0.09
-0.15
-0.16
(0.12)
(-0.98)
(-1.61)
(-1.50)
F-test 𝛽 09 = 𝛽 08𝑄1−𝑄3
2.94*
3.20*
11.69***
6.08**
p-value
(0.10)
(0.08)
(0.00)
(0.02)
Adj. R²
0.10
0.31
0.34
0.17

16. EVIDENCE FROM CDB LGFV LOAN
CDB is a policy bank and thus usually its loan has longer maturity
Less rollover pressure for provinces with more CDB LGFV loan received in 2009
abnormal MCB/GDP on 2009 abnormal BL/GDP, the fraction of 2009 CDB LGFV Loan, and the intercept term
2012
2013
2014
2015
Panel
2009 BL/GDP
0.19***
0.22***
0.37***
0.40***
0.29***
(3.20)
(3.04)
(5.36)
(4.98)
(4.83)
CDB LGFV BL%
0.06
0.06**
0.11***
0.17***
0.10***
(1.09)
(2.19)
(2.57)
(3.26)
(2.73)
BL×CDB BL%
-0.31
-0.36**
-0.67***
-0.98***
-0.58***
(-1.04)
(-2.22)
(-3.24)
(-4.07)
(-2.96)
Year FX No
Yes
Adj. R²
0.08
0.37
0.47
0.48
0.43
Obs 30
120

17. Direct evidence on MCB issuance purposes
81% of MCB prospectus reveal its purpose…. Perfect for us

18. Panel Regression results of MCB issuance
abnormal MCB/2009 GDP on 2009 abnormal BL/GDP
MCB
𝑀𝐶𝐵 𝑟𝑒𝑝𝑎𝑦
𝑀𝐶𝐵 𝑖𝑛𝑣
𝑀𝐶𝐵 𝑜𝑡ℎ𝑒𝑟
𝑀𝐶𝐵 𝑟𝑒𝑝𝑎𝑦 10
2009 BL/GDP
0.15***
0.10**
0.04**
0.01
0.02*
(3.45)
(2.10)
(1.97)
(0.43)
(1.89)
(4.45)
FD/GDP
0.07
0.06
0.02
0.02***
-0.16***
(0.89)
(1.47)
(1.41)
(3.31)
(-3.67)
FAI/GDP
-0.01
-0.01**
0.00
-0.00
(-0.65)
(-2.17)
(0.50)
(-1.56)
(0.08)
LS/FR revenue
-0.02
(-0.68)
(-0.31)
(-1.02)
(0.62)
(1.21)
GDP growth
0.16***
0.04
0.08***
0.01***
0.18***
(3.57)
(1.39)
(4.99)
(2.59)
(2.57)
Corruption Index
(3.17)
(3.16)
(0.90)
(0.15)
(4.12)
Year fixed effects
Yes
Adj. R²
0.31
0.49
0.52
0.39
0.28
0.75
Obs.
120 40

19. How about MCB Prices?
Does relative quantity matter?
Integrated interbank market, homogeneous investors, only bond risk matters
MCB Issuing Spread over China Development Bank Bond Yield
Controls omitted
Spread
𝑆𝑝𝑟𝑒𝑎𝑑 2012
𝑆𝑝𝑟𝑒𝑎𝑑 2013
𝑆𝑝𝑟𝑒𝑎𝑑 2014
𝑆𝑝𝑟𝑒𝑎𝑑 2015
2009 BL/GDP
-0.80
-1.79
-1.30
-0.08
-1.01
(-1.40)
(-1.26)
(-1.63)
(-0.12)
(-0.83)
Rating
0.64***
0.61***
0.54***
0.30***
0.79***
0.84***
(4.84)
(4.30)
(3.92)
(2.82)
(5.81)
(4.22)
Maturity
0.03
0.02
0.04
0.01
-0.02
(0.74)
(0.76)
(0.60)
(0.93)
(0.16)
(-0.71)
Year FE
Yes No
Adj. R²
0.79
0.74
0.62
0.76
0.60
Obs.
117 28 30 29

20. Link to Shadow banking: Time-series

21. Link to Shadow banking: entrusted LOAN growth
abnormal entrusted loan/GDP and abnormal BL/GDP on 2009 abnormal BL/GDP
𝐸𝐿 2013
𝐸𝐿 2014
𝐸𝐿 2015
𝐸𝐿 𝑝𝑎𝑛𝑒𝑙
𝐵𝐿 𝑝𝑎𝑛𝑒𝑙
2009 BL/GDP
0.20**
0.23**
0.14
0.19**
0.20***
-0.00
(2.00)
(2.08)
(1.37)
(2.35)
(2.54)
(-0.03)
FD/GDP
-0.04
0.79***
(-0.48)
(5.33)
FAI/GDP
-0.05*
0.12**
(-1.79)
(2.44)
LS/FR revenue
0.01
0.00
(0.26)
(0.00)
GDP growth
0.10
-0.25
(0.68)
(-1.46)
Year fixed effects
Yes
Adj. R²
0.13
0.04
0.27
0.60
Obs. 30 90
120
BL: bank loan; FD: fiscal deficit; FAI: fixed asset investment; LS/FR: land sale/fiscal revenue

22. Link to Shadow banking: Wealth Management Product
Based on annual official reports on WMP; likely underestimate as unclear whether including certain financial innovation funded through WMP

23. Concluding Remarks
A mechanism that puts together recent various aspects of China’s financial market
Local government debt; shadow banking; interest rate liberalization
Shadow banking as one of unintended consequences of Four-trillion Stimulus plan
Good? bad?
Popular view: hidden risk and leverage, so bad
But it fosters the modernization of China’s financial markets
“Let market be decisive;” interest rate liberalization and deposit insurance
Rocket-speed of the growth of interbank market in China; less reliance on commercial banks; richer set of investment products
Households get the return they ought to get (not just house price appreciation)