Local fiscal pressure and shadow banking activities of nonfinancial enterprises–A story of government intervention

Abstract

The literature documents instances in which governments intervene in the allocation of local financial resources to serve their specific objectives. However, few studies have delved into the subsequent consequences of these interventions on local enterprises. Using a dataset that matches variables at both the city and company levels in China, we reveal the promotive effect of fiscal pressure faced by local governments on the engagement of large nonfinancial enterprises in shadow banking activities. Upon mitigating the disturbances caused by short-term economic fluctuations and excluding a potential alternative explanatory mechanism, we delineate the core operative mechanism: under fiscal pressure, local governments direct local credit resources preferentially towards local large enterprises. Such biased guidance leads to disparities in credit availability between large enterprises and small and medium-sized enterprises. As a result of receiving augmented credit support, large enterprises, driven by profit-seeking motives, partially assume the role of substantive financial intermediaries. Our findings highlight the critical need for regulatory measures regarding government interventions in the allocation of resources within the financial market, as well as the engagement of nonfinancial enterprises in "quasi-banking" activities.