Divergent credit risk responses to local government debt among Chinese banks: a stress test analysis

This study explores the heterogeneous impact of local government debt on credit risk across state-owned and urban and rural commercial banks in China, through the analysis of stress test methodology and quarter-based data in the period 2014-2021. It found that if the scale of local government debt expands, the Non-Performing Loan (NPL) rates will reduce in state-owned commercial banks, while the rural and urban commercial banks will increase. In the case of further decay in the scale of local government debt and macroeconomic indicators, there would be more credit risk in a heterogeneous manner among different-sized commercial banks. Medium-sized urban commercial banks have the smallest rise in non-performing loan rates due to the higher individual and corporate credit risks they face. Moreover, the study finds the resiliency of the risks weak and poor preparation for loan impairment in covering the potential loan losses in a pressured scenario compared to their counterpart urban and state-owned rural commercial banks. The findings suggest that rural commercial banks need to improve their risk resilience to cope with extreme shocks.