Local Government Debt Swaps, Fiscal-Financial Governance, and Bank Risk in China

Amid rising implicit local government debt risks and tight fiscal–financial linkages, China’s debt swap program has become a key instrument for restructuring local liabilities and mitigating systemic risk. Using bank–region panel data for 2011–2024, this paper evaluates the impact of debt swaps on bank risk and identifies underlying mechanisms. The results indicate that debt swaps reduce bank risk on average, but the effects are highly heterogeneous: risk declines markedly for state-owned banks, whereas non-state-owned banks experience limited improvement. Moreover, higher debt-swap intensity strengthens the risk-reducing effect among state-owned banks. Mechanism tests reveal two channels. Ex ante, by shifting local government credit risk from implicit to explicit, debt swaps affect LGFV bond yield spreads, which transmit to bank soundness through differential exposure. Ex post, by resolving legacy non-standard assets, debt swaps lower non-performing loan ratios overall, although the marginal effect is weaker in regions with greater pre-existing non-standard exposure, consistent with path dependence. These findings highlight the structural nature of fiscal–financial risk transmission and provide empirical evidence to inform local debt governance and the coordination of financial regulation. JEL: G21 G28 E65