Banking Integration and Capital Misallocation: Evidence from China

Abstract

Using the staggered intercity but within-province deregulation of local banks in China as exogenous variations, we evaluate the effect of banking integration across geographical segmentation on capital misallocation. Based on an administrative data set comprehensively covering Chinese manufacturing firms, we find that for firms with initially high marginal revenue products of capital (MRPK), the integration increases physical capital by 19.3%, and reduces MRPK by 33.1% relative to low MRPK firms. Our findings are more pronounced for non-stated-owned firms and firms with higher exposure to integrated banks. Integration also significantly increases the responsiveness of firms’ investments to deposit shock on other cities within the same province.