Politically Connected Non-State Banks and the Credit Smoothing Behavior : Evidence from China

Given that state-owned banks are found to play a credit smoothing role over the business cycle, this paper adds to the literature by examining the lending behavior of non-state banks from the perspective of political connections. Using the sample of 128 Chinese banks over the period 2007-2014, we find that the lending behavior of politically connected non-state banks is less procyclical than their non-connected counterparts. Further analyses regarding the driven forces rule out the lazy manager hypothesis and better funding source hypothesis, while support the political rent-seeking hypothesis since politically connected non-state banks are found to grant more loans in election years and experience a higher growth rate of the number of branches. In addition, this credit smoothing behavior causes the deterioration of the credit quality, but it is masked in special-mention loans instead of being reflected as higher non-performing loans, which may threaten the stability of the banking sector inconspicuously. The results suggest that regulators should scrutinize the political connections of banks more thoroughly and pay more attention to the supervision of the special-mention loans