The spread of debt risk from real estate companies to banks: Evidence from China

Abstract

The recent real estate debt crisis in China has dealt a huge blow to the banking sector. To address this challenge, we construct a dynamic game model that considers the interaction of the government, banks and real estate companies. The model is used to analyze the default behavior of real estate companies and loan losses for banks when facing information asymmetry. In addition, we empirically demonstrate the contagion effect of debt risk of real estate companies to banks, using a sample of 119 listed real estate companies and 42 listed banks in China from 2001 to 2020. The results show the following. (1) The debt risk associated with non-state-owned real estate companies is more likely to be contagious to banks compared to state-owned real estate companies. (2) The contagion effect of debt risk of real estate companies to banks is more significant among small and medium-sized banks. (3) The debt risk of non-state-owned real estate companies is most contagious for rural banks, followed by urban banks. Further tests show that the rising debt risk of non-state-owned real estate companies significantly increases the asset risk of small and medium-sized banks. This effect is reinforced through the liquidity channel. This implies that controlling the contagion of debt risk of non-state-owned real estate companies to small and medium-sized banks is an effective way to prevent the occurrence of banking crises.