This paper examines the use of finance leases in China’s local government debt. Using a unique dataset of government finance lease transactions, we document that local government financing vehicles (LGFVs) rapidly adopted finance leases, with the outstanding amount growing from virtually nothing in 2013 to a cumulative total of 1.02 trillion RMB by 2018. Our difference-in-differences (DID) analysis reveals that the central government’s restrictive financial policies account for a substantial portion of this surge. Because these restrictive policies confined LGFVs’access to conventional borrowing channels, finance leases emerged as a key alternative, particularly through bank-affiliated leasing firms. While LGFVs' use of finance leases offers low-cost financing for local governments, the low quality of the underlying assets poses significant risks to the leasing firms.

This paper argues that ffnancial lease, a dominant representation of shadow banking in China, plays a special role in improving the capital allocation efficiency. In a two-sector general equilibrium model with heterogeneous firm, information asymmetry and financial frictions, this paper shows that existence of finance lease market increases aggregate TFP by allowing low productivity SOE firms to lend out and allowing high productivity POE firms to leverage up. Due to the repossession advantage, financial leasing is a “good“ form of shadow banking that does not necessarily cause financial systemic risks.

By analyzing a hand-collected transaction-level dataset on the finance leases of China’s public firms for the period 2007-2019, this paper sheds light on China’s financial leasing industry. We find that banks use their affiliated leasing firms to provide credit to constrained clients in order to circumvent the government’s targeted monetary tightening policy. Finance Lease offsets the expected decline in traditional bank loans in affected industries, and therefore hampers the effectiveness of the monetary policy. Although this regulatory arbitrage may accumulate systemic risk at the macro level, bank-affiliated leasing firms charge lower leasing rate and exert tighter risk control than non-bank-affiliated leasing firms at the micro level. This finding indicates that banks use finance leases as a channel to keep low-risk clients rather than to make excessive profit.