When green credit policies backfire: banking competition, low-end lock-in and capital misallocation in China

Abstract

Purpose This study aims to investigate the unintended consequences of China's 2007 Green Credit Policy (GCP) on capital allocation and firm behavior. It specifically examines how local banking competition mediates the policy's effectiveness, testing whether intense competition distorts credit flows to facilitate a “low-end lock-in” of polluting enterprises rather than promoting their green transformation. Design/methodology/approach Utilizing the 2007 GCP as a quasi-natural experiment, this study matches firm-level production and emission data with geocoded bank branch locations from 2003 to 2009. A difference-in-differences framework is employed to quantify how banking density within 3 km of firms impacts credit availability, environmental performance and industry-level capital misallocation. Findings The study finds that regions with higher banking competition disproportionately channel credit to polluting firms, intensifying both capital misallocation and environmental degradation. High bank intensity fosters a “low-end lock-in,” where firms prioritize capacity expansion over technological upgrades, resulting in lower energy efficiency and increased pollutant emissions. This phenomenon is most pronounced in private firms and markets dominated by large state-owned banks. The research highlights that stricter monitoring of polluting firms and enhanced financial regulation can mitigate the adverse effects. Originality/value This study bridges development and environmental economics by identifying banking competition as a critical friction causing green policy failure. Unlike studies focusing on average policy effects, it uncovers the micro-mechanism of “low-end lock-in” driven by spatial price discrimination, offering actionable insights for designing regulatory-proof green finance systems in emerging economies.