in Tables A2A through A2D of the Appendix. The results for the firm-bank-month level are summarized in Table A2E of the Appendix. Overall, we find that the outcomes of states of varying indebtedness levels indeed followed parallel trends before the FD Law was introduced.<sup>31</sup> We additionally check the validity of our estimates by relying on alternative identification strategies. First, we estimate the impact of the Law by exploiting differences in the alert system classification (i.e., sustainable vs under-watch) of states with ex ante similar debt-to-net-income ratios. We summarize these results in Internet Appendix Tables IA2 and IA3. Second, we adopt a difference-in-difference approach where the treatment variable is discrete and equal to one if a state's measure of public indebtedness in the quarter prior to the FD Law is above the median indebtedness and zero otherwise. This specification allows us to rule out that our results are driven by states with extreme values in their 2016Q1 ratios of total public debt over free disposable income. The results of this alternative specification are displayed in Internet Appendix Tables IA4 and IA5.

# **4.2. Bank Heterogeneity in the Impact of the FD Law**

Banks provide us with yet another layer of variation to study the impact that the FD Law, and debt ceilings in particular, had on credit markets. In particular, we expect that banks that lent a larger share of their funds to ex ante more indebted local governments, would likely experience more drastic changes to their lending once the debt ceilings were introduced. Descriptive evidence displayed in Figure 5 shows that there was a large divergence in lending across banks with varying ex ante exposures to local government debt after the Law.<sup>32</sup> In the figure, we split banks into two

> 31 We further check for differences in the non-linear trends of bank lending volumes to local governments and private firms across states before and after the reform. To examine bank lending volumes to local governments, we run a series of regressions using the specification summarized in Equation 3:

> where _HighDebtStates,16Q1_ is indicator variable that equals one for states that in the quarter prior to the FD Law had public indebtedness above the median and zero otherwise. _Monthm_ is an indicator variable that equals one in month _m_ and zero otherwise, while the other variables are defined as before _._ To analyze bank lending volumes to private-sector firms, we run a series of regressions akin to Equation 3, where observations are at the firm-bank-month level _._ The coefficients of interest _βm_ are plotted in Figure A1. We corroborate that prior to the Law, the dynamics of bank lending to local governments (Panel A) and private-sector firms (Panel B) were similar across states, and only begun diverging after the implementation of the Law.

> 32 In Table A3B, we compare a series of statistics prior to the FD Law between banks with an exposure to local governments in April 2016 above vs below the median. The results show that banks with different exposures to local governments were statistically similar along several characteristics and help us rule out that banks of varying exposures to local government debt are different in other dimensions, such as their capital and liquidity ratios, or their

18