Abstract: The liquidity creation of local small and medium-sized banks (LSMBs) is crucial for regional industrial upgrading and economic development. However, how financial decentralization (FD), a key institutional arrangement, affects their liquidity creation remains further in-depth investigation. From an industrial upgrading perspective, this study utilizes the data from Chinese city commercial banks and rural commercial banks spanning 2010-2022 to systematically examine the impact of FD on the liquidity creation of LSMBs and its transmission mechanisms. The findings indicate that, overall, FD promotes the liquidity creation of LSMBs, with its primary transmission mechanism being an increase in banks’ corporate loan share. This promoting effect is particularly prominent in regions with slower industrial upgrading. Nevertheless, the deepening of FD is not entirely beneficial: in regions with slower industrial upgrading, the increase in liquidity of LSMBs brought about by financial decentralization is often accompanied by an increase in medium-term maturity mismatch risk of LSMBs, which may lead to short-term credit allocation and a“lack”of support for the manufacturing industry, which is not conducive to regional industrial upgrading. Therefore, local governments should timely adjust the control rights structure of LSMBs to optimize the scale and efficiency of their liquidity creation, thereby better serving the regional industrial upgrading while effectively preventing local financial risks.

Key words: financial decentralization, local small and medium-sized banks, liquidity creation, industrial upgrading