["Journal of Regional Science, EarlyView. ", "\nABSTRACT\nThis paper examines how state capacity influences the effect of economic shocks on local bank performance in urban and rural areas. Our identification strategy exploits COVID‐19's impact on Indonesia's community credit banks, which can only operate in a single region. Using loan loss provisions to represent credit risk and return on assets for profitability, we find that COVID‐19 provoked more adverse impacts on the rural banking sector compared to urban areas. This heterogeneity is driven by greater state capacity in urban areas, allowing prompt and effective policy responses to mitigate the adverse effects of COVID‐19 on the local economy.\n"]