SHANGHAI—China is bailing out the nation’s heavily indebted local governments, relying on trusted methods to keep its financial system stable despite promises to allow market forces to play a greater role.

Beijing is permitting provinces to issue at least 2.6 trillion yuan ($419 billion) in bonds in 2015, the first local-government issuances in more than 20 years, to stave off a debt crunch. Local administrations have accumulated some 18 trillion yuan in bank loans and bonds to fund risky land and property deals—equivalent to a third of China’s economy. As the real-estate market slows, state-owned banks that did much of the lending are on the hook.

The municipal bonds are aimed at allowing local governments to refinance short-term bank loans, which carry high interest rates of 7%. The move won plaudits from economists and investors as a market-based solution to the debt problem.

What is transpiring, however, is more akin to the public bailout of China’s state-owned banks in the 1990s. Back then, the government pumped billions of dollars in fresh capital into the banks and carved out bad loans from the lenders. Only around a fifth of the soured debt was ever recovered.

Though they are permitted to issue debt, provinces are unable to offer adequate yields to attract private investors. A lack of liquidity in the nascent market for municipal bonds is another deterrent.