A data-driven econo-financial stress-testing framework to estimate the effect of supply chain networks on financial systemic risk

Supply chain disruptions constitute a widely neglected risk for financial stability. As in financial networks, systemic risk in supply chain networks (SCNs) arises when the local failure of a single or a small group of firms impacts the production of others and might trigger cascading drops in production that affect significant parts of the economy. Here, we study how systemic risk in SCNs translates into financial systemic risk through a mechanism where supply chain contagion leads to correlated bank-firm loan defaults. We propose a financial stress-testing framework for macro-prudential applications that features a national firm level SCN in combination with bank-firm loans and the interbank network. The model is calibrated with a unique data set including about 1 million firm-level supply links, practically all bank-firm loans, and all interbank loans in Hungary. As a showcase we implement a real COVID-19 shock scenario based on firm-level labour data. This model allows us to study how the disruption dynamics in the real economy can lead to and amplify interbank solvency contagion dynamics. We estimate to what extent SCN contagion amplifies financial systemic risk, discuss the relative importance of these contagion channels, and find an increase of interbank contagion of 70% when SCN contagion is present. A key finding is that the interaction of SCN contagion and financial network contagion amplifies financial systemic risks and leads to heavier tails of banks’ loss distributions. We then examine the financial systemic risk of individual firm failures and find that interbank contagion can amplify bank equity losses from supply-chain-contagion-induced defaults by up to 28%. This framework is the first financial systemic risk model that takes real economy shocks mediated by supply chain contagion into account at the agent-level. This opens a path for a direct and event-driven understanding of the dynamical interaction between the real economy and financial systems.