Framework of Supply Chain Contagion-Adjusted Financial Stress: Interconnected Risks between Firms and Banks (IMAGE)
Caption
The schematic illustrates a framework of the supply chain contagion-adjusted financial stress model. Firm-to-firm network at the bottom represents the real economy and the upper network of banks represents the financial system. These two systems are interconnected through bank loans to firms, demonstrating that banks are exposed to credit risk of firms. Failure of firm f causes loss to its Bank 3 (indicated by the orange bar in panel (b)). Additionally, failure of f triggers supply chain contagion leading to indirect failure of firm d. Consequently, both Bank 3 and Bank 4 incur additional indirect losses (blue bars in panel (b)). Traditional credit risk models, which rely mainly on firm-level information and lack awareness of supply chain links, would overlook these indirect losses. Panel (c) shows the total contagion-adjusted losses caused to the toy-model banking system of 4 banks from a failure of single firms. In this example, firm c has the highest financial systemic risk index (FSRI) equal to 20% of the total equity of banks.
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