Modeling structure and credit risk of the economy: a multilayer bank-firm network approach

TL;DR

This paper presents a comprehensive framework to reconstruct and analyze the multilayer network of the economy, enabling stress testing and systemic risk assessment without needing detailed private network data.

Contribution

It introduces a novel method combining advanced techniques to reconstruct the entire multilayer economic network from publicly available balance sheet data.

Findings

Identified key systemically important firms and industries.

Pinpointed most vulnerable banks within the network.

Provided insights into determinants of systemic risk.

Abstract

Assessing the resilience of the economy requires accounting for its intrinsic multi-layer nature, by assessing for instance how disruptions at the firm level spread through the production network and propagate to the banking sector. Methods exist to measure the reverberation of shocks over the multilayer network of supply-customer relations among firms, corporate loans of banks and their interbank market exposures. However, empirical network data are often privacy protected and thus inaccessible to researchers and regulators. In this work we develop an unified framework, combining state-of-the art techniques to reconstruct the whole multilayer structure of the economy from balance sheet information of banks and firms, as well as dynamics of shock propagation from the inter-firm to the interbank layers. We showcase application of our methodology using data of the Italian economy. We identify the most systemically important firms and industries, as well as the most vulnerable banks, further assessing the determinants of systemic risk -- obtaining results coherent with the empirical literature on network contagion. Overall, our framework allows performing detailed network-based stress tests on a digital twin of the economy, without requiring detailed network information that is difficult to acquire.