Combined climate stress testing of supply-chain networks and the financial system with nation-wide firm-level emission estimates

Abstract: On the way towards carbon neutrality, climate stress testing provides estimates for the physical and transition risks that climate change poses to the economy and the financial system. Missing firm-level CO2 emissions data severely impedes the assessment of transition risks originating from carbon pricing. Based on the individual emissions of all Hungarian firms (410,523), as estimated from their fossil fuel purchases, we conduct a stress test of both actual and hypothetical carbon pricing policies. Using a simple 1:1 economic ABM and introducing the new carbon-to-profit ratio, we identify firms that become unprofitable and default, and estimate the respective loan write-offs. We find that 45% of all companies are directly exposed to carbon pricing. At a price of 45 EUR/t, direct economic losses of 1.3% of total sales and bank equity losses of 1.2% are expected. Secondary default cascades in supply chain networks could increase these losses by 300% to 4000%, depending on firms' ability to substitute essential inputs. To reduce transition risks, firms should reduce their dependence on essential inputs from supply chains with high CO2 exposure. We discuss the implications of different policy implementations on these transition risks.