Propagation of liquidity crisis and monitoring potentially risky firms: Evidence from Korea

Abstract

Secured Loan of Credit Sales (SLCS) is a short-term loan system of Korean interfirm transactions. It was adopted in 2000 to effectively collect bilateral trade amount and to substitute the promissory note system. Under this system, however, the supplier has an obligation of reimbursing the bank if the customer does not pay the trade amount to the bank. Therefore, the liquidity shock is not limited to the damaged supplier but propagates to the connected firms throughout the network. This study applied “DebtRank” index to quantify systemic risk of individual firms in the financial network. The insolvency of highly diversified customers was shown to cause bigger potential risk. Even if the size of customers turned out to be insignificant in regression, the outdegree coefficient of huge firms is bigger than other small firms. Thus, firms with high degree of diversification and huge size should be monitored to prevent liquidity risk in the entire SLCS network.