The COVID-19 (coronavirus) pandemic and the risk-fraught economic recovery has riled supply-chain linkages and raised multiple credit risk red flags for many commercial bank lines of business (LOBs). Since February, hardly a day goes by without headlines warning of impending doom to a fledgling economic recovery owing in large part to global value-chain disruptions.
The media-driven “analysis” of supply-related stress does provide useful reporting on what going on, although it fails to afford a workable procedure or tool to address the challenge of the supply chain morass. A few others brashly purport that globalization is either moribund or in serious structural retreat, while some politicians both here and abroad assert that autarky is achievable. Serious analysis suggests otherwise, as such assertions lack quantitative support. Shifting day-to-day views are myopic, narrowly focused, and simply scatter pieces of the supply chain puzzle.
There are several factors that frame our analysis.
- Much like during the initial stages of the coronavirus fog-of-war, decision makers are preoccupied by near real-time information overflow. As such, they often struggle to distinguish between cyclic vs. structural adjustments, and what credit risk factors are transitory against those that will likely influence credit risk beyond the short-term.
- Transitory factors can lead to a bullwhip effect with multiplicative resonance through a supply chain resulting in overcapacities that are difficult to unwind. Many companies will push on the production gas pedal, restocking inventories on the belief that today’s swelling demand will persist. This demand miscalculation will then be transmitted and amplified along the supply chain, with orders to suppliers most distant from the point of sale far removed from the realities of the end-market. This will create numerous, latent single points of failure, being non-redundant parts of a risk system that, if dysfunctional, cause the entire system to collapse. What a nightmare for risk management professionals!
- Commercial banks may lack a procedure to cope with shocks and establish priorities based on their exposures to prioritize what is actionable. There is a dearth of decision tree algorithms, and an acknowledgment that in times of unprecedented shocks, expert judgment and qualitative right-brain analysis should prevail. Models and grading systems fail when documented history and performance data provide little help, or solace.
- Concentration risk, and the correlations that exist between credit, operational, market and liquidity risk, seem to be left at the wayside given the distraction of the supply gap phenomenon and the lack of organizational infrastructure to incorporate shocks into the fabric of a decision-making culture. As such, the Enterprise Risk Management (ERM) framework, which has become increasingly popular since the financial crisis, can be compromised. After all, the ERM framework at its core models probability as opposed to assessing the potential impacts of risk factors, thus necessitating the use of right-side brain judgmental factors.
- Finally, many of us have somehow forgotten about risk factors prior to the pandemic. This involves neglecting key risk indicators (KRIs) that are seemingly unrelated to the supply chain shortages but will help uncover which supply gaps are more persistent as compared with those that are transitory. This is a question of causality, not necessarily correlation. Indeed, supply chain issues are an important part of the story, but they cannot be analyzed in isolation of potent KRIs.
