The labor market channel of systemic risk

Abstract

In this paper, we explore the labor market channel of systemic risk. We consider that distressed firms, besides defaulting on part of their debt commitments, also react to negative shocks by laying off part of their employees. This constitutes another source of systemic risk, as we assume that laid-off employees will default on their debt commitments. Using Brazilian data, we compute the systemic risk considering three possible strategies distressed firms can adopt: layoff of employees, default on debt commitments, or both strategies. Our findings highlight the importance of the labor market channel. It has contributed noticeably more to overall systemic risk during the study's assessment period (2015–2020). Moreover, the shock multiplier of the employees' layer is higher than that of the firms' layer. We also assess, through machine learning techniques, the determinants of firms' systemic impact under different layer configurations–that is, when the bank-firm layer is composed of the corporate loans extended to the firms, and when this is composed of the loans extended to the firms' employees. This study emphasizes the crucial role that the labor market plays in determining systemic risk dynamics and calls for improved risk management practices to address these issues effectively.