Examining the Contagion Effect of Credit Risk in a Supply Chain under Trade Credit and Bank Loan Offering

Abstract

Supply chain finance can alleviate participants’ capital constraints and optimize their cash flow. However, demand risk can cause debtors to default on their creditors, which can spread the contagion effect of credit risk along the entire supply chain. In this study, we examine a dual-channel financing model, in which the capital-constrained retailer can seek both loans from the bank and trade credit from the manufacturer. The capital-constrained manufacturer can also obtain bank loans. Using a game theoretical approach, we find the equilibrium of the operational and financing decisions of the manufacturer, retailer, and bank. We find that the dual-channel financing increases the retailer’s order quantity and thus provides additional value to all participants. Under dual-channel financing, the contagion effect of credit risk is higher when the retailer prioritizes repaying the bank loan rather than repaying trade credit, and the contagion effect also depends on the bank loan ratio and production costs. Compared with single-channel financing, dual-channel financing lowers the contagion effect of credit risk. The findings are consistent when the bank offers a unique interest rate to both the manufacturer and retailer based on its pooled profit. Counterintuitively, we find that the traditional financing tools adopted by banks in single-channel financing, such as reducing the credit line to reduce credit risk, will have the opposite effect in dual-channel financing. Our findings provide important implications that urge participants to use dual-channel financing to alleviate capital constraints, earn extra profits, and reduce the contagion effect of supply chain credit risk.