21 mega tonnes of emissions emitted by Hungarian firms are not covered by carbon permits. When the EU Emission Trading System II  (EU ETS II) is introduced in 2027 with the price cap of 45 euro/t it will cause up to 945mn euro of additional costs to the commercial sector. It is unclear to what extent this climate transition policy will stress firms within the country’s supply chain network and how the stability of the financial system, hence, will be affected. So far, these assessments had to rely on industry sector affiliations of firms to determine banks’ exposures to climate policies, e.g., the Climate Policy Relevant Sectors (CPRS) scheme.

Here we utilize a unique firm-level supply network data set that allows us to estimate the fossil fuel consumption of over 160 thousand companies that do not report their emissions yet, up from 140 firms included in EU ETS I. These new emitters have loans in banks worth 10bn euros. Based on the emission estimates we test the resilience of firms to additional carbon costs by comparing them to their liquidity and equity buffers, and identify which firms can not withstand the cost shock. Then we assess the effects on their suppliers and buyers with a supply chain network contagion model and calculate additional losses to banks from firms’ indirect defaults.

We find that in the Business As Usual (BAU) – with 45 Euro per tonne – scenario firms can lack up to 7mn euros of liquidity to cover carbon costs before price pass-through adjustment. When taking SCN contagion that causes additional liquidity and solvency problems into account liquidity gaps rise by 43mn euro with potential losses to banks equal to 84mn euro.

For a CO2 price of approx. 150 euro/t direct liquidity gaps are still relatively modest, 76mn euro, but the higher CO2 price leads to the “direct” failure of a high systemic risk firm that causes substantially larger indirect losses to banks of up to 451mn euro.

Our results show that the modest CO2 price seems to have only very mild consequences on financial stability even when considering the indirect effects of supply chain contagion. However, a sudden large jump in CO2 price could cause larger losses if the firms don’t transition in time. These findings suggest that countries need to make sure that systemically relevant firms manage the transition fast to avoid large supply chain-induced losses from the green transition.