Financial Development and Carbon Emissions Nexus: Assessing the Moderating Role of Institutional Quality in a Heterogeneous Global Panel

Abstract

Financial development helps countries to achieve a high growth trajectory. However, its implications for environmental sustainability are rather complex. Rising carbon dioxide emissions, a byproduct associated with financial development activities, pose serious constraints on environmental sustainability. Numerous factors influence emission levels; among them, this study examines how financial development affects carbon dioxide emissions across overall developed and developing countries using the GMM approach over the period 1998-2024. The study relies on a broader global panel data comprising 92 countries, including 55 developed and 37 developing countries. Findings for the global panel, in general, and for developing countries reveal that institutional structures facilitate economic growth but don’t preserve the environment. Better institutions minimize market friction and direct credit into traditional fossil-fuel-reliant industrial frameworks. Conversely, the advanced economy sample reveals a critical structural inversion, validating an institutional threshold hypothesis. The study calls for aggressive integration of environmental standards by developing countries through a green taxonomy framework. Developed countries should eliminate subsidies on non-renewable energy and implement strict carbon adjustment mechanisms. Climate governance should promote environmentally friendly regulatory adaptation from advanced economies to developing nations.