The Moderating Effect of Institutions on the Relationship between Financial Development and Environmental Quality: Evidence from GCC countries

Abstract

The existing literature does not present a unified perspective on the impact of financial development on environmental quality. Consequently, this study seeks to enhance existing knowledge by investigating how institutions moderate the relationship between financial development and carbon emissions. It uses a dynamic GMM model to estimate a panel data of GCC countries over the period 2010–2020. Financial system development has been proxied by both the development of the banking sector and the development of the financial markets. The findings indicate that there is a significant increase in carbon dioxide emissions as a result of financial development. Nevertheless, the presence of strong institutions mitigates this effect, leading to a reduction in carbon emissions. Indeed, findings reveal that control of corruption, good quality of regulations and a strong rule of law contribute to reduce pollution effects of financial development. In light of this, policymakers should focus on enhancing institutional quality while redirecting their focus towards environmentally responsible financial practices. This approach will bolster the impact of financial development in effectively improving environmental quality.