Financial Development and CO ₂ Emissions: The Moderating Role of Institutions and Human Capital

ABSTRACT

This study aims to examine the effects of financial development (FD) on CO ₂ emissions in Bangladesh, a developing economy with low income, and the moderating effects of institutional quality (IQ) and human capital (HC). To capture the important literature gaps, the study proposes an integrated theoretical framework to understand the environmental impact of financial deepening through the lenses of governance and skills. The study uses 44 years of annual time‐series data (1980–2023) and the Autoregressive Distributed Lag (ARDL) bounds testing approach which is supported by Fully Modified OLS (FMOLS) and Dynamic OLS (DOLS) estimations, as well as Vector Error Correction Model (VECM) Granger causality tests. The results found that the dominance of the capitalization channel has a positive impact on CO ₂ emissions that is significantly reduced by the presence of institutional quality and human capital. In addition, “pollution halo” hypothesis is supported by the presence of FDI. The study finds that in poor institutional environments, financial development has negative environmental impacts, whereas in good institutional environments, it can act as a catalyst for decarbonization when supported by competent human capital and strong governance. The results provide policy insights for policy coherence in financial sector policies in the context of environmental sustainability in emerging economies.