Policy Stringency, Carbon Risk Exposure and Renewable Energy: Does Financial Development Matter to Climate Actions and Environmental Performance under Uncertainty?

The study examines how financial development (FD) multidimensionally has contributed to economies adjusting climate policies and environmental performance with international lens over the past three decades. Employing the newly updated environmental policy stringency (EPSI) index for a panel of 36 economies from 1990 onward, the study finds the eco-friendly effects of FD on climate policies and environmental performance. Higher FD supports countries in speeding up their race to net-zero targets for climate actions and sustainable energy transition. Using the Paris Agreement (COP21) for our quasi-experimental design, the difference-in-differences (DiD) regressions show that COP21 has urged countries to become more stringent in their climate policies, leading to an observed increment in the overall environmental performance. FD does not only matter to mitigating carbon risk exposure with reduced total greenhouse gas emissions and increased renewable energy use in a stable world but also presents its roles through times of uncertainty. Testing for both overall uncertainty and equity market volatility, we contribute to the literature strands on finance-energy-environment nexuses by affirming the irrefutable roles of FD to green growth. Besides the DiD methods with two-way fixed effects (TWFE), we also validate our results for endogeneity using two-step system GMM estimators. The findings are critical to policymakers and governments in maintaining FD momentum to achieve net-zero targets and sustainable transition with the multidimensionality of both financial markets and institutions toward SDGs.