Financial innovation, financial development, and regulatory quality: Evidence from E7 economies on carbon emissions and environmental sustainability

Abstract

The relationship between finance and the environment has attracted increasing attention in energy and sustainability research. While financial development is often considered a driver of economic growth, it also entails environmental consequences, particularly through increased energy use and carbon emissions. This study investigates how financial innovation and financial development influence environmental sustainability in the E7 economies (2000–2021), with a specific focus on the moderating role of regulatory quality. Using panel data and random-effects generalized least squares (RE-GLS) estimations, the results show that financial innovation contributes to emission reduction and supports sustainability objectives, particularly when complemented by strong regulatory quality. In contrast, financial development and trade expansion are found to intensify carbon emissions, underscoring the persistence of environmentally harmful financing patterns. The inclusion of supplementary governance indicators, such as voice and accountability, confirms the robustness of the findings. Overall, the study demonstrates that regulatory quality plays a pivotal role in shaping whether financial systems act as environmental enhancers or detractors. These findings provide actionable insights for policymakers and stakeholders in emerging economies, highlighting the need to strengthen governance frameworks and align financial systems with long-term sustainability and emission-reduction goals.