The financial sector's response to environmental policy stringency: Comparative analysis of developed and developing economies

Abstract

This study examines the impact of Environmental Policy Stringency (EPS) on bank performance across developed (G7) and developing (E7) economies over a 21-year period. Employing fixed-effects, random-effects, and Generalized Method of Moments (GMM) methodologies, our models focus on EPS's association with two performance metrics: Return on Assets (ROA) and Return on Equity (ROE). Our findings indicate that while EPS generally exerts a negative impact on bank performance, the effects differ significantly between developed and developing economies. Banks in developed economies (G7) experience negative impacts from EPS but display relatively greater resilience, with more moderate declines in profitability. In contrast, banks in developing economies (E7) face more significant challenges, as the negative effects on profitability are more pronounced across both ROA and ROE. Additionally, variables such as regulatory capital, policy rates, and debt ratios have minimal impact on bank profitability, while unemployment unexpectedly shows a positive effect. These results underscore the complex relationship between economic conditions, monetary policies, and environmental regulations. This study contributes to the existing literature by emphasizing the importance of tailoring environmental regulations to the specific capacities of financial institutions in different economic contexts. We advocate for policies that promote sustainability without compromising financial stability and suggest avenues for future research that include broader regional analyses, taking into account factors such as financial openness and technological progress.