Institutional quality and the environment–finance nexus: evidence from global economies

Abstract This study examines the intricate relationship between financial development, institutional quality and environmental efficiency. While financial development has the potential to support environmental sustainability, concerns remain regarding its unintended negative effects through unchecked economic expansion. The objective of this research is to investigate how financial development affects environmental efficiency and to assess the moderating role of institutional quality, particularly when financial development proxies reflect financial market accessibility and efficiency. Using a directional distance function within a stochastic frontier framework and incorporating multiple financial development indicators alongside measures of institutional quality, we find that financial development significantly reduces environmental inefficiency, with institutional quality strengthening this effect. These results highlight the importance of policy approaches that simultaneously enhance financial development and institutional quality. Furthermore, our findings support targeted initiatives such as promoting green finance, building institutional capacity and investing in research and data infrastructure to inform evidence-based policymaking for sustainable development.