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Financial development and climate risk: unpacking the mediating role of ESG performance

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  • Khan, Salman

Abstract

How does financial development influence climate risk, particularly in low- and middle-income countries (LMICs) facing structural climate and institutional constraints, and does ESG performance mediate this relationship? Using a global panel of 153 countries and a multi-path IV-GMM mediation framework, we examine whether financial development reduces climate risk directly and indirectly through ESG performance. We analyze both an aggregate climate risk index and its core components: hazard exposure, lack of coping capacity, and vulnerability. Results show that financial development significantly improves ESG ratings, which in turn reduce climate risk. Indirect effects via ESG consistently exceed direct effects, highlighting ESG’s role as a key institutional transmission channel. Quantile mediation results further reveal that the ESG pathway is strongest in high-risk countries, suggesting that ESG governance is especially vital for translating financial deepening into climate resilience in structurally vulnerable economies.

Suggested Citation

  • Khan, Salman, 2026. "Financial development and climate risk: unpacking the mediating role of ESG performance," Finance Research Letters, Elsevier, vol. 94(C).
    • Handle: RePEc:eee:finlet:v:94:y:2026:i:c:s1544612326001856
    DOI: 10.1016/j.frl.2026.109654
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