Who Finances the Carbon Transition? Financial Structure, Institutional Quality, and Emissions in OECD Economies

This study aims to examine the interrelated effects of finance structure, institutional quality, and macro-demographics on CO₂ emissions per capita in OECD countries from 2004 to 2021. Building on the conventional linear and aggregate nature of the finance–environment relationship, this study suggests an improved methodology based on a hybrid framework combining panel estimation, machine learning-based clustering, and nonlinear modeling. The empirical findings support a positive relationship between bank-based intermediation structure, represented by private credit and credit quality, and CO₂ emissions per capita, which could be explained by a scale effect. At the same time, a negative relationship is found between non-performing loans and CO₂ emissions per capita. In addition, a negative relationship is found between the assets of pension funds and mutual funds and CO₂ emissions per capita. This suggests a critical role played by long-horizon investors in offsetting the carbon footprint of economic activity. Government effectiveness is found to have a positive relationship with CO₂ emissions per capita. This could reflect development stage considerations rather than institutional failure. Finally, a weak positive relationship is found between population density and CO₂ emissions per capita. This supports scale efficiencies. The K-means clustering methodology reveals a strong structural heterogeneity in the finance–environment relationship. This supports the view that there are unique structural regimes in which similar CO₂ emissions per capita outcomes are influenced by a variety of interrelated finance structure and institutional quality drivers. In addition, the Random Forest methodology outperforms other machine learning techniques. This suggests a strong nonlinear nature in the finance–environment relationship. Finally, the empirical findings support a relatively stronger emphasis placed on structural finance structure and institutional quality variables rather than short-run macroeconomic variables in explaining variations in CO₂ emissions per capita.