How Financial Inclusion Affects Environmental Pollution: Using a Threshold and the DID Model

Abstract

This study investigates the nonlinear impact of financial inclusion on environmental pollution across 61 developing countries from 2005 to 2022. Using a threshold regression model, the findings reveal a critical threshold at which the impact of financial inclusion changes direction. Below this threshold, financial inclusion tends to increase carbon emissions; however, beyond this point, the relationship reverses, with financial inclusion contributing to pollution reduction. To gain deeper insights, the study further applies the Difference-in-Differences (DID) method. The DID results indicate that the effect of financial inclusion is heterogeneous and depends on the level of financial development, national income, and the timing of each country’s participation in the Paris Agreement on climate change. These findings underscore the multidimensional nature of the relationship between financial inclusion and the environment, which is significantly influenced by country-specific economic and policy factors. In addition, the study finds that national income and urbanization levels are associated with increased pollution, while credit to the private sector plays a mitigating role in reducing emissions. These results have important implications that policymakers should consider when designing strategies that promote financial inclusion while aligning with Sustainable Development Goals.