The Effect of Financial Development on Environmental Quality: A Developing Country Evidence

Abstract Financial development is vital to enhance the inclusive growth of a country in the modern world, and environmental quality, affected by financial development, is also a highly debated topic. Thus, this study attempts to investigate the role of financial development in determining environmental quality in Sri Lanka considering other variables namely economic growth, energy consumption, trade openness, and foreign direct investments. The key econometric tool used for the purpose is the Autoregressive Distributive Lag (ARDL) approach with the data from 1992–2021. As per the findings, financial development, economic growth, energy consumption, and foreign direct investments adversely impact environmental quality in the long run and short run. Additionally, trade openness established a negative impact in the short run only. Importantly, the Environmental Kuznets’ Curve hypothesis and Pollution Haven Hypothesis are established. Finally, all variables except trade openness confirmed a unidirectional causal relationship with environmental quality. This study recommends that all the modelled variables are vital to enrich the environmental quality in Sri Lanka.