Environmental Sustainability and Climate Change: An Emerging Concern in Banking Sectors

Abstract

This study explores the crucial role of the banking industry in addressing climate change and promoting environmental sustainability. As climate change increasingly threatens global economies, ecosystems, and public health, financial experts recognize the potential for the banking sector to contribute to a low-carbon economy. By incorporating green-banking practices, which blend traditional financial services with environmental, social, and economic considerations, banks can foster sustainable development while reaping financial benefits. The research examines the dynamics of sustainable banking, focusing on its ability to drive efficiency improvements through eco-friendly programs and enhance profitability. Furthermore, the study discusses the challenges in adopting and implementing environmental sustainability, comparing the command-and-control regulatory model with voluntary approaches. The findings emphasize the importance of effective regulation and incentives for ensuring that banks adopt sustainable practices, ultimately contributing to a more resilient and low-carbon economic system. Through this analysis, this study underscores the banking industry′s pivotal role in shaping the transition towards a sustainable future.

1. Introduction

Climate change represents one of the most significant challenges of our time, with far-reaching consequences for economic systems, environmental sustainability, and societal well-being. Governments, organizations, and institutions worldwide are working collectively to address the adverse effects of climate change, recognizing its potential to disrupt ecosystems, displace populations, and undermine economic stability [1,2]. As part of this collective effort, the financial sector plays a crucial role in mitigating environmental risks by promoting sustainability, financing green initiatives, and aligning portfolios with global climate goals. Green banking, a concept rooted in ethical and sustainable financial practices, has emerged as a critical tool for achieving these objectives and transitioning toward a low-carbon economy [3,4].

Green banking refers to financial services that prioritize environmental sustainability alongside profitability. By integrating environmental, social, and governance (ESG) principles into decision-making processes, green banking extends beyond traditional banking practices. It seeks to finance renewable energy projects, support eco-friendly housing, and promote resource-efficient industries [5]. This approach positions green banking as a catalyst for change, enabling financial institutions to contribute to the fight against climate change while fostering sustainable economic growth. The significance of green banking lies in its ability to bridge the gap between environmental concerns and financial practices. It aligns with international frameworks like the Paris Agreement and the United Nations Sustainable Development Goals (SDGs), which emphasize the importance of reducing carbon emissions and promoting sustainable development globally. In doing so, green banking serves as a vital mechanism for achieving both environmental and economic resilience in the face of escalating climate challenges [6,7].

The concept of green banking has evolved over several decades, reflecting changing societal values, regulatory pressures, and environmental priorities. Its development can be traced through six distinct phases: (1) Ethical banking foundations in the 1970s: The roots of green banking can be found in the ethical banking movement of the 1970s, which emphasized the integration of social and environmental considerations into financial decision-making. During this period, financial institutions began to recognize the importance of aligning their operations with societal goals. Triodos Bank, established in the Netherlands in 1980, exemplified this shift by focusing exclusively on financing projects with social and environmental benefits [8]. This era laid the groundwork for incorporating sustainability into banking practices. (2) Growing environmental awareness in the 1980s: The 1980s marked a period of heightened environmental awareness as global concerns about deforestation, pollution, and biodiversity loss intensified. Financial institutions began adopting basic environmental risk assessments to mitigate the impact of their investments on ecosystems. The release of the Brundtland Report in 1987 further underscored the need for sustainable development, influencing global banking strategies [9]. This report popularized the concept of meeting present needs without compromising the ability of future generations to meet their own needs, catalyzing a shift in financial approaches toward sustainability. (3) Global environmental frameworks in the 1990s: The 1990s were pivotal in embedding sustainability into financial systems. Landmark events, such as the 1992 United Nations Earth Summit in Rio de Janeiro, set the stage for integrating environmental considerations into economic policies. Financial institutions responded by offering products such as green loans and energy-efficient mortgages, aligning their services with emerging global environmental frameworks [10]. The decade also saw increased collaboration between governments, non-governmental organizations, and financial institutions to promote sustainability. (4) Introduction of green bonds in the 2000s: A major milestone in green banking was the introduction of green bonds, which provided an innovative financial instrument for funding renewable energy projects and other environmentally friendly initiatives. The European Investment Bank issued the first green bond in 2007, creating a pathway for institutional investors to support sustainability-focused projects [11]. Green bonds signaled a shift from purely reactive environmental measures to proactive financing of low-carbon initiatives. (5) Embedding sustainability in the 2010s: The 2010s witnessed the mainstream adoption of ESG frameworks by financial institutions, driven by growing regulatory pressures and consumer demand for sustainable financial products. The launch of the United Nations Principles for Responsible Banking in 2019 marked a significant step in formalizing sustainability as a core banking priority [12]. During this decade, banks increasingly incorporated climate-related risk assessments into their operations and aligned their portfolios with net-zero carbon objectives, reinforcing their commitment to environmental stewardship. (6) Mainstream Adoption and Technological Integration in the 2020s: In the current decade, green banking has gained widespread acceptance, supported by advancements in technology and data analytics. Tools like artificial intelligence and blockchain have enhanced the efficiency, transparency, and traceability of green-banking initiatives. The urgency of climate action has also driven banks to expand their green portfolios and implement policies aligned with net-zero carbon commitments [1]. These efforts reflect a growing recognition of the interconnectedness between financial stability and environmental sustainability.

Green banking differs from traditional banking in several keyways. While conventional banks primarily focus on profitability and risk management, green banks integrate environmental considerations into their financial decisions. Traditional banks often invest in industries with high carbon footprints, prioritizing short-term gains. In contrast, green banks actively finance renewable energy projects, energy-efficient housing, and sustainable infrastructure, aligning their portfolios with long-term environmental goals [5]. This distinction highlights the transformative potential of green banking in addressing climate challenges. By prioritizing sustainability, green banks not only mitigate environmental risks but also enhance economic resilience by fostering growth in low-carbon industries [3,13].

Despite its promise, green banking faces significant challenges. One of the primary barriers is the prevalence of greenwashing, where organizations misrepresent their environmental commitments to attract investors. This practice undermines the credibility of green banking and erodes consumer trust [8]. To address this issue, regulatory authorities must enforce stricter transparency standards and enhance the accountability of financial institutions in their sustainability reporting. Another challenge is the perception of financial risk associated with green projects. While these initiatives align with environmental goals, their uncertain profitability and long payback periods may deter traditional investors. This highlights the need for innovative financial instruments, such as blended finance, to de-risk green investments and attract a broader pool of investors [11]. Furthermore, regulatory inconsistencies across regions complicate the scalability of green-banking initiatives. A harmonized global framework is essential to standardize sustainability practices and ensure the effective implementation of green-banking strategies worldwide.

This article makes several contributions to the discourse on green banking. First, it provides a historical perspective, tracing the evolution of green banking from its ethical foundations to its current status as a mainstream financial strategy. Second, it highlights the unique features of green banking, distinguishing it from traditional banking practices. Third, it critically examines the challenges facing green banking, such as greenwashing and regulatory barriers, and proposes solutions for overcoming these obstacles. Finally, it underscores the global relevance of green banking, emphasizing its applicability across diverse markets and contexts.

In sum, green banking represents a transformative approach to financial management, aligning economic objectives with environmental sustainability. Its evolution, from ethical banking movements in the 1970s to the widespread adoption of green finance strategies in the 2020s, underscores the growing recognition of the financial sector′s role in addressing climate challenges. By financing renewable energy projects, promoting sustainable infrastructure, and integrating ESG principles, green banking has the potential to drive significant progress toward global climate goals. However, realizing this potential requires addressing key challenges, such as greenwashing, financial risks, and regulatory inconsistencies. Through continued innovation, collaboration, and regulatory oversight, green banking can contribute to a sustainable and resilient future.

2. Literature Review

2.1. Defining the Sustainability and Sustainable Growth

The terms “sustainability” and “sustainable development” have become trendy in recent years. However, generically defining sustainability, sustainable growth, and other key phrases is difficult. First, from 1970s until the 1990s, the term “sustainability” was predominantly associated with environmental issues. Surprisingly, in the 1992 “United Nations Conference on Environment and Development (UNCED)”, a worldwide action plan for sustainable development was formed [14]. Agenda 21, which provided instructions and practices on sustainability with an emphasis on environmental elements, was one of the critical deliverables [15]. Moreover, the modern corporate sector makes a significant contribution to the discussion on environmental problems. From an economic standpoint, sustainability refers to a company′s willingness and capacity to endure through time in terms of economic efficiency and resource management. Economic sustainability, according to [16], is indeed the business of remaining in the industry. These three components deal with various sustainability goals, including urban and agricultural growth, transportation, infrastructure, energy use, access to water, and power generation. There are three of them: (1) economical sustainability, (2) ecological sustainability, and (3) social sustainability [17]. Decision makers and policymakers must really be constantly mindful of the interconnections, interdependences, and trade-offs between the components. Only after will they be capable of ensuring responsible human conduct at the personal, national, international, and regional levels. Throughout the statute that comprised the “National Environmental Policy Act (NEPA)”, sustainable growth was defined as “economic growth that may provide advantages for present and future generations without hurting the planet′s resources or biological species” [18]. One can question, up to this point, how sustainable development differs from sustainability. In fact, there is no such thing as a narrow line between one thing and another. However, sustainability is frequently regarded as a long-term objective or ambition. For instance, a sustainable firm or a sustainable world. So, environmental sustainability refers to the combination of several perspectives, procedures, and paths to accomplish that goal, such as growing crops, self-sustaining agriculture and food, well-structured governance, technological developments, use of recyclable materials as well as renewable fuels, construction of additional community inside a previously rural region without demolishing the eco-systems or causing environmental harm and so forth [19].

Financial performance is defined as “the degree to which intended outcomes have been met”. Assessing financial performance has emerged as a significant topic both in academics and the banking industry, since businesses are now under pressure to provide consistent results. Most corporate development analyses use both accounting- or market-based parameters to quantify a firm’s financial performance: (1) the financial reporting indicator is the bank′s profitability, and (2) the market indication is the bank′s market price at the completion of the calendar year [20].

2.2. Financial Development and Sustainability

Although definitions are indeed a useful tool for understanding concepts, various efforts have been made to go further than such basic understandings and identify a set of rules or correlations. As per [21], there should only be one social duty of business in terms of the negative relationship between financial development and long-term performance: to regulate its resources in ways that increase profits [22]. Firms that invest in sustainability incur additional costs, limiting their ability to generate positive financial returns. As a result, it is implied that executives are mismanaging the company′s resources if they make investments that are not beneficial for both employees, shareholders, and consumers. According to [23] in management opportunism theory, “social responsibility in businesses has a negative impact on financial performance, to be more specific, if financial results indicate a favorable trend, managers minimize social spending in order to increase their personal earnings” [24]. In comparison, they may endeavor to compensate for unsatisfactory financial performance by investing in flashy public projects. Montabon et al. (2007) [25] examined the link between current sustainability practices and corporate financial indicators, such as return on investment (ROI) and increased sales to evaluate the beneficial impact of sustainability on financial performance.

In sum, the relationship between financial development and sustainability is multifaceted, encompassing theories that offer diverse perspectives on how financial systems interact with economic growth, social welfare, and environmental outcomes. This Section explores four main theoretical frameworks that explain the connection between financial development and economic sustainability, providing a more comprehensive understanding of the dynamics at play. These theories are foundational for analyzing the implications of financial development on long-term performance, particularly in the context of sustainability.

• Resource Theory: Resource theory asserts that financial development directly contributes to economic growth by improving the allocation of resources. In a world with inherent frictions—such as informational, transactional, and monitoring costs—financial institutions are indispensable for reducing these barriers and facilitating economic transactions. According to [26], a well-developed financial system lowers transaction costs, making it easier for firms and individuals to exchange goods and services, invest in new ventures, and access capital. This, in turn, promotes the efficient use of resources, leading to increased productivity and economic growth. In this context, financial institutions play a crucial role in improving resource distribution and enhancing capital accumulation, which are essential for fostering long-term sustainable growth. For instance, a well-functioning banking system enables businesses to access the necessary funding to invest in infrastructure, research and development, and technology. These investments lead to the accumulation of both physical and human capital, which are key drivers of technological progress. Additionally, financial development encourages innovation, which may result in the development of more sustainable technologies or business models. By improving the allocation of resources, financial institutions contribute to the efficient use of capital, thus promoting economic growth while minimizing waste and inefficiency. From the perspective of sustainability, resource theory suggests that financial development is essential to supporting investments in sustainable projects, such as renewable energy, green technologies, and social enterprises. However, it is important to note that financial institutions must prioritize sustainable investments to avoid fostering unsustainable practices. A financial system that only supports short-term profit-driven investments may inadvertently contribute to environmental degradation or social inequality, undermining long-term sustainability goals.
• Market Theory: Market theory presents the inverse causality, proposing that economic growth leads to financial development. As the real economy grows, there is an increasing demand for financial services, which, in turn, drives the expansion of financial markets and institutions [27]. This theory posits that as economic activity expands, businesses require more complex and varied financial products to meet their needs. This leads to the creation of new banking institutions, capital markets, and financial products designed to accommodate the growing demands of the economy. For example, as industries scale and new sectors emerge, such as the green economy, the need for specialized financial services increases. This could include financing for clean energy projects, carbon credit markets, or sustainable agriculture initiatives. Therefore, financial markets must adapt to these new demands by offering products and services tailored to sustainable development goals. As the market expands, financial institutions are also better positioned to innovate and offer new solutions that support long-term economic sustainability. However, market theory also highlights the potential risks associated with financial development. The growth of financial markets driven by economic expansion can sometimes lead to speculative behavior or over-leveraging. If financial institutions prioritize profit maximization without due consideration of long-term sustainability, the expansion of financial markets could contribute to systemic vulnerabilities or create bubbles in speculative sectors, such as real estate or technology. These risks could undermine the stability of the financial system and threaten sustainability efforts, particularly in emerging markets that may lack the regulatory frameworks necessary to prevent financial crises. Furthermore, market theory suggests that the growth of financial markets can sometimes lead to a focus on short-term gains at the expense of long-term sustainability. This is particularly true if financial institutions and investors are not incentivized to consider environmental, social, and governance (ESG) factors in their decision-making. As the financial market expands, it is essential that sustainable financial products, such as green bonds and impact investing, become the norm rather than the exception.
• Bi-Directional Causation Theory: The bi-directional causation theory offers a more integrated view by combining elements of both resource and market theories. It suggests that financial development and economic growth are mutually reinforcing, meaning that financial depth fosters economic growth, and economic growth drives further financial development [28]. This bi-directional causality indicates that there is a feedback loop between financial institutions and economic performance, where each element influences and strengthens the other. In this context, the development of financial systems promotes economic growth by improving access to capital and reducing transaction costs. However, as economic growth accelerates, the demand for financial services also increases, leading to further expansion of the financial sector. This creates a positive feedback loop, where financial institutions and markets continue to evolve in tandem with economic performance. The bi-directional causation theory is particularly relevant in the context of sustainability. As economies grow, there is an increasing need for capital to fund sustainable projects, such as renewable energy initiatives, sustainable infrastructure, and climate change adaptation programs. This growing demand for sustainable investments drives the financial sector to develop new financial products and services that support long-term sustainability goals. However, this feedback loop can also have negative implications if financial institutions prioritize short-term profitability over long-term sustainability. For example, excessive lending to sectors that contribute to environmental degradation or social inequality could exacerbate sustainability challenges, creating systemic risks for the financial system. As such, it is important for financial institutions to ensure that their growth aligns with sustainability objectives and that they adopt responsible lending practices that minimize negative externalities.
• Independent Theory: The independent theory takes a more skeptical stance, arguing that financial development and economic growth are not necessarily correlated. According to this theory, financial inclusion and sustainable growth are not directly related, and the impact of financial development on long-term growth may be limited [29,30]. The independent theory suggests that financial development may have only a minimal impact on economic growth, and other factors, such as technological advancements, education, and policy frameworks, play a more significant role in determining the trajectory of sustainable growth. This theory challenges the assumption that financial development is always beneficial for long-term sustainability. It suggests that an overemphasis on financial innovation or the expansion of financial markets may lead to financial instability or contribute to systemic risks. In the absence of strong regulatory frameworks, financial markets may become more prone to speculative bubbles, excessive risk-taking, or mispricing of assets, all of which can undermine sustainability efforts. For example, financial institutions may focus on short-term profits derived from speculative investments, such as high-risk ventures in fossil fuels or unsustainable agriculture practices. These activities could undermine long-term sustainability goals by contributing to environmental destruction, climate change, or social inequalities. The independent theory underscores the importance of ensuring that financial development is aligned with broader societal goals, including environmental protection, social equity, and economic resilience.

Each of these four theories provides a distinct perspective on the relationship between financial development and sustainability. While resource theory highlights the importance of financial development for promoting resource efficiency and long-term growth, market theory emphasizes the role of economic expansion in driving financial sector development. The bi-directional causation theory underscores the mutual relationship between finance and growth, while the independent theory challenges the notion that financial development automatically leads to sustainable growth. Together, these theories offer a comprehensive framework for understanding the complex interactions between financial systems, economic growth, and sustainability. Financial institutions must consider these theories when designing policies and strategies that promote long-term stability and sustainable development, ensuring that financial innovation supports not only economic growth but also the broader goals of environmental protection and social welfare.

3. Sustainable Banking

Green finance is more than simply a banking strategy; it represents a shift in the banking system′s worldview [31]. With the launch of the “International Finance Corporation′s Sustainable Banking Network (SBN)” in 2012, green banking adoption gained traction in developing nations (“IFC”) [32]. It was established to aid in the implementation of green banking in poor nations. Currently, 15 of the 35 SBN member nations have established national green-banking policies, guidelines, principles, or roadmaps.

A formal definition of green banking is still being developed; however, it is characterized in a variety of ways by various scholars and regulatory authorities. According to the IFC, the literal definition of green banking depends on the nation′s socio-economic setting as well as its degree of achieving sustainability [33]. It is outlined as “the adoption and adoption of sustainable finance standards and procedures by banking institutions, the quantity and dispersion of bank deposits to green financial objectives, the effects on the performance of financial investments from incorporating environmental and social aspects, this same evasion of negative E&S effects, as well as the accomplishment of beneficial effects in core financing” [34]. Green banking has been defined by the United Nations Environmental Program as “growing allocation of resources of capital requirements to green assets, organizational governance, and governmental obligations, new industry green-banking procedures, increasing support for internationally accepted principles, as well as the execution of specifically aimed policies and legislative steps” [35] IFC characterized the value that may be generated from green banking as the avoidance of negative environmental consequences and the accomplishment of environmentally positive benefits in core financing activities. Green banking can safeguard banks from a variety of risks, such as credit risk, significant liability, reputation damage, and threats to the environment [36]. It can provide a competitive edge, particularly for banks in emerging economies where the notion has not yet been accepted or is in the early stages of development. Green-banking practices will raise operational efficiency and improve the institutions′ brand image. Sustainable banking practices will lead to higher operational effectiveness and a better brand picture for banks. The capacity of a green bank to have access to effective financing portfolio quality, attribution of new ventures in the shape of sustainable and environmental initiatives, enhanced third ranking, and remunerations from different stakeholders has been recognized in the strategic plan for a green bank [37]. Despite the fact that green banking has a plethora of advantages, it is currently failing to gain traction in many nations due to a variety of impediments.

Several of the factors that influence green-banking implementation include the following: a lack of professional classifications and standardization for green banking that are relevant to the host nation′s economic individual situation; an inadequate knowledge on how to successfully implement sustainable banking into an institution′s already-existing banking activities; a lack of research literature on green banking; limited resources; lack of economic operators for green banking; and ineffectual information exchange among relevant stakeholders for the enablement of green banking. Other key obstacles to the successful execution of green banking are lack of green capacity between many financial institutions, struggle in generating revenues toward these green power projects or pollution reduction practices, lack of technical case studies or representatives in the green-banking areas, and increasing adoption expense of some green policies [38].

Classical economics researchers define growth as progression, economic growth, or “changing” in individual and society, both quantitatively and qualitatively [39]. The agile methodology was also viewed as a series of consecutive phases of economic development that all economies have to go through. The design process disregarded the environmental and societal pillars of development by focusing exclusively on financial growth. With the passage of time, it became clear that there is a need to combine environmental concerns and growth. As a result, the notion of ecological sustainability was developed. The notion of environmental sustainability informs sustainable banking and defined sustainable development as “development that satisfies the requirements of the today without endangering future generations′ ability to satisfy their own needs”.

Strange and Bayley define “environmental sustainability as a comprehensive and integrated conceptual framework; an ability to apply integration fundamentals across time and space in selection; and an ultimate goal that helps to identify and addresses specific issues such as depletion of resources, universal healthcare, social isolation, poverty, as well as unemployment, among many others”. The pillars of environmental sustainability are the social, the economic, and the environmental. Figure 1 shows how the three pillars are embedded in the social. Overlooking either of these pillars results in a systemic disaster, such as global warming [39].

Agenda 21 expressly recognizes the importance of business and industry in ensuring long-term development. It states that rising wealth, as an objective of the development process, is principally provided by commercial and industrial activity. It further said that improving production practices via techniques and practices that use resources in an effective way while producing less pollution is an essential road towards sustainable industry and business. Furthermore, it emphasizes the need for supporting and fostering ingenuity, competitiveness, and voluntary efforts in order to stimulate more diverse, productive, and efficient solutions. The emergence and wide adoption of environmental sustainability has prompted the banking sector to make significant efforts to incorporate sustainability throughout their activities and operations. Leading financial organizations have developed sustainability criteria for acceptance in the sector. “The International Finance Corporation′s (IFC)” sustainable development approach is founded on altering markets, fostering innovation, and adding value for businesses by aiding them in improving their production success. The IFC also guarantees that economic advantages are shared with the poor and disadvantaged and that growth is ecologically and socially sustainable. “The International Finance Corporation (IFC)” is a pioneer in promoting economic sustainability. Most banks implement sustainability principles and environmental, social, and governance (ESG) requirements in order to secure international funding. Major development banking organizations promoting sustainable finance adoption include the “German Investment Corporation (DEG)”, the “Netherlands Development Finance Company (FMO)”, the “French Agency for Development (AFD)”, and the “African Development Bank (AFDB)” [40].

3.1. The Role of Capital Infusion in Shaping the Green-Banking Landscape: Government Subsidies, Venture Capital, and Private Equity

Sustainable banking, or green banking, has become a central focus in the global financial sector as financial institutions increasingly integrate environmental, social, and governance (ESG) considerations into their business operations. The transition towards green banking is driven by the growing recognition that environmental and social sustainability are integral to long-term financial stability and economic growth. However, despite the clear environmental and economic benefits, the development and implementation of green-banking practices require significant capital. The mechanisms of capital infusion—primarily through government subsidies, venture capital, and private equity—play a crucial role in shaping the green-banking landscape. This article examines the role of these funding sources and their interactions, providing a more comprehensive understanding of the mechanisms driving sustainable finance.

Government Subsidies: Government subsidies are a crucial element in the financing of green-banking initiatives, particularly for environmental projects that may initially be considered too risky or costly by traditional financial markets. Governments can use subsidies to encourage financial institutions to adopt green-banking practices and provide lower-cost financing for sustainable projects. These subsidies often take the form of grants, tax incentives, and low-interest loans, which help reduce the financial barriers for both banks and their clients to engage in green investments [41]. One of the keyways in which government subsidies influence the green-banking sector is through the issuance of green bonds. Green bonds are a popular tool used by governments to raise capital specifically for projects with environmental benefits, such as renewable energy, energy-efficient infrastructure, and sustainable agriculture [42]. By offering these bonds, governments can lower the cost of capital for banks and investors, creating a more favorable environment for financing sustainable projects. For example, the World Bank’s Green Bond program has helped raise billions of dollars for environmentally sustainable initiatives, demonstrating the effectiveness of such mechanisms in fostering sustainable finance [41]. In addition to green bonds, governments can provide direct financial support to financial institutions through subsidies aimed at reducing the cost of offering green financial products. In developing countries, where financial institutions may be less inclined to finance green projects due to perceived risks, these subsidies can be crucial in incentivizing banks to make green loans or investments. The International Finance Corporation (IFC), for instance, has been instrumental in helping developing nations adopt green banking by offering technical assistance and financing through its sustainable finance programs. By lowering the costs and risks associated with green projects, these subsidies enable financial institutions to support the transition to a green economy while also helping to mitigate climate change [43]. However, the efficacy of government subsidies in supporting green banking depends on the clarity and consistency of environmental policies. In some regions, unclear or inconsistent regulations may hinder the effective allocation of funds to green initiatives. Additionally, government subsidies are often subject to political changes, which can affect the long-term stability of funding programs. For green banking to thrive, there is a need for a more robust and predictable regulatory environment that ensures the sustainability of these subsidies [44].

Venture Capital: Venture capital is another important funding source in the green-banking landscape, particularly for early-stage green innovations and startups. Venture capitalists play a vital role in financing the development of new technologies, business models, and financial products that support sustainable finance. These innovations may include green fintech platforms, clean energy technologies, and sustainable supply chain solutions. Given the higher risks associated with these ventures, venture capital firms are often more willing to take on early-stage investments that traditional banks may not be able to finance [45]. In the context of green banking, venture capital is instrumental in funding clean tech startups and other green innovations that can be integrated into banking operations. For instance, green fintech platforms, which use technology to facilitate sustainable investment opportunities, are becoming increasingly popular. These platforms, backed by venture capital, enable individuals and institutions to invest in sustainable projects, making it easier for banks to offer green investment products [46]. The rise of green bonds and sustainable mutual funds also owes much to venture capital’s role in developing the infrastructure and technology that support such initiatives [47]. Venture capital also drives innovation in the financial products offered by banks. Many venture-backed green fintech startups are developing platforms that make it easier for banks to assess and monitor the environmental impact of their lending portfolios, enabling them to make more informed decisions about financing sustainable projects. The collaboration between venture capitalists and financial institutions is thus critical in the development of new products and services that align with green-banking goals [48]. However, venture capital has its limitations in the green-banking sector. While it plays a vital role in financing innovation, the capital provided by venture capitalists is typically high-risk and geared towards short-term returns. This may not always align with the long-term nature of many green investments, which often require a more stable and patient source of funding. Additionally, venture capital tends to focus on high-growth sectors, often overlooking smaller-scale sustainable projects that could have a significant environmental impact but lack the growth potential needed to attract venture funding [49].

Private Equity: Private equity plays a complementary role to venture capital in the green-banking sector. While venture capital is focused on early-stage investments, private equity provides capital to more mature companies that are already operating in the green space and need funding to scale their operations. Private equity firms typically invest in established businesses that have demonstrated profitability and operational viability but require additional capital to expand or enter new markets. In the context of green banking, private equity is particularly useful for financing large-scale projects, such as renewable energy plants, green infrastructure, and sustainable agriculture [50]. Private equity is especially relevant for financing large-scale green infrastructure projects, which require significant amounts of capital. These projects often have high upfront costs but can generate long-term returns. For example, a private equity firm might invest in a wind or solar energy project, which can provide substantial returns over time while contributing to the transition to a low-carbon economy. By providing the capital needed to scale these projects, private equity firms are helping to accelerate the growth of sustainable industries and integrate them into the broader economy [51]. In addition to financing green infrastructure projects, private equity can also help banks and other financial institutions diversify their portfolios by investing in green assets. Private equity investments in green projects offer banks the opportunity to expand their sustainable investment offerings, such as green real estate or clean energy projects. This allows banks to better meet the growing demand for sustainable financial products while also benefiting from the strong returns generated by these investments [52]. However, like venture capital, private equity faces challenges in financing green projects. The large capital requirements of many green infrastructure projects can make it difficult for private equity firms to achieve the desired returns within their typical investment horizon. Furthermore, the long-term nature of many green projects may not align with the short-term focus of private equity firms, which typically aim to exit investments within five to seven years. Overcoming these challenges requires greater collaboration between private equity firms, financial institutions, and governments to ensure that green projects are financially viable and meet the needs of both investors and the environment [53].

The Interactions Between Capital Sources: While government subsidies, venture capital, and private equity are distinct sources of capital, their interactions are essential for shaping the green-banking landscape. These sources of capital complement each other, providing the necessary financial support at different stages of green project development. Government subsidies help reduce the costs of implementing green projects, while venture capital funds innovation and research in new technologies and financial products. Private equity, on the other hand, helps scale successful green projects and integrate them into the broader economy. The collaboration between these funding sources can create a virtuous cycle of green investment, where government subsidies reduce the risk for private investors, venture capital supports innovation, and private equity funds large-scale green projects. This interaction creates a financial ecosystem that fosters the growth of sustainable finance and facilitates the transition to a green economy. However, challenges remain in the alignment of these capital sources. Government subsidies can be unpredictable and subject to political changes, which can create uncertainty for banks and investors. Venture capital firms may focus on high-growth sectors, neglecting smaller-scale projects that could have a significant environmental impact. Similarly, the long-term nature of many green projects may not align with the investment horizons of private equity firms. Addressing these challenges requires greater coordination among governments, venture capital firms, private equity firms, and financial institutions to ensure that capital is allocated effectively and efficiently to green projects [54].

In conclusion, government subsidies, venture capital, and private equity each play a critical role in the development and growth of green banking. These funding sources provide the necessary capital for financial institutions to engage in sustainable finance and support the transition to a low-carbon economy. While each source of capital has its unique strengths and challenges, their interactions create a dynamic and supportive financial ecosystem that fosters innovation, scales successful green projects, and reduces the risks associated with green investments. As the demand for sustainable finance continues to grow, the collaboration between these capital sources will be essential in shaping the future of green banking and achieving global sustainability goals.

3.2. Sustainability in Economy

Sustainable economic practices are essential for safeguarding economic efficiency in a world with limited resources. According to [55], the efficient use of resources is crucial to maximizing their potential. For banks and financial institutions, the focus should not only be on growth and stability but also on minimizing negative impacts on society and the environment. Economic sustainability emphasizes the integration of risk management frameworks, enabling banks to identify and evaluate the risks they are willing to take on and ensuring that they do not expose themselves to significant financial dangers.

However, the increasing integration of sustainability and climate considerations into banking and finance presents both opportunities and risks. While the influx of capital into emerging markets through sustainable finance can stimulate growth and development, it can also expose financial institutions to new types of risks. The potential for over-reliance on speculative investments or the creation of asset bubbles in the green economy is a concern, as financial markets may not be sufficiently resilient to absorb shocks resulting from such a speculative activity. As economic sustainability necessitates robust risk management, financial institutions must balance innovation with caution, ensuring they have effective safeguards against market volatility and systemic risks.

Moreover, the role of banks in promoting sustainable practices should be viewed in the context of broader financial stability. While introducing capital into emerging markets can foster positive change, the risks of market distortions, including mispricing of assets and overdependence on high-risk investments, cannot be ignored. For instance, investments in green technologies and climate-related projects may face challenges, such as regulatory uncertainties, technological risks, or changes in public policy. These uncertainties could lead to significant financial losses if not properly managed.

Economic sustainability, therefore, calls for more than just the adoption of best practices in sustainability, transparency, and accountability [56]. It requires a deep understanding of the risks posed by financial innovations and their implications for long-term stability. Financial institutions must maintain a balanced approach that encourages innovation while mitigating potential financial shocks and vulnerabilities. Enhanced reporting and clear accountability measures for senior executives and boards are essential to ensure that sustainability goals are met without compromising financial resilience.

3.3. Social Sustainability

The social aspects of a bank′s functions and processes are the focus of social sustainability. Corporations do not live in a bubble. They must ensure equity in the distribution of opportunities, as well as support social projects such as “health”, “education”, “gender equity”, “political accountability”, “transparency”, and “public participation” [57]. Social sustainability also necessitates employee training, workplace health and safety, the hiring of employees from different cultural backgrounds, the restoration of local cultures, the allocation of goods and services to underserved groups, as well as the participation of stakeholders′ interests, community groups, as well as minority shareholders. It also necessitates adherence to internationally renowned values like ISO 26000:2010 [58]. ISO 26000:2010 gives businesses recommendations on how to function in an ethically and responsibly. Additional top practices for social sustainability also include IFC guidelines and the International Labor principles. “United Nations Global Compact Guidelines UNEP FI”, Equator Principles, “GRI Sustainability Reporting Guidelines, and Global Sullivan Principles” Guide to Banking and Sustainability.

3.4. Sustainability in Environment

Sustainability in environment is the third aspect of economic development. Resource degradation is being caused by an overdependence on environmental services for development priorities. This has forced necessary resource environmental protection [59]. It is important for humans to fulfill their requirements yet remaining within the capacity of supporting ecosystems, in order to continue reproducing the resources required to satisfy such demands. Sustainable environmental attempts to find a balance between both the environment′s output levels and the population′s resource consumption. However, it can be seen in Figure 2 that the costs of climate change adaptation as a proportion of GDP are likely to grow. Figure 2 compares four key regions in terms of GDP per capita with regard to climate change adaptation. Changing climate adaptation measures will necessitate a joint effort from all, including that of the finance industry [60].

Destructible environments, such as changing climate, have consequences in major financial industries like agricultural, tourism, transportation, and energy. Economic slump, unemployment, immigration, rising commodity costs, and real estate market instability are all indications of all these consequences. Banks as well as other investment firms are critically worried more about direct and indirect climate crisis on major financial assets, that include securities from other banking firms.

Compliance with environmental laws, air pollutants and climate change policies, energy production consumption, environmental cost, and associated impacts linked with goods and services are just a few of the concerns for the environment a bank must examine. Furthermore, banks must assess their clients′ environmental behavior, any future liabilities resulting in new laws, and previously untapped markets for ecofriendly good and services. Internally, banks can incorporate environmental programs, such as green power, double-sided printing, recyclable materials, worker buses, and water efficiency. Banks might limit finance to ecofriendly initiatives from the outside. “UNEP FI”, as well as a vast number of major climate funds formed underneath the “United Nations Framework Convention on Climate Change (UNFCCC)” and the “Kyoto Protocol”, offer benefits to adopt sustainability in banking [61].

4. Methodology

In empirical estimates of the relationship between financial development and economic growth, “Real GDP will be the dependent variable (RGDP)”. The method utilized the ratio between domestic giving credit by the banking industry to a private industry to GDP to evaluate the growth of an economy. To eliminate concurrent bias in our regression analysis, this study incorporated two macroeconomic control variables: real interest rate and foreign direct investment peroxide by ratios of foreign direct investment intake to GDP.

4.1. GMM Estimator Method for Panel Modeling Techniques

This study employs the generalized method of moments (GMM) estimation technique derived by [62,63,64] for models of panel data [65]. Examine the regression models below:

$$Y_{it}-Y_{it-1}=\left(\mathsf{\alpha }-1\right)Y_{it-1}+{\mathsf{\beta }}_0{X}_{it}+{\mathsf{\mu }}_i+{\pounds }_{i,t}$$

(1)

where “$Y_{it}$ is the logarithm of real per capita GDP, $Y_{it-1}$ is the rate of per capita income growth, $Y_{it-1}$ is the initial level of per capita income, $X_{it}$ is a vector of explanatory variables, i is an unobserved country-specific effect, i is the error term, and the subscripts i and t represent country and time period”, respectively. By restructuring (1), we obtain the following:

$$Y_{it}=\alpha \cdot Y_{it-1}+{\beta }_0\cdot C_{it}+{\mathsf{\mu }}_i+{\pounds }_{i,t}$$

(2)

To remove country-specific impacts, we start with initial differences from this Equation and obtain the following:

$$Y_{it}-Y_{it-1}=\mathrm{a}·\left(Y_{it-1}-Y_{it-2}\right)+{\beta }_0\cdot \left(X_{it}-X_{it-1}\right)+{\pounds }_{it}-{\mathit{\pounds }}_{i,t-1}$$

(3)

Levine et al. (2000) [66] recommend using measures for two main reasons: to cope with the potential confounding variables of financial development and growth, but also because the new standard error (${\pounds }_{it}$ − ${\pounds }_{it-1}$) in (Equation (3)) is associated with said dependent variable, ($Y_{it-1}$ − $Y_{it-2}$). The author applied a new estimate that merges the regression in variations with the regression in levels in a system to decrease the potential biases linked with the difference estimator. The author applied a GMM estimator that includes lagged variations of Y_it as instruments for equations in levels as well as lagged variations of Y_it as variables for equation in baseline variations. According to [67,68,69], Monte Carlo simulations and asymptotic variance estimations reveal that this extended GMM estimator provides efficiency advantages while the first GMM estimator fails [70]. The instruments provided are applicable there under the following assumption: while there may be a link between both the level of the right side of the screen variables and the region-specific effects in the levels equations, there is really no relationship between any of these variables′ differences and the region effects. The following are the additional moment conditions for said second component of the system, which would be the level regression:

$$\mathrm{E}·\left\{\right(Y_{it-s }-Y_{it-s-1 })·({\mathrm{\mu }}_i+{\pounds }_{i,t}\left\}\right) = 0 \mathrm{where} \mathrm{S} = 1$$

$$\mathrm{E}·\left\{\right(X_{it-s }-X_{it-s-1})·({\mathrm{\mu }}_i+{\pounds }_{i,t}\left\}\right) = 0 \mathrm{where} \mathrm{S} = 1$$

Because the lagged levels are used as instruments in the differences specification, the levels specification only employs the most recent difference as an instrument. The use of different lags will result in duplicate moment conditions [71]. To create consistent and efficient parameter estimations, the authors apply the above-mentioned moment requirements and a GMM method.

In sum, this study employs a robust econometric framework to analyze the relationship between financial development and economic growth in seven Sub-Saharan African countries from 1981 to 2016. Four estimation methods—pooled OLS, fixed effects, GMM-Difference [63], and GMM-System [67]—are utilized to address key econometric challenges, such as unobserved heterogeneity, endogeneity, and serial correlation. The fixed-effects model captures country-specific characteristics that remain constant over time, while the GMM approaches handle endogeneity by using lagged variables as instruments and combining level and differenced equations for improved efficiency. Diagnostic tests, including the Hausman test for model selection and the Hansen test for instrument validity, further ensure the reliability of the estimations. These diverse methods provide a comprehensive analysis, revealing the nuanced dynamics between financial development and economic growth in the region.

The study′s data, sourced from the Central Bank of Nigeria and World Bank publications, covers critical indicators of financial development, such as domestic credit to the private sector (DCP), alongside GDP growth. The dataset spans diverse economies within Sub-Saharan Africa, ensuring that the results are generalizable to varying levels of financial and economic development.

4.2. Data, Results and Analysis

From 1981 to 2016, we gathered panel data from seven Sub-Saharan African economies: Nigeria, South Africa, Lesotho, Malawi, Sierra Leone, Botswana, and Kenya. All of the data used in this study were obtained as secondary results from the “Central Bank of Nigeria (CBN)” and “World Bank publications on World Bank Data” [72]. The selected nations were chosen depending on availability of data in this research period. The seven countries chosen to have been picked from among 48 countries in Sub-Saharan Africa. Four estimating strategies were utilized to explore the previously published econometric methodologies that studied the relationship between financial development and economic growth.

These approaches include pooled OLS, OLS-fixed effect, and the generalized method of moments in difference (GMM-Difference [63]), and in system (GMM-System [67,73]). Our study results will be taken as the final one, which was the focus of current applications. First and foremost, we have used Least—square method for estimating. This last one allows for a closer look at the issue of country heterogeneity. “Hausman. A Test” is used, which allows the user to choose between a specified fixed effect and a random effect. In the majority of regressions, the importance of fixed effects is demonstrated, as indicated in

Table 1. Static and dynamic panel estimate of financial development and economic progress [74].

	Estimation of a Static Panel		Estimation of Dynamic Panels
	Pooled OLS	FE OLS	Diff−1-GMM	Diff−2-GMM	Sys−1-GMM	Sys−2-GMM
GDP-t−1			1.3455	1.459	0.876	0.798
DCP	0.0345 (0.0000)	0.0078 (0.0000)	−0.0013 (0.410)	−0.0032 (0.389)	0.0048 (0.468)	0.0062 (0.489)
Coefficients	0.7022 *** (0.0000)	1.2870 *** (0.0000)			0.1457 (0.496)	0.1021 (0.419)
Instruments			6	6	8	8
Difference in over-identification (Hansen-test)			(0.361)	(0.361)	(0.327)	(0.319)
Arellano–Bond test			(0.155)	(0.191)	(0.037)	(0.034)
Observations	231	231	215	215	222	222
Regions	7	7	7	7	7	7

Note: *** denote significance at 1% level. The “6” and “8” instruments refer to the number of instrumental variables used in the GMM estimations for the difference and system specifications, respectively. These instruments are critical for addressing potential endogeneity by providing valid proxies for endogenous variables. In the difference GMM model, lagged levels of the variables serve as instruments for the first-differenced equations, while in the system GMM model, both lagged differences and levels of the variables are used. The choice of instruments ensures the validity of the estimation, as confirmed by the Hansen and Arellano–Bond tests, which suggest that the instruments are appropriately chosen and not over-identified.

[74].

The GMM estimations first in difference and then in system allow for the consideration of variable indigeneity. The problem arises when analyzing the relationship between financial development and growth in terms of the presence of causation with a dual significance between financial development and economic growth. The GMM system estimator handles both distinction and leveling variables. The deferred variables on level were utilized as instruments inside the difference equation. Additionally, variables in level equations are integrated by their respective variations. GMM estimates this set of equations at the very same time. Both Hansen test and Arellano and Bond′s test of second serial correlation were employed to determine over identification. The statistics of the Hansen test permitted the validity of the research instrument to be accepted. The research results of such serial regression analysis verify the hypothesis of the lack of second serial correlation of regression. In all regressions, the standard deviations of the variables are normalized using the White test to analyze heteroscedasticity.

To show correlation, we conducted the same regression outlined previously, but this time, the estimate for financial progress serves as the dependent variable. The results stand identical to those from the growth model, and there is no statistically significant correlation among both financial sector development and economic growth; as a result, the findings offer support to the independent hypotheses, which hold that financial inclusion and sustainable growth are statistically independent. As estimate methodologies, the pooled OLS, fixed-effect model, and generalized method of moments panel model were used. Over the years 1980–2016, this analysis examined the correlation between both financial and economic sector development across Sub-Saharan Africa. The findings indicate there is an urgent need for us to expand the financial industry in terms of driving sustainable growth in such states′ industries. The emergence of banks as a supplement to banking institutions will contribute significantly in raising capital and improving financing, thereby fostering sustainable growth in Sub-Saharan Africa.

5. Conclusions

For the banking industry, climatic change is a challenge. Whereas the effects of climate change have become a greater threat to the state′s healthcare, economy, and ecosystem, economic experts are also recognizing that protecting the environment and promoting a low-carbon economic system can bring financial benefits. Banks can play a key role in the necessary economic transformation by providing new options for banking and investment initiatives, along with portfolio management, in order to develop a sustainable and efficient low-carbon ecosystem. Green banking is similar to traditional banking because it also analyses all economic, social, and environmental elements with the aim of protecting and sustaining the environment′s resources. It is also described as both sustainable banking and ethical banking. In line with sustainable annual growth, micro-economic regulations must seek to improve sustainable growth rate, so the decision in regulating the company′s financial and organizational functions toward development is tied towards its profitability. Several businesses, for example, use ecological, energy, or environmental services programs in order to maximize efficiency gains and thus increase their financial performance.

Environmental sustainability remains essentially a challenge to adopt, regulate, and implement. The command and control model and the voluntary approach are indeed the two primary methods for monitoring, implementation, and enforcement. Each method has distinct advantages and disadvantages. The command and control paradigm comes from the government or government entities establishing rules and protocols, with noncompliance resulting in sanctions. Licenses can be revoked or denied, fines could be imposed, and initiatives can be canceled. The key benefits of a command and control approach are that if the regulations are clear, that compliance is required, or that a high level of compliance is feasible since consequences are in place. Furthermore, government entities can provide incentive schemes for compliance while still ensuring acceptance and implementation. The command and control approach, on the other hand, does have disadvantages. First, an absence of adequate capabilities can decrease the efficacy of corporate sustainability implementation. Second, government entities may be vulnerable to regulatory capture, which also occurs when the authority shields banks from regulatory oversight. Finally, non-compliant banking institutions may go morally bankrupt or affect the regulator due to poor or ineffective national guidelines.