Role of Green Finance in Determining the Financial Performance and Credit Risk in Banking Sector of Pakistan: Moderating Role of Capital Structure

Abstract

As the world grapples with the challenges of climate change and environmental degradation, the role of green finance has gained significant attention as a mean to promote sustainable development. Environmental degradation has increased due to population growth, large-scale production, and impulsive buying behaviors. Financial sector is responsible for introducing environmental protection strategies. Pakistan faces environmental challenges such as air pollution, ozone-depleting substances, inefficient energy use, increased road usage, and careless burning of solid waste. Transitioning towards a sustainable green economy is crucial for ecological economic growth. Green financing is emerging as a strategy to stimulate sustainable development and mitigate environmental risks. This study examines the impact of green financing on financial performance and credit risk in Pakistan's banking sector with the focus on the moderating role of capital structure. This study aims to provide insights into the dynamics of green finance in the context of the Pakistani banking sector. By exploring the interplay between green finance, financial performance, credit risk, and capital structure, this study seeks to contribute to the growing body of knowledge on sustainable finance and its implications for banking institutions in Pakistan. Annual data of the time period 2017 to 2022 is collected about these variables from the audited reports of 25 scheduled banks of Pakistan. Panel GMM model is applied for the hypotheses testing. This study finds that green loans significantly impact the return on assets (ROA) and return on equity (ROE) of banks, with the impact influenced by a company's capital structure. Green financing can optimize financial performance by strategically utilizing green loans, highlighting the complex relationship between sustainable financing and corporate finance strategy. The capital structure of a financial institution also influences the impact of green loans on non-performing loans (NPLs). Green projects carry a lower credit risk compared to traditional projects, reducing default and NPLs. Financial institutions should consider incorporating green financing into their risk management strategies to mitigate credit risk and improve asset quality. The integration of ecological aspects in monetary decisions can help build an adaptable future for future generations.