This paper aims to investigate the direct and indirect effects of financial development on CO2 emissions, using a global sample of 100 countries from 1990-2012. Our main contribution to the literature lies in the identification and explanation of possible transmission channels that allow financial development to affect environmental quality. The paper employs 2SLS and 3SLS estimators to investigate these channels. Empirical results confirm the positive direct effect of financial development on environmental degradation. Development of the financial system also gives rise to more energy demand and consequently leads to more pollutant emissions. Besides, there is evidence about a trade-off between income inequality and environmental quality. Financial development can help redistribute income more effectively. However, high living standards will put pressure on environmental conservation. The paper also considers the nonlinear effects of financial development on carbon emission rates. Only a small proportion of the population receive the benefits at the early stages of financial development. After a certain amount of time, financial development benefits a more significant part of the population and reduces income inequality.

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