Renewables strengthen financial stability in OECD nations

The Z-score, a key measure of financial resilience, rises with renewable energy expansion. This indicates that economies powered by sustainable energy are better able to absorb shocks, maintain liquidity, and avoid systemic banking crises. Conversely, fossil fuel reliance correlates with higher volatility and lower financial robustness, as carbon-intensive industries remain vulnerable to price shocks, environmental regulations, and stranded asset risks.

A new study offers powerful evidence that the transition to renewable energy is not only an environmental necessity but also a financial stabilizer. The research, conducted across 13 European OECD countries between 2009 and 2019, shows a clear link between sustainable energy growth and enhanced banking system resilience. It concludes that the gradual move away from fossil fuels toward cleaner energy sources reduces financial vulnerability and strengthens overall economic stability.

Published in Sustainability, the study “Sustainable Energy and Financial Stability in European OECD Countries: An Analysis Based on GMM Dynamic Panel Estimation” employs the Generalized Method of Moments (GMM) dynamic panel model to explore how different types of renewable energy, wind, solar, and hydropower, affect financial stability indicators such as Z-scores (banking system soundness) and non-performing loan ratios (NPLs) (credit risk).

How renewable energy shapes financial stability

The authors argue that renewable energy adoption has effects that reach far beyond environmental sustainability, it directly influences the financial ecosystem. The study reveals that renewable energy growth significantly improves financial stability, while heavy dependence on fossil fuels undermines it.

The Z-score, a key measure of financial resilience, rises with renewable energy expansion. This indicates that economies powered by sustainable energy are better able to absorb shocks, maintain liquidity, and avoid systemic banking crises. Conversely, fossil fuel reliance correlates with higher volatility and lower financial robustness, as carbon-intensive industries remain vulnerable to price shocks, environmental regulations, and stranded asset risks.

The study highlights wind energy as the most stabilizing renewable source. Countries investing heavily in wind power, backed by consistent regulatory frameworks, show the largest improvements in financial stability. The hydropower sector, while generally beneficial, presents a nuanced outcome: it contributes to long-term stability through energy security but may increase short-term credit risk due to high initial infrastructure costs and exposure to weather-related variability. Solar energy plays a complementary role by reducing loan default rates, though it shows a minor trade-off in banking sector resilience due to initial financing volatility.

These findings shows that not all renewable energy types affect the financial system equally, emphasizing the need for diversified and balanced energy strategies tailored to national contexts.

The economic mechanism: Linking clean energy to financial health

The study’s GMM-based empirical model provides a structural explanation for how sustainable energy improves financial stability. It identifies three key mechanisms through which renewables shape the financial landscape: credit risk reduction, energy price stability, and green investment returns.

First, as countries invest in renewables, their exposure to fossil fuel price fluctuations diminishes, reducing the probability of corporate defaults in energy-intensive industries. This directly lowers non-performing loan ratios across the banking system. Banks, therefore, face fewer liquidity constraints and enjoy greater lending flexibility, enhancing economic resilience.

Second, renewable energy helps stabilize energy costs, which reduces inflationary pressures and improves monetary predictability. Stable energy prices foster long-term investment confidence and encourage responsible lending, contributing to stronger macro-financial stability.

Third, the transition stimulates green finance and innovation. As banks and investors channel funds into renewable energy projects, new financial products, such as green bonds and sustainability-linked loans, emerge, improving financial diversification. These instruments create safer and more sustainable asset portfolios, which in turn bolster Z-scores and reduce systemic risk exposure.

However, the authors warn that the transition must be gradual and well-managed. Abrupt policy shifts or misaligned subsidies can destabilize markets and trigger temporary liquidity risks for banks exposed to carbon-heavy industries. Policymakers must therefore balance environmental goals with prudent financial risk management, ensuring the transition remains both inclusive and economically sustainable.

Fossil fuels: The weak link in financial stability

The study finds a strong negative relationship between fossil fuel dependence and financial stability. Economies heavily reliant on coal, oil, and gas face increased exposure to market shocks, regulatory tightening, and environmental liabilities. Such pressures amplify credit risk within the banking sector and constrain investment in cleaner industries.

The authors observe that as environmental policies become more stringent across OECD countries, carbon-intensive firms experience declining profitability. This raises the likelihood of loan defaults, reflected in higher NPL ratios. Fossil-fuel-dependent economies also face transition risk, as outdated infrastructure and stranded assets diminish the value of financial portfolios.

Moreover, the volatility of fossil fuel prices, exacerbated by geopolitical tensions and global market speculation, creates systemic uncertainty for both banks and policymakers. By contrast, renewable energy investment reduces these external shocks, fostering long-term price stability and predictable growth patterns.

Through empirical evidence, the authors conclude that the energy-finance nexus is central to economic resilience. The data show that countries integrating renewables more deeply into their energy mix consistently outperform others in maintaining credit stability and avoiding financial crises.

Policy recommendations: Aligning green energy with financial governance

Based on their findings, the researchers propose a roadmap for policymakers and financial regulators to strengthen the synergy between sustainable energy and financial systems.

1. Integrate Green Finance Frameworks: Governments and central banks should adopt green taxonomies that define sustainable financial products and direct capital toward renewable energy infrastructure. This will ensure that financial institutions incorporate environmental risk assessment into their credit and investment models.

2. Encourage Public–Private Partnerships (PPPs): Collaboration between state and private investors can mitigate financing risks associated with large-scale renewable projects. PPPs can improve resource allocation, spread risk, and accelerate energy transition without undermining financial stability.

3. Enhance Regulatory Supervision: Financial regulators must monitor the exposure of banking institutions to carbon-intensive sectors. Incorporating climate stress testing into financial oversight can help identify vulnerabilities early and protect against potential systemic shocks.

4. Promote Technological Innovation: Investment in research and development (R&D) for clean energy technologies not only improves energy efficiency but also strengthens the profitability of green assets. This enhances the risk-return profile of renewable investments, reducing financial uncertainty.

5. Gradual Transition Strategy: A phased energy transition allows markets and institutions to adapt. Rapid decarbonization without financial buffers could disrupt credit flows and reduce liquidity, especially in economies still dependent on fossil energy exports.

The authors argue that sustainability and financial stability are not competing goals but mutually reinforcing pillars. A coordinated approach, combining financial innovation, regulatory adaptation, and energy diversification, can transform the green transition into a source of systemic strength rather than risk.