Global Trade Flows and the Role of Bank Financing: Policy Path for Mitigating Associated Environmental Impacts in Import-Oriented Economies

International trade and investment flows provide a mechanism for geographical separation between production and consumption processes. In this study, countries that rely heavily on international trade to supply home demand and have reported positive net CO2 emissions from trade (TrdCO2) over the period 1991–2018 were identified. Accounting for possible distributional heterogeneity, this study examined whether the structural composition of bank credit allocation explains TrdCO2 in these countries. With the growing competition for bank credit resources, the impact of a credit allocation system that prioritizes credit demands of government and state-owned enterprises (GSEs) is modeled and compared to another scenario where the credit allocation decisions of banks rather prioritize financing needs of the private sector. The results showed that the structure of bank credit allocation significantly shapes the exposure of these countries to embodied CO2 emissions in the global trade flows. Specifically, restructuring bank credit allocation towards private sector-focused reduces TrdCO2 while a credit allocation system that allocates more credit to GSEs increases TrdCO2. By implication, bank financing of private sector activities encourages cleaner consumption and can help in mitigating trade-related environmental concerns in developing import-oriented economies.