Effect of deposit insurance on stability of commercial banks in Kenya: moderating role of bank size

Abstract

Bank stability is fundamental to financial system resilience, depositor confidence, and sustainable economic growth, particularly in emerging banking systems. This study examined the effect of deposit insurance on the stability of commercial banks in Kenya and the moderated role of bank size, focusing on deposit insurance coverage, depositor protection, and deposit insurance funding. The main objectives of the research were to determine the effect of deposit insurance coverage on the stability of commercial banks in Kenya, to establish the effect of depositor protection on the stability of commercial banks in Kenya, to assess the effect of deposit insurance funding on the stability of commercial banks in Kenya, and to determine the moderating effect of bank size between deposit insurance and bank stability. Anchored in moral hazard and bank-run theories, the study adopted a positivist research philosophy and a quantitative, descriptive research design. Using an unbalanced panel dataset of 38 licensed commercial banks from 2015 to 2024, secondary data were sourced from banks’ audited financial statements, the Central Bank of Kenya, and the Kenya Deposit Insurance Corporation. Data analysis combined descriptive statistics with panel econometric techniques. Fixed Effects and Random Effects models were estimated, with selection guided by the Hausman specification test and supported by robustness analysis using Feasible Generalized Least Squares (FGLS). The empirical findings reveal that deposit insurance coverage and depositor protection do not exert a statistically significant within-bank effect on stability once unobserved heterogeneity is controlled for under the Fixed Effects specification. However, robustness analysis using FGLS indicates that depositor protection is positively and significantly associated with asset quality ratio, suggesting potential market-discipline weakening effects consistent with moral hazard dynamics. Deposit insurance funding emerged as a relevant dimension, exhibiting a weak but positive association with asset quality ratio. These underscores increased risk taking by banks with high deposit insurance funding. Interaction effects reveal that bank size does not moderate the relationship between deposit insurance and stability; however, bank size is a significant direct determinant of stability, reflecting diversification and scale advantages. These findings offer policy-relevant insights for strengthening Kenya’s deposit insurance framework through appropriate design of the DIS and supervisory complementarity to strengthen banking stability.

Keywords: Deposit Insurance, Bank stability, Depositor Protection, Moral Hazard, Bank Run