The Moderating role of bank size on sovereign debt exposure and financial stability of commercial banks in Kenya

Abstract

The growing exposure of commercial banks to sovereign debt in developing economies has raised critical concerns regarding financial stability, particularly within the context of Kenya’s evolving fiscal landscape. This study addressed this gap by examining the moderating role of bank size on the relationship between sovereign debt exposure and the stability of commercial banks in Kenya. The general objective was to determine how bank size conditions the effects of sovereign debt exposure on bank stability, while the specific objectives focused on sovereign debt concentration, crowding-out of private credit, and sovereign credit ratings. The study was anchored on the sovereign– bank nexus (doom loop) theory and moral hazard theory, which explain the interconnected risks between government debt and banking sector stability. A positivist research philosophy and an explanatory research design were adopted to facilitate objective hypothesis testing. The target population comprised 39 licensed commercial banks in Kenya, from which an unbalanced panel dataset of 507 observations covering the period 2010–2024 was constructed using secondary data obtained from audited financial statements and Central Bank of Kenya reports. The study employed panel data econometric techniques, specifically the Random Effects Generalized Least Squares (GLS) model. Bank stability was measured using the Z-score, while sovereign debt exposure was proxied through sovereign debt concentration, private sector loans to total assets, and sovereign credit ratings, with bank size introduced as a moderating variable. The findings revealed that sovereign debt concentration significantly reduces bank stability, while sovereign credit ratings and profitability enhance stability. Bank size exhibited a significant moderating effect, indicating that the impact of sovereign exposure varies across large, medium and small banks. The results also showed that asset quality deterioration weakens stability, while crowding-out effects were not statistically significant in the direct model. The study concluded that excessive sovereign debt exposure poses systemic risks to the banking sector, and that bank size plays a critical role in shaping resilience. Policy recommendations include strengthening macroprudential regulations to limit excessive sovereign exposure, enhancing capital requirements, and adopting differentiated regulatory frameworks that account for bank size heterogeneity.

Key words: Sovereign debt exposure, sovereign debt concentration, Sovereign bank nexus, bank stability, bank size,