Deposit Insurance a Precursor of Bank System Stability? An Empirical Evidence of Kenya Banking System

Abstract

Despite deposit insurance increasingly gaining favour from policy makers, it remains an inconclusive debate with different authors taking different arguments on its effect on bank stability. This paper sets out to establish the link between deposit insurance and bank system stability, with an empirical review on the Kenya banking system. At first, we argued that deposit insurance tends to bring stability in the banking sector by providing assurance to the depositors, thereby reducing the possibilities of bank run. However, such an interaction is only possible where other regulatory framework is available without banking competition. The results do not support our earlier arguments but point that deposit insurance coverage-stability nexus exists in the short run and tends to favour smaller banks. The results however support our second argument that with banking competition, the coverage-stability nexus is diluted as the banks competition increases bank appetite for risky activities regardless of the deposit insurance scheme. We recommend that policy makers should not focus a lot on increasing deposit insurance coverage limit, but rather on other supervisory framework, since the effect of the coverage on stability is felt in the short run.