RISK-BASED CAPITAL AND FINANCIAL STABILITY: EMPIRICAL EVIDENCE FROM KENYAN LISTED BANKS

Abstract

Since the Global Financial Crisis, the stability of commercial banks has remained a central policy concern, intensifying in Kenya where mergers, acquisitions and restructuring have concentrated more than 75% of banking-sector market share among nine listed banks. The Central Bank of Kenya has simultaneously tightened Basel III-aligned risk-based capital requirements, yet whether such capital regulation, alongside the underlying risk composition of banks' balance sheets, translates into greater financial stability remains empirically unresolved for Kenya's listed banking segment. This study examines the effects of risk-based capital (RBC) on financial stability among Kenyan listed banks, controlling for the risk-weighted assets-to-total assets ratio, operational cost efficiency, and macroeconomic growth and anchored in the Buffer Theory of Capital. The study uses a balanced quarterly panel of eight Nairobi Securities Exchange-listed banks over 2013Q1–2025Q2. After introducing one-quarter lags, the estimation sample comprises 392 bank-quarter observations.  A Hausman test supports bank fixed effects, and cross-sectional and period heteroskedasticity are addressed through Panel EGLS with cross-section weights and panel-corrected standard errors (PCSE). The lagged dependent variable, financial stability, is positive and highly significant (ρ = 0.5248, p < 0.001), confirming strong persistence and path dependence in bank stability over time. Risk-based capital exerts a positive and significant effect on financial stability (β = 1.2912, p = 0.0004), and the risk-weighted-assets-to-total-assets ratio is also positively and significantly associated with stability (β = 0.2656, p = 0.0045). The cost-to-income ratio is negatively and significantly associated with stability (β = −0.2210, p = 0.0002), while GDP growth is negatively signed but statistically insignificant (β = −0.0172, p = 0.1344). The model explains 86.6% of the variation in financial stability (F = 204.37, p < 0.001), and the results are broadly robust to an alternative two-quarter lag structure. The findings confirm that adequate risk-based capitalisation is central to bank resilience in Kenya and that the composition of risk-weighted assets carries independent information for financial stability beyond capital adequacy alone. The study recommends that capital regulation remain the cornerstone of prudential policy in Kenya, that supervisors monitor the evolving risk-weighted composition of bank balance sheets, and that operational efficiency be strengthened alongside capital adequacy requirements. JEL: G21; G28; G32; G34; L11