Addressing the moral hazard through explicit deposit insurance : a comparative appraisal of the Kenya Deposit Insurance Act 2012

Abstract

This thesis appraises the Kenya Deposit Insurance Act, 2012 and evaluates its effectiveness to address moral hazard in banking. While explicit deposit insurance scheme (EDIS) enhance financial system stability by preventing potential bank runs through reimbursement of depositors of failed banks using ex ante premiums levied from the banks, they also create moral hazard when banks take excessive risks in the knowledge that their losses will be borne by the EDIS. Kenya’s first EDIS under the Deposit Protection Fund Board (DPFB) did not effectively address bank moral hazard. The thesis considers the features the Kenya Deposit Insurance Act has adopted to limit bank risk-taking and mitigate the impact of bank failure by facilitating the orderly exit of failed banks from the financial system. The appraisal of the Act is conducted in the context of the post-GFC reforms that integrate financial regulation for the safety and soundness of individual financial institutions (microprudential regulation) and the systemwide regulation of the risk emanating from the conduct of business of financial institutions for the stability of the financial system (macroprudential regulation). Using the post-GFC reforms in financial regulation, as well as South African and USA bank regulatory and supervisory and deposit insurance and resolution regime perspectives, I recommend reforms to strengthen Kenya’s macroprudential financial regulatory framework and to enhance the effectiveness of its EDIS and SRR. Specifically, I recommend reforms inter alia to strengthen Kenya’s bank supervisory framework through consolidated supervision of financial conglomerates and the incorporation of macroprudential regulation. In addition, I recommend reforms to the Kenya Deposit Insurance Act to inter alia prescribe the assessment criteria for risk-based premiums and the criteria for the enforcement of prompt corrective actions and the requirement for financial conglomerates to prepare recovery and resolution plans.