Does Market Power Influence Financial Stability? Panel Evidence from Kenyan Listed Commercial Banks

Abstract

Kenya’s banking sector has become increasingly concentrated through mergers, acquisitions, restructuring and technology-led scale expansion, with a small group of listed institutions controlling more than three-quarters of sector assets. Whether the resulting market power protects franchise value and promotes prudent behaviour or weakens competitive discipline and increases risk remains unresolved. This study examines the effect of market power on the financial stability of Kenyan listed commercial banks, controlling for lagged stability, the cost-to-income ratio, risk-based capital, risk-weighted assets to total assets, inflation and the lagged natural logarithm of GDP. It uses a balanced quarterly panel of eight Nairobi Securities Exchange-listed banks over 2013Q1–2025Q2 (392 bank-quarter observations after lagging) and is anchored on the Structure–Conduct–Performance paradigm. Following a Hausman test (chi-square = 75.7104, p < 0.001), the preferred model is a bank fixed-effects Panel EGLS regression with cross-section weights and panel-corrected standard errors. The lagged dependent variable is positive and significant (ρ = 0.4947, p < 0.001), confirming strong persistence in bank stability. Market power, measured by the banks share of assets, exerts a negative and statistically significant effect on financial stability (β = −0.7669, p = 0.0343), supporting competition–stability. Risk-based capital (β = 1.1625, p < 0.001) and the risk-weighted-assets-to-total-assets ratio (β = 0.2161, p = 0.0258) are both positively and significantly associated with stability, while the cost-to-income ratio (β = −0.2241, p < 0.001) and GDP growth (β = −0.0286, p = 0.0220) are negatively and significantly associated with stability; inflation is negatively signed but statistically insignificant (β = −0.4241, p = 0.1013). The model explains 87.2% of the variation in stability (weighted R² = 0.8720; F = 183.4554, p < 0.001), and the results are broadly robust to an alternative two-quarter lag structure. The findings indicate that rising market power among Kenya’s listed banks is associated with reduced financial stability, evidence consistent with weakening competitive discipline and implicit too-big-to-fail expectations among dominant institutions. The study recommends that prudential capital regulation be complemented by active competition-policy oversight of concentration and market power, that supervisors monitor risk-weighted asset composition and cost efficiency alongside capital adequacy, and that further consolidation in the sector be evaluated against its implications for scale efficiency as well as competitive discipline.