Despite City having a wafer-thin squad at present, Keegan felt it was time for McCarthy to move on and develop his career as it was beginning to become stale at City with his progress blocked by the regular first-teamers and fellow youngster Nedum Onuoha.
"Rightly or wrongly, I look at managing a football club in two ways," Keegan told the Manchester Evening News. "On one I try to manage the club to the best of my ability and bring success, the other is to manage the players and be right by them.
"Ronald Waterreus has recently said something that I think he will regret for the rest of his life, but he can't say that we weren't right by him here. We were very fair to him and the same applies to Paddy.
"Paddy can argue that he never got a chance and that's a fact. But he never got a chance because of the form of Sylvain and Richard and also that Nedum Onuoha is an exceptional talent.
"We could have kept him here for another year and a half - it might have been wise to do that bearing in mind the size of the squad. But it was right for Paddy to go to Leicester and play for a manager like Craig Levein."
"Paddy has been great at this club," KK added. "He has been here a long time but he has never come and knocked my door down and said anything wrong. He has been an absolute model professional and I think he will end up playing Premiership football."
McCarthy failed to make a first-team appearance for City but had loan spells at Boston and Notts County during the 2002-03 season.