This paper investigates the impact of Sukuk market development on Islamic banks’ capital ratios using a sample comprising 230 Islamic banks spanning the period 2005-2014. We characterize Islamic bank capital along multiple dimensions, namely: capital adequacy ratio, Tier 1 capital ratio, and capital-to-total assets ratio. We employ both the Prais-Winston technique and the system GMM estimator to tackle potential omitted variable bias, endogeneity, and simultaneity issues. The evidence shows that Sukuk market development has had a negative effect on capital ratios of Islamic banks. We argue that the development of Sukuk markets may have stimulated the competition between Islamic Banks, inducing them to hold lower capital ratios. Our results also show that trade openness and bank liquidity are positively and significantly related to capital ratios, while bank size and loan loss reserve ratio are negatively and significantly related to capital ratios, as expected.
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