Pacific-Basin Finance Journal 54 (2019) 42–54

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Pacific-Basin Finance Journal

journal homepage: www.elsevier.com/locate/pacfin

The impact of Sukuk on the performance of conventional and

T
Islamic banks
Karim Mimouni, Houcem Smaoui, Akram Temimi , Moh'd Al-Azzam
⁎

Department of Finance and Economics, Qatar University, Qatar

ARTICLE INFO ABSTRACT

JEL classifications: This paper examines the impact of Sukuk market development on banks' profitability using a
C33 dataset of 71 Islamic banks (IBs) and 146 conventional banks (CBs) spanning 13 countries over
G10 the 2003–2014 period. Using a dynamic panel model, we find that the overall bank profitability
G21 is negatively impacted by Sukuk market development. However, when we control for whether
G29
the bank is Islamic or conventional, important findings emerge. The results suggest that Sukuk
Keywords: development reduces IBs' profitability but has no impact on CBs' performance. In addition, the
Sukuk evidence shows that these adverse effects on IBs' profitability are substantially lower after the
Bank performance
2008 global financial crisis. Accordingly, our findings suggest that IBs were able to overcome
GMM estimation
Sukuk competition after the crisis.
Financial crisis

1. Introduction

Over the last two decades, Sukuk have witnessed unprecedented success rivaling conventional bonds in many countries and have
grown from modest and unknown financing vehicles to well-established instruments.1 Indeed, the distinctive features and rationale
behind issuing Sukuk have been highlighted in many studies (Azmat et al., 2015; Nagano, 2015; Hanifa et al., 2015; Nagano, 2017;
Dimitris et al., 2016; Naifar et al., 2017). However, despite the surge in the global Sukuk issuances and the growing market size, the
extant work on Sukuk is still thin and scattered over different topics (Ibrahim, 2015).2 Meanwhile, a rapidly growing literature
focuses on comparing the performance of IBs to CBs (e.g., Čihák and Hesse, 2010; Olson and Zoubi, 2011; Beck et al., 2013; Johnes
et al., 2013; Bitar et al., 2017; Olson and Zoubi, 2017).
Notwithstanding this growing interest in these two pivotal pillars of Islamic finance (Sukuk and Islamic Banking), to date, the
evidence on how Sukuk affect the banking sector is limited. A notable exception is the work of Smaoui et al. (2017), who investigate
the relationship between the banking sector and Sukuk markets and show that banks and Sukuk are substitutes. Although their
analysis did not investigate the grounds and sources of this substitution and failed to control for whether CBs and IBs compete equally

⁎
Corresponding author.
E-mail addresses: kmimouni@qu.edu.qa (K. Mimouni), hsmaoui@qu.edu.qa (H. Smaoui), atemimi@qu.edu.qa (A. Temimi),
malazzam@qu.edu.qa (M. Al-Azzam).
1
Sukuk markets achieved very high growth averaging 27% annually (Alzahrani and Megginson, 2017). By 2016, the total amount of Sukuk has
reached more than $300 billion. See the 2017 IFS Stability Report for more details.
2
These topics include: Sukuk structures and risks (Tariq and Dar, 2007; Nassir and Zayd, 2014; Kamarudin et al., 2014), stock market reactions to
Sukuk issuances (Ashhari et al., 2009; Alam et al., 2013; Godlewski et al., 2013), firms choice between Sukuk and bonds (Mohamed et al., 2015),
micro-determinants of Sukuk issuances (Azmat et al., 2015), macro-determinants of Sukuk issuances (Smaoui and Khawaja, 2017), Sukuk and
economic growth (Smaoui and Nechi, 2017), and Sukuk versus conventional bonds (Kamarudin et al., 2014; Cakir and Raei, 2007).

https://doi.org/10.1016/j.pacfin.2019.01.007
Received 4 June 2018; Received in revised form 13 January 2019; Accepted 23 January 2019
Available online 24 January 2019
0927-538X/ © 2019 Elsevier B.V. All rights reserved.
K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

with Sukuk, it provides a starting point to carry a thorough investigation on the interaction between Sukuk markets and the banking
sector. Such analysis is especially important in light of the interplay between the bond market and the banking sector and the
documented cointegration relationship between Sukuk and conventional bonds (Hassan et al., 2017).
The link between the banking sector and financial markets has been analyzed in the existing research and is still an open question.
Specifically, one strand of the financial intermediation literature confirms the existence of a competition effect between the two
where the development of one type of financing occurs necessarily at the expense of the other (Dewatripont and Maskin, 1995; Allen
and Gale, 1997; Boot and Thakor, 1997; Song and Thakor, 2010). In a seminal paper, Rajan and Zingales (2003) argue that, within an
interest group theory framework, incumbent banks oppose the development of capital markets as the latter pose a direct threat to
their market. This is especially the case when the banking sector is concentrated. A different explanation is provided by Song and
Thakor (2010) who argue that the competition occurs because banks are experts in resolving the “certification friction” defined as the
inability to screen clients according to their creditworthiness. On the other hand, well-functioning financial markets are better at
mitigating the “finance friction” defined as the failure to obtain the first-best cost of financing. When we assume that banks and
markets are exclusive means of financing (i.e. they do not interact), borrowers will opt for one type of funding only, hence the
competition.
In contrast, another research strand suggests that financial markets are complements to the banking system. For instance,
Demirgüç-Kunt and Maksimovic (1996) report that the development of stock markets leads to higher corporate debt ratios and argue
that this translates into larger banking activity. Song and Thakor (2010) advocate that their relationship is often interactive and
expands from simple complementarity to full cooperation. Accordingly, banks solve the certification problem by screening and
analyzing the credit quality of borrowers whose loans are securitized reducing the informational asymmetry and allowing the market
to offer financing at better costs. On the other hand, because finance frictions are now lower in financial markets, banks can obtain
cheaper equity which increases their capital base to serve more risky clients. This process encourages banks to continuously improve
their screening technology; hence lowering the certification problem further. Ultimately, these enhancement spillovers from banks to
markets and vice versa are beneficial to their collective development. Song and Thakor (2010) designate this relationship as co-
evolution where both banks and markets evolve simultaneously.
While the theoretical framework for the relationship between financial markets and the banking system is well developed in the
literature, the empirical evidence is still mixed at best. While Demirgüç -Kunt and Huizinga (2001) show that the financial structure
does not have an independent impact on the performance of banks, Eichengreen and Luengnaruemitchai (2004) document that banks
and bond markets are complementary to each other using a sample of 41 countries. Yet, Dickie and Fan (2005) show that banks
compete with the bond market in a panel of 30 countries.
Given these mixed findings, our paper is a step forward to uncover such complex relationships by investigating whether Sukuk, a
rapidly growing market based vehicle, affect the performance and profitability of both IBs and CBs. Hence, we aim to show if the
relationship between the Sukuk markets and the banking sector is characterized by competition, complementarity, or co-evolution.
In our study of the bank-market relationship, special attention is devoted to the 2008 global financial crisis. Indeed, the existent
literature documents that the crisis had a profound adverse impact on credit supply (Lo, 2012 and Thakor, 2015). DeYoung et al.
(2015) and Ivashina and Scharfstein (2010) report that the decrease in deposit levels forced US banks to shrink their lending supply
substantially. One would expect that since the crisis originated and spread within the banking system, its adverse effects increased the
vulnerability of banks and negatively affected the public confidence in these institutions.
However, Dimitris et al. (2016) and Naifar et al. (2017) show that Sukuk are not exposed to global shocks or to contagion risks
during financial crisis offering international investors an avenue for portfolio diversification. Moreover, Hasan and Dridi (2010) and
Belanes et al. (2015) document that IBs were resilient to the 2008 global financial crisis. Given this, it would be of interest to
investigate whether the relative resilience of the IBs during the financial crisis has been affected by the development of the Sukuk
market. Additionally, Chang et al. (2017) observe that after the 2008 global financial crisis, capital flows consisting of both corporate
bank loans and bond financing have witnessed a surge in several emerging countries. However, the relative increase in bond fi-
nancing was much faster than that of bank financing after the crisis. Hence, we unveil in this study any new trends that the crisis had
on the impact of Sukuk markets on the banking sector.
Against this backdrop, this paper seeks answers to the following questions: Do Sukuk negatively or positively affect the overall
banking industry? Do they have similar effects on the performance of IBs and CBs? Had the Sukuk affected banks' performance
similarly after the crisis?
A dataset of 71 IBs and 146 CBs from 13 countries adopting dual banking over the period 2003 to 2014 is used in this paper. To
address the joint endogeneity of the independent variables, we apply a dynamic panel model and employ the system GMM estimator
(Arellano and Bond, 1991; Arellano and Bover, 1995).
Our study reveals several novel findings with important policy implications. First, we find that, for the overall sample, the
development of Sukuk markets had a negative effect on banks' performance measured by net interest margin/net profit margin (NIM/
NPM). The results are unchanged when we include the Return on Assets (ROA) as an alternative dependent variable. Second, we find
that Sukuk adversely affect the performance of IBs while the profitability of CBs remains unaffected. To the authors' knowledge, ours
is the first empirical study that examines the interaction between the Sukuk markets and the banking sector (Conventional and
Islamic), thereby offering policy recommendations with respect to the development of both markets. Third, an even more important
result of our study is that the adverse effects of Sukuk market development on the performance of IBs is less pronounced after the
2008 financial crisis, thus suggesting that IBs were able to adjust well to the rapid growth of Sukuk.

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The remainder of the paper proceeds as follows. Section 2 describes the variables employed, the data used, and provides details on
the system GMM estimation technique employed. Section 3 presents a discussion of the main findings and performs several robustness
checks. Finally, section 4 concludes.

2. Variables description, data and estimation methodology

This section lists the variables employed in our empirical analysis, the data and the estimation methodology.

2.1. The dependent variable: bank profitability

The existent literature investigates the factors affecting the performance of IBs and CBs measured using either ROA/ROE (Bourke,
1989; Molyneux and Thornton, 1992; Goddard et al., 2004; Pasiouras and Kosmidou, 2007; Dietrich and Wanzenried, 2014) or Net
Interest Margin (Angbazo, 1997; Brock and Suarez, 2000; Valverde and Fernández, 2007).
Following Ho and Saunders (1981) and Demirgüç -Kunt and Huizinga (1998), we measure bank performance with the Net Interest
Margin (NIM) for CBs and Net Profit Margin (NPM) for IBs. NIM/NPM is calculated as the ratio of the difference between interest
revenue and interest expense to average earning assets.3 We also use, in a robustness test, the ROA measured by the ratio of net
income to total assets (Bourke, 1989; Pasiouras and Kosmidou, 2007; Hassan and Bashir, 2003; Athanasoglou et al., 2008). The
literature identified several relevant determinants of performance and categorized them into two groups: bank-specific variables and
country-specific variables.

2.2. Bank-specific variables

These include the liquidity-credit risk (Bourke, 1989; Molyneux and Thornton, 1992; Kasman et al., 2010; Maudos and Solís,
2009; Tarus et al., 2012), bank capitalization (Pasiouras and Kosmidou, 2007), bank size (Kasman et al., 2010; Lai and Hassan, 1997;
Regehr and Sengupta, 2016), and the cost-to-profit ratio (Angbazo, 1997; Maudos and Fernández de Guevara, 2004). In this paper,
we use the following six bank-specific variables:

2.2.1. Capital ratio (CR)

We measure bank capital ratio with the Capital Adequacy Ratio (CAR). This ratio is computed by dividing the sum of Tier 1 capital
and Tier 2 capital by the risk-weighted assets (RWA).4 Higher CAR implies that the bank is well-capitalized relative to its level of risk,
hence confirming the bank's long-term solvency (Kasman et al., 2010). Given the differential tax treatment of debt and equity
financing, banks tend to reflect the resulting higher cost of capital in their profitability margins (Saunders and Schumacher, 2000).
However, higher CAR implies higher capital holdings, which is an opportunity cost to banks. Therefore, the impact of capital ratio on
bank margin is ambiguous.

2.2.2. Asset quality (LLR)

Asset quality is computed using the ratio of loan loss reserves to gross loans (Angbazo, 1997). The banking literature suggests that
more loans tend to generate greater credit risk, thereby inducing banks to set higher profit margins in order to reflect default
premiums (Kasman et al., 2010; Maudos and Solís, 2009; Tarus et al., 2012). Hence, we expect a positive association between LLR
and bank profitability.

2.2.3. Management efficiency (ME)

Qualified management tends to have an adverse impact on bank profitability (Sun et al., 2017). Therefore, a negative association
is expected between cost-to-income ratio and bank margins. Therefore, a negative association is expected between cost-to-income
ratio and bank margins. We measure the efficiency of management by the cost-to-income ratio (Angbazo, 1997; Maudos and
Fernández de Guevara, 2004).

2.2.4. Liquidity risk (LR)

The effect of liquidity risk on bank profitability is expected to be negative since higher liquidity risk encourages banks to choose
wider bank intermediation margins as a premium, in particular during periods when banks run out of cash and may incur borrowing/
issuing costs from other financial institutions or money markets (Sun et al., 2017; Valverde and Fernández, 2007). We measure LR
with the ratio of liquid assets to deposits and short-term funding.

2.2.5. Size (SIZE)

There are mixed results on the effect of size on bank profitability (Maudos and Fernández de Guevara, 2004; Kasman et al., 2010;

3
Although IBs are prohibited from engaging in interest-bearing operations, we can apply the NIM to them since, in the case of IBs, NIM represents
the differential between the revenues from Sharia-compliant lending and investing activities and the cost of financing those activities such as the
profits distributed to depositors or investors.
4
(RWA) adjusts the class of risk for each asset to determine its real exposure to eventual losses.

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Lai and Hassan, 1997). On one hand, larger size allows banks to spread their fixed costs over a larger asset base, thereby decreasing
their average costs and, hence, realizing higher profits through economies of scale (Regehr and Sengupta, 2016). Small banks,
however, might be able to form closer relationships with local clients and companies than large banks, permitting them to access
valuable information that can be used in making better credit underwriting decisions and setting contract terms (Kosmidou, 2008;
Athanasoglou et al., 2008). These information and pricing advantages may allow small banks to generate higher profits than larger
banks and offset any loss of scale economies. Therefore, the impact of bank size on bank margin is ambiguous, which we leave to the
empirical estimation. Size is proxied by the natural logarithm of total assets.

2.2.6. Overall riskiness (RWATA)

We measure the overall riskiness of a bank with the ratio of risk-weighted assets (RWA) to total assets. More risk-averse banks
may set higher intermediation margins as a compensation of risk tolerance (Nguyen, 2012). Hence, we expected RWATA to exert a
positive effect on bank profitability.

2.3. Country-specific variables

The country-specific determinants identified in the literature include the concentration/market power (Bourke, 1989; Molyneux
and Thornton, 1992), growth (Brock and Suarez, 2000; Demirgüç -Kunt and Huizinga, 1998; Kasman et al., 2010; Sufian and Chong,
2008), and inflation (Hanson and Rocha, 1986; Demirgüç -Kunt and Huizinga, 1998; Claessens et al., 2001). In this paper, we use the
following four country-specific variables:

2.3.1. Sukuk market development (SMD)

We measure Sukuk market development with the ratio of Sukuk market capitalization to GDP (Smaoui and Nechi, 2017; Smaoui
et al., 2017). We argue that SMD may exert a negative impact on bank profitability since Sukuk markets may deprive banks of market
share, resulting in higher competition in the banking sector, thus leading to narrower bank margins. However, Song and Thakor
(2010) argue that there are bidirectional positive spillovers between financial markets and banks leading to their collective devel-
opment. Additionally, according to the pecking order theory and the signaling theory, Sukuk financing is cheaper than issuing
common equity, which suffers from underpricing and negative signaling. Hence, by substituting Sukuk issuance to common equity,
banks could reduce their cost of capital and achieve better performance. Therefore, the impact of Sukuk development on bank
profitability is unclear.

2.3.2. Market power (LERNER)

Banks with higher market power enjoy greater freedom in setting their loan and deposit margins (Maudos and Fernández de
Guevara, 2004). Nevertheless, the “quiet life” hypothesis states that higher market power will reduce the pressure towards efficiency.
Indeed, banks with large market share tend to be less efficient, because they focus their efforts mostly on risk reduction rather than
profit maximization (Berger and Hannan, 1998). Thus, the effect of market power on bank profitability is ambiguous. Market power
of the banking sector is measured using the Lerner index.

2.3.3. Economic growth (GROWTH)

The banking literature posits that higher economic growth leads to higher demand for financial services and, hence, an increase of
bank activity. The resulting growth in the loans granted and the customer deposits may positively affect bank profit margins (Sufian
and Chong, 2008). Therefore, we expect a positive association between economic growth and bank profitability. We measure eco-
nomic growth with the growth of real per capita GDP.

2.3.4. Inflation (INF)

We expect bank profitability to be positively related to inflation since higher anticipated inflation determines the increase in the
interest rate on loans (Demirgüç -Kunt and Huizinga, 1998; Hanson and Rocha, 1986; Claessens et al., 2001; Denizer, 2000).
However, if the increase in the inflation rate is not anticipated, it may lead to a greater cost of financing and, thus, lower bank
intermediation margins.
Table 1 presents our variables, their definitions, and expected signs.

2.4. Sample and methodology

2.4.1. Sample
We examine the effect of SMD on the performance of IBs and CBs using a panel data set from 2003 to 2014. For inclusion in the
sample, a country needs to have an active Sukuk market and a dual-type banking system. The bank-specific data is obtained from
Bankscope Bureau Van Dijk Database. To classify commercial banks as either CBs or IBs, we thoroughly searched the Bloomberg
Database, the Thomson Reuters Zawya Database, and the websites of the central banks of our sample countries. CBs with Islamic
windows are classified as CBs. Financial institutions other than pure commercial banks are dropped from the sample. Sukuk data are
gathered from the Bloomberg database and data on macroeconomic variables are obtained from the World Bank. The total sample

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Table 1
Definitions, proxies and expected sign.
Variable Definition Label Expected sign

Bank profitability Net interest margin/Net profit margin NIM/NPM

Return on assets ROA

Bank-specific
Capital ratio Capital Adequacy Ratio CAR ±
Asset quality Loan loss reserves/gross loans LLR +
Managerial efficiency Cost-to-income ratio ME −
Liquidity risk Liquid assets/deposits & short-term funding LIQUID +
Size Log (Total assets) SIZE ±
Overall riskiness Risk-weighted assets to total assets RWATA +

Country-specific
Sukuk development Sukuk market cap to GDP SMD ±
Market power Lerner index LERNER ±
Growth Annual real GDP growth rate GROWTH +
Inflation Inflation rate INF ±

This table reports the definition of dependent, country-specific, and bank-specific variables and their expected sign.

Table 2
Country specific variables and number of banks.
SMD LERNER INF GROWTH # of IBs # of CBs

Bahrain 1.37 27.57 2.38 −0.29 7 6

Bangladesh 0.00 25.47 7.60 5.92 6 23
Brunei 0.65 0.91 −0.85 2 0
Gambia 0.18 26.04 6.27 0.26 1 6
Indonesia 0.08 33.21 6.99 4.25 14 39
Kuwait 0.02 55.77 4.15 −0.74 5 5
Malaysia 9.10 21.89 2.42 3.39 14 19
Pakistan 0.08 16.43 9.93 2.02 5 13
Qatar 0.55 50.30 4.53 1.54 5 5
Saudi Arabia 0.21 54.38 3.68 3.30 3 7
Turkey 0.03 23.81 9.29 2.87 2 12
UAE 0.01 49.04 3.05 −3.35 3 7
Yemen 0.07 11.90 −1.10 4 4

This table reports the descriptive statistics of the country-specific variables for the sample of 146 CBs and 71 IBs over the period 2003–2014.

used in the analysis consists of 1780 bank-year observations on 146 CBs and 71 IBs from 13 countries in the OIC (Organization of
Islamic Countries) for the period 2003–2014. The data is annual and the panels are unbalanced. Table 2 reports the list of sampled
countries and the number of CBs and IBs in each country.

2.4.2. Methodology
This paper employs the dealership model developed originally by Ho and Saunders (1981) and its extensions. Following the
approach commonly used in the empirical literature on bank performance, we use a dynamic regression technique to examine the
factors that determine bank profitability of our samples of CBs and IBs (Angbazo, 1997; Athanasoglou et al., 2008; Maudos and
Fernández de Guevara, 2004; Demirgüç -Kunt and Huizinga, 1998; Kasman et al., 2010; Yanıkkaya et al., 2018). Our dynamic panel
model is specified as follows:
6 10
BPijt = + BPijt + k BS k + lCS l + µij +
0 1 ijt jt ijt
k=1 l=7 (1)

where BPijt denotes the bank profitability measure (NIM/NPM or ROA) for bank i in country j at year t; BPijt−1 is the lag of bank
profitability; BSijtk stands for all bank-specific variables, while CSjtl denotes all country-specific variables, both described in the
previous section; β0, δ, and β are the regression parameters; μij denotes the unobserved bank-specific effects; and εijt is the residual
term.
To account for the persistence of bank profits stemming from regulatory enforcement of bank capital ratios, market competition
barriers, and sensitivity to external shocks, we include lagged levels of the dependent variables (Saona, 2016).
Since we use a micro-panel data set, which consists of cross-sectional bank-level and time series information, two econometric
problems may arise: unobservable heterogeneity and endogeneity of explanatory variables. The first problem, unobservable het-
erogeneity, refers to the specific time-invariant features of each bank (bank degree of risk aversion, internal policies, corporate
governance, etc.), which become an integral part of the model's random component. The endogeneity problem stems from the
potential impact of bank performance on the bank's capital ratio. For instance, if banks use retained earnings to increase their social

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

Table 3
Descriptive statistics for the dependent and bank specific variables.
Variable Full sample Conventional banks Islamic banks

Obs Mean Std. Dev. Min Max Obs Mean Std. Dev. Min Max Obs Mean Std. Dev. Min Max

Dependent
NIM/NPM 1780 4.93 5.59 −10.2 54 1246 4.71 3.44 −10.2 32.89 534 5.44 8.72 −10.2 54
ROA 1776 1.52 2.46 −12.43 21.04 1243 1.5 2.19 −12.43 16.31 533 1.57 3.01 −12.43 21.04

Bank-specific
CAR 850 22.67 25.21 0.15 380.68 623 22.63 26.18 0.15 380.68 227 22.79 22.39 0.58 204.41
RWATA 859 0.78 2.56 0 75.41 624 0.81 3 0 75.41 235 0.68 0.2 0 1.44
LLR 1322 4.16 5.33 0 80.15 953 4.18 5.51 0 80.15 369 4.09 4.87 0 44.6
ME 1409 55.75 51.21 0.59 873.58 979 55 51.14 0.59 873.58 430 57.45 51.39 5.7 760.78
SIZE 1780 14.33 1.99 7.34 19.03 1246 14.42 2.02 7.63 19.03 534 14.1 1.88 7.34 17.89
LIQUID 1406 39.83 60.54 0.39 954.17 980 37.46 43.26 0.86 766.22 426 45.29 88.1 0.39 954.17

This table includes the descriptive statistics of the dependent and bank-specific variables for the sample of 146 CBs and 71 IBs over the period
2003–2014.

capital instead of issuing new seasoned stock offerings, current profits may have a positive impact on bank's capital ratio (Rime,
2001).5 Furthermore, the endogeneity problem is exacerbated by the inclusion of the dependent variable as a lagged explanatory
variable in model (1). Thus, the OLS estimators of parameters of interest are biased and inconsistent. Moreover, the static panel
estimators (fixed or random effects estimators) are not appropriate for estimating model (1) since the correlation is still present
between the lag of the dependent variable and the residual terms (Baltagi, 2001).
To resolve the above econometric problems, this paper employs the two-step system GMM estimator of Arellano and Bover (1995)
and Blundell and Bond (1998). Note that the consistency of the system GMM estimator rests on two tests. The first is the test of
Hansen (1982) for the orthogonality of the instruments employed. Our instruments are exogenous if we are unable to reject the null
hypothesis. The second is the test of Arellano and Bond (1991) for the presence of second-order serial correlation in the differenced
error terms. The moment conditions are valid if we cannot reject the null hypothesis.

3. Empirical results

3.1. Descriptive analysis

Table 2 displays the summary statistics for the country-specific variables as well as the number of CBs and IBs by country and
Table 3 shows the descriptive statistics for the dependent and bank-specific variables for the full sample, the IBs, and the CBs. We
notice that IBs are, on average, more profitable than CBs using both performance measures. IBs have on average an NPM of 5.44%
and an ROA of 1.57% compared to a NIM of 4.71% and an ROA of 1.5% for CBs. Although the IBs in our sample are slightly smaller in
size, both bank categories have roughly the same capitalization with a capital adequacy ratio slightly above 22.5%. Moreover,
Table 3 suggests that CBs are riskier than their IBs counterparts as their risk-weighted assets represent 0.81% of their total assets
compared to 0.68% for IBs. Additionally, CBs carry significantly less liquid assets compared to IBs and therefore bear a higher
liquidity risk. Their liquid assets to deposits and short-term funding is around 37.46% compared to 45.29% for IBs.

3.2. GMM estimation results

Table 4 displays the results using the NIM/NPM for the full sample, the CBs, and the IBs, respectively. In all of the regressions, we
observe no second-order autocorrelation among the residuals (Arellano and Bond, 1991), which confirms that our dynamic panel
data model does not show any evidence of misspecification. Moreover, the Hansen test justifies the overall validity of the instruments
used. Hence, the estimation results in Table 4 and in the subsequent tables show that the system GMM estimator is consistent.
Table 4 highlights some important findings. Specifically, the coefficient of SMD is negative and statistically significant at the 5%
level for the full sample. Accordingly, the issuance of Sukuk may deprive the banking system of market share, thereby forcing banks
to reduce their intermediation margins. Our results suggest that NIM/NPM falls by 0.16% in response to a 1% increase in SMD, all
else being equal. Interestingly, when we control for whether the banks are Islamic or conventional, important differences emerge. The
coefficient of SMD is negative and significant for IBs, but insignificant for CBs. This result is important in light of previous findings of
Smaoui et al. (2017) that show that Sukuk markets and the banking system are substitutes. According to the authors, countries with a
predominance of the banking sector tend to have a limited role of the Sukuk market. Our results confirm this substitution effect. More
importantly, our results reveal the grounds of this competition. Indeed, Table 4 findings show that Sukuk adversely affect the
profitability of IBs while the profitability of CBs is unaffected. A plausible explanation is that both IBs and Sukuk compete to attract
investors and borrowers willing to use Sharia-compliant financial instruments. When seeking Islamic financing, a firm can borrow

5
Athanasoglou et al. (2008) suggests that capital ratios are better included as endogenous variables in bank profitability panel models.

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

Table 4
GMM estimation using the NIM/NPM dependent variable.
Full sample CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.5231*** 0.0000 0.5580*** 0.0000 0.5090*** 0.0010

Country-specific
SMD −0.1646** 0.0370 −0.1087 0.3840 −0.2502*** 0.0040
LERNER −0.0001 0.3330 −0.0002** 0.0130 −0.0001** 0.0400
INF −0.0424* 0.0580 −0.0296 0.0710 −0.0890 0.1190
GROWTH −0.0067 0.7110 0.0052 0.8390 0.0361 0.2280
Bank-specific
CAR −0.0393** 0.0110 −0.0306** 0.0340 −0.0171* 0.0780
LLR −0.0377 0.6040 0.0461 0.2910 −0.0694 0.1540
ME 0.0059 0.4670 0.0028 0.6800 −0.0181 0.1140
LIQUID −0.0233*** 0.0100 −0.0276*** 0.0000 0.0025 0.3750
SIZE −0.3598*** 0.0000 −0.3349*** 0.0020 −0.5246*** 0.0070
RWATA 0.0357 0.8550 −0.0302 0.4720 0.3438 0.7360
Constant 9.4494*** 0.0000 9.0142*** 0.0000 12.3972*** 0.0020
AR2 0.695 0.826 0.176
Hansen 0.572 0.110 0.613
Observations 582 445 137

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable employed here is the Net Interest Margin / Net Profit Margin (NIM/NPM). LDEP denotes the lag of the
dependent variable. The definitions of the independent variables are included in Table 1 above. We use the two-step system GMM and compute
robust standard errors. The p-values are reported next to the estimated coefficients. ***, **, * represent the 1, 5 and 10% significance level
respectively.

from an Islamic bank or issue Sukuk. Similarly, when deciding on investment alternatives, investors may choose among several
Islamic banking products or buy Sukuk. Hence, Sukuk directly compete with IBs. The resulting increased competition forces IBs to
narrow their margins. In addition, this has a potential impact on the quality of IBs' loan portfolios as IBs lose good borrowers to the
Sukuk market; thus impacting their profitability. Denis and Mihov (2003) find that firms with better credit quality use generally bond
financing whereas those with lower credit quality have a preference towards bank financing since they can renegotiate the terms of
the loans (See also De Fiore and Uhlig, 2011).
On the other hand, our results reveal that Sukuk do not compete directly with CBs as their products are mainly designed to
customers willing to invest in conventional instruments. The results in Table 4 suggest a potential segmentation between conven-
tional and Islamic banks.
The results obtained for the other control variables confirm the findings of the literature. Table 4 shows that, as in previous
studies, the coefficient on the lag NIM/NPM is positive and highly significant (p-values less than 1%) for the full sample and for both
subsamples. This result is consistent with the prior empirical literature (Athanasoglou et al., 2008; Berger and Di Patti, 2006; among
others) suggesting that bank profits are persistent over time. This persistency could stem from regulatory enforcement of bank capital
ratios, market competition barriers, and sensitivity to external shocks (Saona, 2016).
The capital adequacy ratio has a negative and significant impact on NIM/NPM for the full sample as well as for the IBs and CBs
subsamples supporting the view that banks having large capital are usually following safer investment strategies, which leads to
lower profitability. This result supports the findings of Brock and Franken (2003) who postulate that the composition of the bank's
balance sheet determines the level of the desired risk. Accordingly, banks with larger capital operate more safely as they are subject to
more losses of equity holders funds in case of default. In addition, more capital base results in a higher opportunity cost and hence the
negative relationship between CAR and bank NIM/NPM.
Table 4 also shows that banks liquidity affects NIM/NPM negatively and significantly in the full sample. When the bank is holding
more liquid assets, the liquidity risk decreases and so does the premium associated to this risk (Kosmidou, 2008). This impact is
mainly driven by the CBs subsample as this effect is insignificant for IBs.
The size has a negative and statistically significant effect on NIM/NPM for the full sample and both CBs and IBs subsamples. Our
findings for the size variable are in line with Berger and Humphrey (1997), Altunbas et al. (2007), and Regehr and Sengupta (2016).
The Lerner index is negative for the CBs and IBs but insignificant for the full sample. This result supports the “quiet life” hy-
pothesis; large banks with less competition tend to focus on efficiency and risk reduction rather than on profit maximization (Berger
and Hannan, 1998).
Other country-specific and bank-specific variables including macroeconomic variables, credit risk, management efficiency, and
the risk-weighted assets show little or no impact on bank's performance.

3.3. Effects of the 2008 subprime crisis

We study in this section the effects of the crisis on the profitability of banks. The global financial crisis had several profound
adverse effects on the conventional banking industry. Despite the tremendous pressure on the banking institutions, IBs were able to

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

Table 5
GMM estimation using NIM/NPM including the effects of the 2008 global financial crisis.
Full sample CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.5445*** 0.0000 0.5801*** 0.0000 0.4219* 0.0940

Country-specific
SMD −0.2568** 0.0400 −0.5731 0.1550 −0.4570*** 0.0010
LERNER −0.0136 0.1210 −0.0189** 0.0250 −0.0255** 0.0580
INF −0.0346** 0.0330 −0.0374* 0.0930 −0.1306** 0.0530
GROWTH −0.0091 0.6190 −0.0027 0.9210 0.0422 0.4540
CRISIS*SMD 0.1653 0.1420 0.4447 0.2380 0.2996** 0.0370
Bank-specific
CAR −0.0216** 0.0510 −0.0326* 0.0850 −0.0251** 0.0240
LLR −0.0828 0.1560 0.0304 0.5250 −0.0352 0.5650
ME 0.0013 0.7160 0.0025 0.7460 −0.0150 0.1660
LIQUID −0.0073 0.2420 −0.0272*** 0.0000 0.0064 0.1590
SIZE −0.2401*** 0.0090 −0.3167*** 0.0010 −0.4573** 0.0120
RWATA −0.0004 0.9950 −0.0324 0.3970 0.5734 0.6540
Constant 7.232*** 0.000 8.8683*** 0.0000 12.0306*** 0.0100
AR2 0.092 0.392 0.131
Hansen 0.362 0.885 0.693
Observations 582 445 137

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable employed here is the Net Interest Margin / Net Profit Margin (NIM/NPM). LDEP denotes the lag of the
dependent variable. The definitions of the independent variables are included in Table 1 above. We use the two-step system GMM and compute
robust standard errors. The p-values are reported next to the estimated coefficients. ***, **, * represent the 1, 5 and 10% significance level
respectively.

endure the negative implications of the crisis and remain relatively strong in the midst of economic downturns Hasan and
Dridi (2010).
To unveil the consequences of the crisis on the performance of IBs and CBs, we define a dummy variable (crisis) that takes the
value of 1 for 2008 onwards and 0 otherwise. We then introduce an interactive term equal to the crisis dummy multiplied by the SMD
variable. This interactive term is intended to detect any potential variations in the Sukuk influence on banks performance after the
crisis. The results are reported in Table 5 below.
Table 5 shows that the results are consistent with those displayed in Table 4. SMD has a negative impact on NIM/NPM for the full
sample and for the IBs, while the effect is insignificant for CBs. These results corroborate our main findings according to which Sukuk
issuance adversely affect the profitability of IBs only. When we control for the bank type, several interesting variations emerge. In
particular, the impact of the SMD interactive term disappears. This result is expected given that Sukuk do not compete directly with
the conventional banking businesses as noted in Table 4. For IBs, however, the interactive term shows a positive and significant
impact at the 5% level, suggesting that the post-crisis negative effect of SMD on IBs performance is lower. The post-crisis overall effect
remains negative since the interactive term does not completely offset the negative coefficient on the SMD variable. A plausible
explanation for this lower post-crisis effect is that the banking system has undergone substantial reforms and innovations after the
crisis to become more competitive and aggressive in acquiring larger market share (Ariss, 2010; Beck et al., 2009; Claessens and
Laeven, 2004). Additionally, in recent years, banks' Sukuk issuances became popular in strengthening their capital base to comply
with the Basel III framework, sustaining banks growth and maintaining healthy capital adequacy levels. Indeed, numerous IBs have
recently issued Sukuk that qualify for Tier 1 and Tier 2 capital.6 For example, Abu Dhabi Islamic Bank (UAE, 2012), Dubai Islamic
Bank (UAE, 2013), Boubyan Bank (Kuwait, 2016), and Qatar Islamic Bank (Qatar, 2016) have issued perpetual Sukuk that qualify for
Tier 1 capital. Additionally, Asya Bank (Turkey, 2013) and Kuveyt Turk (Turkey, 2016) have issued Sukuk that are eligible for Tier 2
capital. These Sukuk issuances suggest that a well-functioning Sukuk market would help IBs improving their capital ratios. Sukuk are
also used to increase the maturity of the banks' liabilities and to secure alternative sources of financing.
To sum up, Sukuk market expansion had no noticeable effects on CBs prior and after the crisis. Nonetheless, their issuance had
severely affected IBs before the crisis but this effect has mostly vanished after the crisis. The overall impact on IBs performance
remains slightly negative.

3.4. Robustness checks

To test the validity of our results, we perform several robustness checks. We start by checking if our results are robust to the use of

6
Under the Basel Accord, a bank's capital consists of two sources: Tier 1 capital, which is the bank's core capital, such as equity capital including
perpetual debts and disclosed reserves, and Tier 2 capital, which is the bank's supplementary capital, such as unsecured subordinated debt with an
original maturity not less than five years.

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

Table 6
GMM estimation using the ROA dependent variable.
Full sample CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.1743** 0.0450 0.2281** 0.0490 0.3411** 0.0190

Country-specific
SMD −0.1692*** 0.0000 0.0538 0.6360 −0.1012** 0.0390
LERNER −0.0001 0.5380 −0.0002** 0.0450 0.0000 0.9990
INF 0.0074 0.6980 −0.0262 0.3110 0.0121 0.7420
GROWTH 0.0540*** 0.0040 0.0371** 0.0380 0.0376 0.2620
Bank-specific
CAT −0.0068 0.8350 0.0349*** 0.0070 −0.0066 0.7430
LLR −0.0343 0.6510 −0.1521*** 0.0060 0.1537 0.1460
ME −0.0265** 0.0120 −0.0352*** 0.0000 −0.0396*** 0.0000
LIQUID 0.0212 0.2000 −0.0059 0.4480 0.0028 0.3550
SIZE 0.1324 0.2290 0.1053 0.1720 −0.1017 0.5130
RWATA −0.0792 0.7100 0.0205 0.6590 0.2551 0.8170
Constant 0.3773 0.8660 1.8591 0.1230 3.8356 0.1290
AR2 0.255 0.882 0.374
Hansen 0.204 0.831 1.00
Observations 582 445 137

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable employed here is the return on assets (ROA). LDEP denotes the lag of the dependent variable. The definitions of
the independent variables are included in Table 1 above. We use the two-step system GMM and compute robust standard errors. The p-values are
reported next to the estimated coefficients. ***, **, * represent the 1, 5 and 10% significance level respectively.

an alternative measure of performance. To do so we replicate Tables 4 and 5 using ROA and investigate whether there is a structural
change in the SMD impact on profitability after the crisis. Subsequently, we check whether the use of an alternative measure to the
Lerner Index alters the findings of this paper. In doing so, we use the percentage of assets held by the largest three banks as another
measure of market power.7

3.4.1. Using the ROA as an alternative dependent variable

In this section, we replicate Tables 4 and 5 using ROA as an alternative measure of performance. The ROA estimations in Table 6
confirm our results obtained in Table 4. Sukuk issuance has a negative impact on banks performance for the full sample and the result
is significant at the 1% level. As for the NIM/NPM results, this effect originates from the IBs only where the coefficient of SMD is
negative and significant at the 5% level.
The other control variables in Table 6 do either maintain their signs (as in Table 4) or become statistically insignificant with few
exceptions. In particular, the credit risk variable affects negatively and significantly the ROA for the subsample of CBs. Additionally,
the impact of the management efficiency variable is negative and statistically significant, for the full sample and for both CBs and IBs
subsamples, implying that a good management can achieve higher revenues with an overall lower cost (Kasman et al., 2010). Finally,
the GDP growth coefficient becomes positive and significant for the full sample and for the CBs subsample. Accordingly, higher GDP
growth levels in the country foster banks profitability. Maudos and Fernández de Guevara (2004) find that economic prosperity tends
to enhance good management practices reducing the bank costs and lowering default risks.
Table 7 confirms the results in Table 5 regarding the effects of the crisis. The negative effect of SMD on ROA for IBs is lower after
the crisis as the interactive term is positive (but does not totally offset the negative coefficient of SMD).
Overall, Tables 6 and 7 show that our results in Tables 4 and 5 are robust to the use of other measures of profitability and do not
depend on the choice of the performance measure.

3.4.2. Performance and market power

Banks market power may affect their ability to impose the desired prices and reduce their costs influencing their profitability. A
positive relationship between measures of market power and profitability has been documented in Berger and Hannan, 1998. Berger
(1995) suggests two explanations for this observed positive relationship. The first, called the structure-conduct-performance (SCP)
model argues that monopolistic firms can set their prices freely. Accordingly, banks evolving in concentrated market structures can
easily increase their profit margins. The second hypothesis known as the market power (RMP) model stipulates that companies
offering different products compared to competitors can impose higher prices.
On the other hand, a highly concentrated banking industry may encourage bank managers to be inefficient. Thus, the potential
negative effect between market power and efficiency (Berger and Hannan, 1998). The loss of efficiency may be attributed to the fact

7
We also tested the robustness of our results to the presence of outliers by winsorizing the data. Winzorizing the data did not alter our main
findings and the results with winzorized data are available upon request.

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

Table 7
GMM estimation using ROA including the effects of the 2008 global financial crisis.
Full sample CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.1693** 0.0370 0.1908* 0.0700 0.2994** 0.0480

Country-specific
SMD −0.2796*** 0.0010 0.0798 0.7800 −0.2879** 0.0120
LERNER −0.0078 0.5400 −0.0113 0.2310 −0.0123 0.4930
INF 0.0088 0.6780 −0.0133 0.6330 −0.0081 0.8810
GROWTH 0.0484*** 0.0030 0.0451** 0.0340 0.0339 0.3730
CRISIS*SMD 0.1509** 0.0630 −0.0567 0.8340 0.2180** 0.0320
Bank-specific
CAR −0.0111 0.7230 0.0227 0.1450 −0.0048 0.7990
LLR −0.0123 0.8850 −0.1331** 0.0310 0.1499 0.1110
ME −0.0277** 0.0150 −0.0337*** 0.0000 −0.0415*** 0.0000
LIQUID 0.0225** 0.0380 −0.0028 0.6430 0.0039 0.2700
SIZE 0.1115 0.3840 0.0908 0.2020 −0.0847 0.5390
RWATA −0.0702 0.7010 0.0085 0.7750 0.0457 0.9670
Constant 0.7754 0.7390 1.8773 0.1180 4.4935* 0.0720
AR2 0.255 0.992 0.323
Hansen 0.5 0.992 0.999
Observations 582 445 137

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable employed here is the return on assets (ROA). LDEP denotes the lag of the dependent variable. The definitions of
the independent variables are included in Table 1 above. We use the two-step system GMM and compute robust standard errors. The p-values are
reported next to the estimated coefficients. ***, **, * represent the 1, 5 and 10% significance level respectively.

Table 8
GMM estimation using NIM/NPM and the bank concentration as a measure of market power.
Full CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.3988*** 0.0000 0.4196*** 0.0000 0.4169*** 0.0040

Country-specific
SMD −0.1094*** 0.0020 −0.0323 0.1500 −0.0533** 0.0190
CONC −0.0218*** 0.0040 −0.0102** 0.0410 −0.0179** 0.0260
INF −0.0294 0.1080 0.0125 0.5800 −0.0508 0.3630
GROWTH −0.0143 0.4150 −0.0186 0.3680 0.0517** 0.0270
Bank-specific
CAR −0.0353** 0.0180 −0.0352** 0.0430 −0.0346** 0.0270
LLR −0.0427 0.5830 0.0014 0.9690 −0.0033 0.9240
ME −0.0015 0.8610 0.0068 0.1460 −0.0024 0.4050
LIQUID −0.0074 0.3780 −0.0085 0.3080 −0.0027 0.6350
SIZE −0.2714*** 0.0070 −0.2495*** 0.0030 −0.3351*** 0.0030
RWATA 0.2402 0.6220 0.1876 0.3660 3.0316*** 0.0090
Constant 9.1590*** 0.0000 7.2259*** 0.0000 7.7158*** 0.0000
AR2 0.089 0.07 0.116
Hansen 0.571 0.811 0.898
Observations 696 512 184

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable employed here is the Net Interest Margin / Net Profit Margin (NIM/NPM). LDEP denotes the lag of the
dependent variable. The definitions of the independent variables are included in Table 1 above. We use the two-step system GMM and compute
robust standard errors. The p-values are reported next to the estimated coefficients. ***, **, * represent the 1, 5 and 10% significance level
respectively.

that managers having comfortable profits may not be concerned with profitability. Instead, the bank resources would be devoted to
maintaining their high market share and sustaining future growth, among other objectives.
Since our results for the Lerner index fall within the “quiet life” hypothesis and given that most of the literature finds a positive
relationship between market power and performance (Maudos and Liang, 2008, among others), it would be interesting to employ
alternative market power variables to check the robustness of our results. Hence, we use the percentage of bank assets held by the
three largest commercial banks in the country as a proxy for concentration and employ this variable as an alternative to the Lerner
index. We report the results in Tables 8 and 9. Table 8 uses the NIM/NPM as a dependent variable while Table 9 uses the ROA instead.
It is clear from both Tables that, independently of the use of any performance measure, the inclusion of the concentration variable
does not alter our original findings. The development of domestic Sukuk markets has negative externalities on the profitability of IBs

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

Table 9
GMM estimation using ROA and the bank concentration as a measure of market power.
Full CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.1912*** 0.0170 0.1808** 0.0450 0.3564*** 0.0020

Country-specific
SMD −0.0712*** 0.0040 0.0093 0.7690 −0.0730** 0.0450
CONC −0.0131** 0.0460 −0.0082** 0.0480 −0.0146 0.1110
INF 0.0059 0.7630 0.0073 0.6780 −0.0493 0.4870
GROWTH 0.0331* 0.0570 0.0322** 0.0140 0.0085 0.7770
Bank-specific
CAR −0.0085 0.5630 0.0305*** 0.0030 −0.0036 0.8570
LLR 0.0345 0.5800 −0.0511** 0.0130 0.1496 0.1790
ME −0.0326*** 0.0010 −0.0392*** 0.0000 −0.0154*** 0.0040
LIQUID 0.0173 0.1630 −0.0013 0.8570 0.0012 0.7280
SIZE 0.0940 0.3500 0.0518 0.4180 0.1118 0.1090
RWATA −0.0176 0.8660 0.0092* 0.0740 −0.4480 0.7640
Constant 1.6452 0.4300 2.2545* 0.0620 1.1205 0.4520
AR2 0.229 0.906 0.373
Hansen 0.513 0.850 1.00
Observations 696 512 184

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable employed here is the return on assets (ROA). LDEP denotes the lag of the dependent variable. The definitions of
the independent variables are included in Table 1 above. We use the two-step system GMM and compute robust standard errors. The p-values are
reported next to the estimated coefficients. ***, **, * represent the 1, 5 and 10% significance level respectively.

Table 10
GMM estimation using the overall bond market development as our main independent variable.
Full sample CBs IBs

Coef. P > |z| Coef. P > |z| Coef. P > |z|

LDEP 0.572*** 0.0000 0.5222*** 0.0000 0.5034*** 0.0020

Country-specific
BOND −0.0070 0.3150 0.0290** 0.0420 −0.0058 0.2360
LERNER 0.0017 0.8720 −0.0140 0.1300 0.0009** 0.9250
INF −0.0381 0.1340 −0.0313 0.1010 0.0212 0.7100
GROWTH −0.0070 0.0254 −0.0050 0.8320 0.0407 0.2520
Bank-specific
CAR −0.0467*** 0.0090 −0.0305* 0.0960 −0.0171*** 0.0020
LLR −0.0472 0.5140 −0.0001 1.0000 −0.0476 0.5010
ME 0.0087 0.4880 −0.0013 0.8320 −0.0145 0.1470
LIQUID −0.0170* 0.0870 −0.0254*** 0.0040 0.0039 0.1880
SIZE −0.3875*** 0.0000 −0.3316*** 0.0010 −0.4606*** 0.0010
RWATA −0.0088 0.6995 −0.0505 0.8320 −0.6341 0.4990
Constant 9.0751*** 0.0000 8.8566*** 0.0000 10.4752*** 0.0020
AR2 0.742 0.076* 0.064*
Hansen 0.662 0.801 1.000
Observations 582 445 137

The table shows the results of the regressions estimates using a Dynamic Panel Model for our sample of 71 IBs and 146 CBs for the period
2003–2014. The dependent variable is the Net Interest Margin / Net Profit Margin (NIM/NPM). LDEP denotes the lag of the dependent variable. The
overall bond market development (BOND) is the sum of the Sukuk Market Capitalization and the Outstanding Public and Private Bonds over GDP.
The definitions of our explanatory variables appear in Table 1. We use the two-step system GMM and compute robust standard errors. The p-values
appear next to the estimated coefficients. ***, **, * refer to the 1, 5 and 10% levels of significance respectively.

while the performance of CBs remains unaffected. Additionally, the market power's negative effect on banks performance obtained
using the Lerner index is confirmed when the bank concentration variable is employed supporting the “quiet life” hypothesis.

3.4.3. Overall bond market development

Thus far, we have observed the effect of Sukuk market development on the performance of IBs and CBs. It would be interesting to
analyze the effect of the overall bond market development on the profitability of the banking sector.8 In this regard, Rajan and
Zingales (2003) argue that financial development stimulates competition, renders financial institutions' human capital obsolete, and

8
We are thankful to an anonymous referee for suggesting this additional test.

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K. Mimouni et al. Pacific-Basin Finance Journal 54 (2019) 42–54

demolishes the banks rents and relations, which leads to lower banks' profit margins. To do so, we estimate our model (1) using the
overall bond market development in lieu of the Sukuk market development, while controlling for the same country-specific and bank-
specific variables. The overall bond market development (BOND) is measured by the sum of the Sukuk market capitalization and the
outstanding public and private bonds over GDP. The data on public and private bonds is taken from the World Bank's Global Financial
Development Database.
The results that appear in Table 10 show that the coefficient of BOND is expectedly negative but insignificant at the 5% level for
both the full and the IBs' samples. For the sample of CBs, however, BOND is positively and significantly associated with NIM, implying
that the development of the overall bond market stimulates the profitability of CBs. This finding is in line with the empirical results of
Jiang et al. (2001) and Eichengreen and Luengnaruemitchai (2004) that bond market development and bank profitability are po-
sitively correlated in the emerging economies.
Overall, our results points to a complementary relationship between bond market development and CBs, while the overall bond
issuance has no effect on the performance of IBs.

4. Conclusion

This paper explores the impact of Sukuk market development on the performance of CBs and IBs and examines whether the
impact of Sukuk markets on bank performance is significantly different after the global financial crisis. Using a panel dataset of 71 IBs
and 146 CBs spanning 13 countries over the 2003–2014 period, our system GMM estimations yielded several novel results. We find
that, for the overall sample, more Sukuk issuances have a negative impact on banks performance measured using NIM/NPM. These
findings are robust to the use of other measures of performance (ROA). Our results confirm that the banking system and Sukuk
issuance are substitutes. When we control for whether the bank is Islamic or conventional, some important disparities are unveiled.
Sukuk adversely affect the performance of IBs while that of CBs remains unaffected. Additionally, the post-crisis effects of Sukuk on
NIM/NPM (and ROA) are lower, suggesting that IBs were able to adjust to the competition due potentially to all banking reforms
implemented following the crisis.
Our findings are of paramount importance to financial authorities and policy makers. It is self-evident that governments and
policy makers in emerging economies are determined to develop their financial systems and make them resilient to external shocks.
Well-developed Sukuk markets are increasingly considered as an integral part of resilient financial systems. However, the evidence
shown in this paper suggests that Sukuk development brings about competition in the lending business and may draw profits away
from IBs. Therefore, IBs will naturally oppose the development of Sukuk markets. Governments in emerging countries should find
ways to stimulate the development of Sukuk markets, while, at the same time, minimizing the disintermediation effect the devel-
opment of Sukuk will have on IBs.

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