The financial stability of Islamic banks and sukuk market development: Is the effect complementary or competitive?

The purpose of this study is to examine the effect of the development of a market for sukuk (Islamic bonds) on the financial stability of Islamic banks. In addition, we test a hypothesis on whether the link between sukuk markets and Islamic banks (IBs) with respect to financial stability is determined by competition or complementarity. This study applies a dynamic panel system–generalized method of moments to explore the effect of sukuk market development on IBs' financial stability. We employ a Z-score model, the optimal model for measuring IBs’ financial stability, and measure sukuk market development by total sukuk holdings issued. The sample consists of all the Islamic financial institutions in operation in the sample countries (Malaysia, Saudi Arabia, Indonesia, Turkey, and Brunei). Our findings demonstrate that sukuk market development positively affects the financial stability of Islamic banks, by expanding complementarity between Islamic banks, encouraging them to maintain stability.