Liabilities Sukuk vis-à-vis Equity Sukuk and the Profitability of UAE Islamic Banks

<b>Purpose</b>&nbsp;Liabilities sukuk and equity sukuk are recorded on the liabilities and equity side of Islamic banks’ statements of financial position. Tier One sukuk are equity sukuk with special characteristics of loss absorption and perpetuity to meet Basel III requirements. This paper attempts to investigate if the impact of Liabilities sukuk on the profitability of Islamic banks differs from that of Tier One sukuk.&nbsp;<b>Design / methodology / approach&nbsp;</b>The dataset contains all Islamic banks in the United Arab Emirates that issued liabilities sukuk or Tier One sukuk from 2008 to 2021. We compiled 88 observations from 7 Islamic banks over 14 years. Then, we applied panel OLS multivariate linear regression models using pooled, fixed effects, and random effects methods. The suitable estimation method was selected based on the redundant fixed effects test and the Hausman test.&nbsp;<b>Findings&nbsp;</b>The results of this study reveal novel findings. Liabilities sukuk reduces all profitability indicators. That is, Liabilities sukuk are costly, and issuing more of this sukuk will damage the return to shareholders. Hence, we conclude that Liabilities sukuk do not encourage managers to better utilise bank resources and do not necessarily change the appetite of those banks to engage in riskier activities.&nbsp;<b>Research limitations&nbsp;</b>The effect of Liabilities sukuk on the profitability of Islamic banks is only investigated in the UAE. It will be interesting to conduct an out-of-sample test of this relationship in other Islamic countries to accommodate institutional differences. Moreover, we examine only the effect of issuing Liabilities sukuk on Islamic banks’ profitability and not on their risk. These limitations represent venues for future research.&nbsp;<b>Practical implications&nbsp;</b>Islamic banks should avoid issuing liabilities sukuk and increase their issuance of Tier One sukuk. Moreover, we encourage investors to buy stocks of Islamic banks that have larger Tier One Sukuk while avoiding investing in Islamic banks that utilise liabilities sukuk because the latter rewards them lower EPS.&nbsp;<b>Originality / value&nbsp;</b>&nbsp;This paper contributes to sukuk literature in threefold. First, it complements the prevailing literature on how sukuk affects Islamic banks’ profitability. Second, this study shows that Liabilities sukuk neither enhances the profitability indicators of Islamic banks nor improves the utilisation of banks’ assets. These findings support the signaling theory projections that Liabilities sukuk are costly and Islamic banks should only resort to them if other sources of funding are unavailable. Third, this study runs a horse race between two sources of funds for Islamic banks to test how each source affects profitability