When the cycle turns, pessimism sets in, losses increase, value of assets and collaterals diminish and liquidity dries up and becomes costlier. These erode the financial health of banks, households and corporates who become risk averse. The demand for credit by households and corporates as also the supply of credit by banks slows down. Banks also deleverage to preserve their capital.
All these exacerbate the downturn. Leverage is an amplifier in as much as it amplifies the profits during upturn and exacerbates losses during the downturn: higher the leverage, more severe is the downturn. This amplification is also called procyclicality. Prior to the crisis, the regulatory policies did not effectively address the systemic risks arising out of procyclicality and interconnectedness.