Two, it was believed that only banks were important from the financial stability perspective as they held deposits and were at the core of the payment and settlement systems. Three, it was assumed that if banks’ exposure to shadow banking system was regulated, it was easy to contain risks in the shadow banking system.
Four, it was also believed that regulation of shadow banking system would be very costly, reduce innovation and impede risk transfer. The compensation structure in financial institutions was also seriously flawed as it encouraged perverse incentives and, therefore, was another major reason attributed for the outbreak of the crisis.