A host of factors – innovation of complex products by slicing and dicing, the originate and distribute mode of lending, misuse of derivative products, securitization that encouraged aggressive off-balance sheet activity, loose supervision and regulation – all culminated in the build up of systemic risks, and this despite the growing sophistication of risk management systems.
Regulation typically focussed on individual institutions, not recognizing the fallacy of composition – that systemic stability could be threatened even if individual institutions within the system are stable. A whole network of bank-like institutions – now called the “shadow banking system” – grew and flourished outside the regulatory regime of banks.