The banking crisis had many causes, some of which are complex enough to make a quantum physicist's head spin. But a central cause is simple: banks relied far too much on debt to fund their activities - they used too much leverage. That's why a new study, quietly released by the Bank for International Settlements almost exactly five years after Lehman Brothers collapsed, makes for encouraging reading. It suggests that attempts to reduce leverage are paying off. The regulators' medicine is working - and with fewer side-effects than feared.
A highly leveraged bank gets most of its money from debt-holders, which is risky because those debts must be repaid on schedule or the bank is bust. A less leveraged bank gets more of its money from shareholders and it is not obliged to pay them anything in particular at any given time. In troubled times, the less leveraged bank is far more resilient.
Despite this, banks resist funding their activities with equity capital rather than debt. No wonder: because highly leveraged banks are at greater risk of collapse, they enjoy a larger implicit “too big to fail” subsidy from the taxpayer. While such implicit subsidies continue to exist (for ever, I suspect), bankers will prefer to fund themselves with risky debt and rely on the taxpayer to provide the free safety net.