Proponents of financial reform appeared to have won a major victory with the December 10 release of the long awaited Volcker Rule. The accompanying White House statement claimed that the rule heralded “a new era of accountability,” and that it was now illegal for banks “to make speculative bets that threaten the entire financial system.” The rule, which is supposed to ban banks from trading for their own benefit rather than merely as a means to facilitate client transactions, was greeted with cautious optimism and relief from those who have fought to “make banking boring again.”

This provocative catchphrase is an unfortunate distraction from the real issues. “Making banking boring” implies a world where wildcat traders making too big bets are a fundamental cause of financial ruin. By looking at the ways a bank ultimately makes (or loses) money, however, we see a different reality.

Efforts to make banking safer suffered substantive setbacks over the last few weeks.  On December 18, the Federal Reserve delayed implementation of leverage limits on the largest American financial institutions, explaining that they wanted to wait to see the finished rule from the Basel Committee on Banking Supervision before acting. This was followed by news this week that the Basel Committee decided to ease some of its leverage ratios requirements for banks. Banks globally focused their lobbying efforts on these capital ratio discussions—namely, how much cash or liquid securities need to be held in reserve as a percentage of total liabilities. These discussions have received less coverage but are a magnitude more meaningful.

Loan Losses Versus Trading Losses

The Volcker Rule will have little effect on the day-to-day operations of a bank, but more importantly it will have little effect on the likelihood of financial crisis. For one thing, the ability to define and regulate proprietary trading versus market making is not nearly as straightforward as most journalistic accounts would lead you believe. If a health care credit trader buys 500 shares of Tesla stock, he’s engaging in proprietary trading irrelevant to his clients. But what if he sells to a client $10 million of five-year credit default swaps (CDS) on HCA Healthcare and hedges it by buying $20 million of three-year CDS on Community Health Systems? To steal the words of Justice Potter Stewart, judging the intent behind trading activity is a very subjective enterprise, but you know proprietary trading when you see it.

But perhaps an even more important point is that the practice of proprietary trading is a lot less vital to today’s banks than people commonly believe. Banks make money mostly through 1) lending, where cash, usually from customer deposits, is lent against, 2) market making, where securities are bought and sold with clients to facilitate a two-sided marketplace, and 3) syndicate, where banks raise debt and equity financing transactions for companies in return for a percentage fee.

It’s true that in the run-up to the financial crisis banks had proprietary trading desks that used internal funds to speculate on asset prices without necessarily facilitating client activity. The GAO’s July 2011 report on Proprietary Trading found that the six largest U.S. banks made a cumulative loss of $221 million from June 2006 through December 2010. But these sums pale in comparison to other bank activities. In contrast, loan activity, which the Volcker Rule does not target, resulted in more than $1 trillion of write-downs between 2007 and 2009. Proprietary trading alone thus represents a small percentage of a bank’s business and did not appear to wildly underperform during the crisis.

But are banks hiding proprietary trading functions in their market making operations? Again, the answer appears to be “no.” There should be signs of proprietary trading in market-making activity. A trader taking directional risk—that is to say, knowingly exposing oneself to the fluctuations of an asset’s value in an attempt to make a profit—will have a more volatile profit and loss chart than a trader engaged purely in market making. Let’s take a look at the financial filings of major banks, which disclose how many days of trading gains and losses there were in the last quarter. In the first quarter of 2010, Bank of America, Citigroup, Goldman Sachs, and JP Morgan all had perfect trading quarters: Their trading desks didn’t lose money on a single day. In the most recent quarter, Bank of America had two daily losses, Goldman Sachs had 15, and Morgan Stanley had seven. These ledgers are indicative of businesses that largely generate income by facilitating client business while holding small amounts of inventory at the end of the day. They stand in contrast to hedge funds, whose ledgers reflect significant directional gains and losses from day to day.

Simply put, the Volcker Rule has targeted an area of trading that did not suffer significant losses in the financial crisis, unlike bank lending. Furthermore, proprietary trading desks have already been shut down, with little more than superficial pushback by nearly every financial institution.

It’s All About Leverage

The “make banking boring” paradigm is a distracting dead end in financial reform that has led to the passage of a glamorous rule at the cost of delaying true reform. There is no doubt that trader compensation was too high and that it rewarded one-time gains rather than recurring profitability. It’s also true that financial innovation facilitated and accelerated the credit boom in housing and personal finance. But these flaws were symptoms rather than causes of the cycle that led to the financial crisis. At the root, an excess of credit was extended by institutions that were too leveraged. We can address this two ways: by requiring debt originators to retain “skin in the game” in order to encourage sound lending decisions, and by instituting stricter capital requirements to forcibly reduce leverage.

“Skin in the game” is a concept worth keeping around. In initial Dodd-Frank discussions, it was suggested that mortgage originators retain as much as 5 percent of economic interest in the loans they originate. This would force originators to focus on making loans of appropriate quality rather than focusing on volume and selling off as many loans as possible. Unfortunately, after intense lobbying, it’s unclear that this rule will ever see the light of day.

There has been some movement on the capital requirements front, however. Global regulators have introduced a set of regulatory rules called Basel III, which requires a capital ratio of 3 percent on all global banks. Regional regulators have introduced higher requirements, with the Federal Reserve targeting 5-6 percent and Switzerland likely aiming above 6 percent. Banks certainly have been improving their balance sheets; the European Banking Authority reported in December that EU lenders have reduced risk-weighted assets by $1.1 trillion between December 2011 and June 2013. But it’s imperative they continue to do so under an organized global effort and for the Federal Reserve to resist pressure to further delay regulations.

To understand the power of leverage, consider the example of a new homeowner. If Nancy buys a $100,000 home while putting down 20 percent capital, she will need to borrow $80,000 on top of her $20,000 in cash. If this home drops by five percent in value to $95,000, she will have lost 25 percent of her cash investment. In contrast, if she had only put down 10 percent in capital, she would have lost 50 percent of her cash investment. Moderate changes in leverage can result in startlingly higher losses for even small asset movements.

Make Reform Boring

The Volcker Rule has been a public battleground for opponents and proponents of financial reform, but for the wrong reasons. It’s exciting to talk about personalities like the London Whale or Kweku Adoboli who made large directional commitments and lost big. It’s also provocative to imagine that a cabal of adrenaline junkies is causing the world economy to teeter on the brink of disaster. In truth, the real problems are much more entrenched and far quieter. It is politically popular and frequently financially profitable to extend credit. We lost control of the incentives that would ensure prudent loan origination, and we had insufficient limits on leverage.

The goal of financial reform should not be to make banking boring, but rather to make it more prudent. With Volcker now out of the way, we should focus on the less glamorous parts of financial reforms and have a broader discussion about how we use credit as a means of benefitting society. Are we willing to cut back on the American dream of homeownership? Should students be allowed to take out education loans regardless of future earning potential? There’s much work to be done and many more questions to answer. Here’s to hoping the Volcker Rule will not be the crowning achievement of financial regulation. Let’s make reform boring, but impactful.