The failure to give regulators enough legal power and rapid growth of a shadow banking system were at the heart of the eruption of the financial crisis, Treasury Secretary Timothy Geithner will tell an official inquiry on Thursday.

In testimony for delivery on Thursday before the commission investigating the causes of the 2008-2009 turmoil, Geithner said loosely-regulated non-bank financial firms had grown to a size nearly equal to the traditional banking system with $8 trillion in assets.

Financed with short-term funds and with thin cushions of resources, the shadow banking system was "particularly vulnerable to a classic run or banking panic," Geithner said.

While all financial forms need to be brought under tougher regulation as part of a broader regulatory overhaul, Geithner cautioned against preventing banks from engaging in some risk-taking on behalf of customers.

"We cannot make the economy safe by taking functions central to the business of banking, functions necessary to help raise capital for businesses and help businesses hedge risk, and move them outside banks," he said.

In prepared testimony for the same commission, Geithner’s predecessor Henry Paulson said that, while flaws in the financial system must be fixed, the United States must avoid returning to a system of monolithic commercial banks.

The Senate is in the middle of work on the Obama administration’s sweeping reform of the financial sector, with a central issue whether to rein in banks’ trading in some financial instruments to curb risk.

Both Geithner and Paulson agreed it was necessary to regulate trading of derivatives more closely, and to put more of the trading on central exchanges.