At a speech to industry types on Monday, Vikram Pandit, CEO of Citibank, argued that federal regulators ought to spend more time regulating shadow banking, not retail banks. Does his argument have merit?

The subject is too far away from the verb try:  At the Securities Industry and Financial Market Association (SIFMA) conference that took place in New York on Monday, Citigroup (NYSE:C) CEO Vikram Pandit argued that MF Global’s collapse last week demonstrates how shadow banking should be subject to more regulation and scrutiny from the federal government, considering industry size and risk. Watch his conversation with Charlie Rose at Bloomberg.

Shadow Banking: Not Quite as Scary as It Sounds

Shadow banking is a term widely used to describe financial institutions like hedge funds and structured investment vehicles, which help issue credit and trade in complex financial instruments, but do not take deposits. Because these institutions are not technically banks, they are not subject to the same regulations as banks are. In a post-Dodd-Frank era, they can take on more risk than banks, but they also cannot access risk-easing capital sources like Federal Reserve loans and FDIC insurance.

As such, these shadow banks pose serious risks to our economy’s wellbeing. Bear Stearns and Lehman Brothers, for example, operated within the shadow banking system.

And what’s troubling is that shadow banking is slowly growing again, having avoided the scrutiny that retail banks have faced in the years since the financial crisis. The Financial Stability Board, an international banking think tank, recently released a report on the lack of oversight in shadow banking.

They found that shadow banking makes up ” 25-30% of the total financial system,” and that the United States has the largest shadow banking system in the world, with $24 trillion in assets in 2010, compared to a pre-crisis high of $25 trillion. Indeed, little has changed in this massive segment of the banking industry.

Pandit: A Friend of Regulation

Taken out of context, Pandit’s complaints about the lack of regulation in shadow banking might initially look like sour grapes from the CEO, whose bank has been hit with an onslaught of new regulations while others in the same industry can operate as if 2008 never happened. But that doesn’t appear to be the CEO’s angle at all. In his conversation with Charlie Rose, he defended Washington regulations again and again.

On the Volcker Rule: “I think banks’ capital should be capital that you need to serve your clients, not to serve yourselves. I don’t think banks should be speculating with [investors’] capital.”

On Dodd-Frank: “I think Dodd Frank does a lot of things that are important…the focus on the consumer is exactly right.”

“I think we all ought to invest in safety and soundness. We live off of safety and soundness,” said Pandit. “But in order to get to safety and soundness you can’t only…look at certain institutions.”

Will Washington respond, or be able to respond, to Pandit’s recommendations given the political blowback from Dodd Frank? Hopefully they can before it’s too late.

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