To protect the international financial system, regulators should rely more on a benchmark portfolio as a tool to guard against excessive risk-taking, rather than the capital standards now in use, Citigroup
Pandit said that capital rules, such as the international Basel agreements, are not transparent and do not give investors a good idea of how much risk a bank is facing.
Pandit said that under the current capital rules it is difficult to tell whether two banks who claim to be meeting the same standard are equally risky.
You don't know how to calibrate risk because you don't know enough about what those underlying assets actually are nor how that risk is measured, Pandit said in remarks prepared for delivery on Friday to a Bretton Woods Committee meeting in Washington.
Pandit said a better way for making sure the financial system is sound would be to create a benchmark portfolio that banks and other financial institutions would measure their own portfolios against.
He said those results should be disclosed publicly.
Knowing how a given company's risk measurements perform against the benchmark portfolio tells the world how its management thinks about risk, and therefore just how conservative or risky its own portfolio probably is, Pandit said. An institution that cheerfully reports minimal expected losses from the benchmark portfolio in the event of a one-in-a-thousand market decline might well be understating the risk in its own portfolio.
Large banks are lobbying intensely against new international capital rules that would require the world's largest banks to meet a higher capital standard than their smaller competitors.
Banking executives and their lobbying groups contend the higher standards would result in less lending, which in turn would hurt the economy.
Regulators and other supporters of higher capital standards have countered that the economy would benefit from a sounder financial system and that the industry is overstating the impact of the rules on lending.
The heads of the Group of 20 leading and emerging economies are expected to give final approval to the so called Basel III capital rules for the largest banks in November and then it will be up to each country to implement them.
The Basel agreement will require banks to maintain top-quality capital equal to 7 percent of their risk-bearing assets.
On top of that, global systemic banks may have to hold up to an additional 2.5 percent buffer. Another 1 percent surcharge would be imposed if a bank became significantly bigger.
In his speech, Pandit also threw his support behind efforts in the United States to have derivative transactions cleared through exchanges.
I will not win any popularity contests for supporting these changes but they would introduce much needed transparency and discipline and enhance systemic safety significantly, he said in his prepared remarks.
(Reporting by Dave Clarke, Editing by Tim Dobbyn)