Shadow banking will have a permanent and necessary role in credit markets, including mortgage lending, where regulation has forced banks to retrench, Citigroup Chief Executive Michael Corbat said.

Nonbank financial institutions should not be viewed as "villainous," Corbat said Monday evening at New York University's Stern School of Business.

"There were many things we were doing [precrisis] as regulated institutions that today we can't do," Corbat said. "Many of those things are very important. We still don't have a fully functioning mortgage securitization or mortgage lending market…. Shadow banking will have to fill those voids."

Overhauls of the financial system, including the Dodd-Frank Act and Volcker Rule, have sought to lessen risk at the largest institutions, primarily banks. The flip side is that more forms of credit must be accessed outside the traditional lending system, which is not subject to the same oversight.

Deutsche Bank co-CEO Anshu Jain took a more aggressive tone on the topic earlier this month, warning of "bank-like risks" and calling for a clear regulatory framework.

Corbat's remarks came during a discussion with other financial heavyweights on the growth of what the Financial Stability Board estimates is a $71 trillion-asset shadow-banking market worldwide, comprised of nonbank financial institutions that provide traditional banking and market-making services.

"The markets keep getting bigger and bigger," said hedge fund tycoon John Paulson, the president and founder of the $22.8 billion Paulson & Co.

Joseph Landy, co-CEO of the $39 billion leveraged buyout firm Warburg Pincus, sees a world with many growing funding needs.

"In my view, anything that actually increases credit, that makes liquidity available to businesses that need them, that is almost a prerequisite to growing economies," Landy said.

Regulation will have to stay focused and keep up, he said. "One of the children gets out of line and needs to get slapped to get back in line at some point," he said. "You will have that. You are going to have some crises."

For banks like Citigroup, the new world order will have lasting effects with mixed implications, Corbat suggested. On one hand, regulation has handcuffed them from continuing in the most complex of businesses, creating a vacuum of opportunity for less-constrained institutions. Simultaneously, the competitive field among megabanks has a new barrier to entry.

"If you are not global today, regulators probably don't want to see you get bigger, and they probably don't want to see you expand," Corbat said. "If you don't have scale in a particular product or business line today, you probably can't buy it. Therefore, you have to build it. If you're going to build it in a slower-growth and lower-interest-rate environment, that's just tough."

Corbat offered shareholders one positive takeaway of a simpler banking business. Investors should expect lower volatility of earnings, and steadier returns, but at lower levels than historically, he said.

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