Vikram Pandit, who abruptly resigned today as chief executive officer of Citigroup Inc., was among the most vocal critics of shadow banking, the lightly regulated lending that can mask risk in the financial system. He was also among the kings of the business.

Under Pandit, Citigroup arranged more than $7 billion of collateralized loan obligations in the U.S. this year through September, three times as much as the same period in 2011 and more than any other lender, according to data compiled by Bloomberg and Morgan Stanley. The bank also caters to money- market funds, managed share sales in mortgage real estate investment trusts and runs a stable of internal credit funds.

All are part of a shadow-banking system that offers complex forms of credit and that led to billions of dollars in losses during the financial crisis. While regulators from Washington to Brussels say they’re scrutinizing this lending to prevent another calamity, banks including Citigroup, Goldman Sachs Group Inc. and JPMorgan Chase & Co. are among its biggest enablers.

“I agree with Mr. Pandit that financial reform really hasn’t dealt with shadow banking,” said Erik Gerding, a law professor at the University of Colorado in Boulder who specializes in banking regulation. “But I disagree in that large financial institutions, large investment banks, are really key players in the shadow-banking network.”

Unregulated Entities

Pandit’s departure and that of President John P. Havens, announced a day after the bank reported a surprise quarterly profit, removes a leadership team that navigated the firm through the 2008 global credit crisis, when taxpayers rescued it from collapse with a $45 billion bailout. Citigroup was forced to buy back $25 billion of mortgage-backed securities because of commitments made by shadow-banking conduits the company kept off its balance sheet, contributing to a $27.7 billion loss.

Regulators targeted traditional banks after the worst financial crisis since the Great Depression. Lenders such as New York-based Citigroup have had to boost capital to protect against future losses, comply with new rules for derivatives and exit risky trading businesses.

Pandit, 55, criticized lawmakers for neglecting unregulated entities while saddling lenders such as his with restrictions. Investors are “flowing” into shadow banks as a result, a “major concern that should trouble us all,” he said in Singapore in August. Those views echo a June report by the Institute of International Finance, which represents more than 450 financial firms, urging regulators to scrutinize risks.

‘Seemingly Riskless’

Shadow-banking entities include money-market funds, CLOs, credit hedge funds and asset-backed commercial paper conduits, according to a 2010 Federal Reserve Bank of New York staff report. They provide “sources of inexpensive funding for credit by converting opaque, risky, long-term assets into money-like and seemingly riskless short-term liabilities,” the authors wrote in an abstract of the report.

The industry has escaped the reach of new laws despite its size, Pandit has said. Shadow-banking assets in 11 countries including the U.S. have more than doubled since 2002 to $51 trillion, an amount equal to about half of total bank assets in those nations, according to a 2011 report by the Financial Stability Board, which coordinates the work of regulators, central bankers and policy makers.

The lack of oversight of these financial intermediaries has created an unchecked market that resembles a chaotic street scene in his native India, Pandit said at a conference in Washington in September 2011.

Chaos, Disorder

“I’m reminded of towns in India in which every house, on the inside, is as clean and orderly as you can imagine,” said Pandit, who was born in Nagpur, a city in central India. “While just beyond the door, chaos and disorder reign.”

Just beyond the door lies profit as well.

Citigroup, the third-largest U.S. bank by assets, dominates the market for arranging CLOs, entities that bundle high-yield loans and slice them into securities of varying risk and return. As the arranger of about 25 percent of CLOs issued this year, the firm helps managers structure and market the deals and earns fees for its efforts.

CLOs are among shadow-banking products that are difficult to value and whose liquidity can evaporate quickly, as happened during the financial crisis, Gerding said. They and other such instruments can expose sponsors to litigation risks if a product collapses and investors seek compensation, he said. New regulations for U.S. lenders haven’t dealt with the “implicit support” they provide to the shadow-banking system, Federal Reserve Governor Daniel Tarullo said last week.

Liquidity Puts

Support for shadow-banking products led to losses in the past. Citigroup bailed out investors in distressed special investment vehicles, or SIVs, in 2008, soon after Pandit took the top job. The move cost the lender at least $3.3 billion, while some investors in the Citigroup-advised SIVs got all their money back. Pandit, who was succeeded today by Michael Corbat, had no contractual obligation to rescue the SIVs.

Citigroup also collects fees for administering asset-backed commercial paper conduits, which sell short-term notes to investors such as money-market funds and use the proceeds to buy securities backed by longer-term loans. While the firm doesn’t disclose how much it makes from the business, it has $24.2 billion of so-called liquidity puts, guarantees to repay investors if the conduits can’t, according to a June filing.

Because of similar commitments, Citigroup had to buy back mortgage-backed securities as markets broke down in 2007.

‘Contradictory’ Stance

The company also is among the biggest underwriters of shares in U.S. mortgage real estate investment trusts, or REITs, which invest in debt tied to residential and commercial-property loans. It helped the trusts sell $2 billion of shares this year through September, behind only Bank of America Corp. and JPMorgan, according to data compiled by Bloomberg.

“Citigroup has its fingers in a lot of these different markets,” said Gerding, the University of Colorado law professor. “Citi and other investment banks are really hubs of the shadow-banking network.”

Citigroup’s stance on shadow banking is “contradictory,” said Robert Eisenbeis, a former research director at the Federal Reserve Bank of Atlanta who’s now chief monetary economist at Cumberland Advisors Inc., based in Sarasota, Florida.

“If this is such a bad thing, why are they doing it?” Eisenbeis said.

Pandit’s Proposals

Pandit’s comments about shadow banking comport with those made by other bank executives and with proposals he made to increase transparency in risk management and in support of higher capital requirements and financial reforms such as the Dodd-Frank Act, according to Ed Skyler, a Citigroup spokesman.

“Vikram has a record of speaking out on the importance of protecting the safety and soundness of the entire financial system and ensuring a level playing field for all participants,” Skyler said in an e-mail. Pandit declined to comment for this article.

Citigroup yesterday reported a $468 million third-quarter profit, beating analysts’ estimates, as revenue from fixed- income trading surged 63 percent. The shares have gained about 40 percent this year in New York.

The bank has benefited from an increase in CLO sales as investors seek higher yields. About $30.8 billion of such securities backed by widely syndicated loans were issued in the U.S. this year through Sept. 30, the most since 2007, according to Bloomberg and Morgan Stanley data. Citigroup arranged $7.4 billion in 18 deals, more than any other lender, the data show. It accounted for $2.1 billion across five deals in the same period last year, out of a total of $7.7 billion.

‘Maintained Continuity’

Other banks disbanded or shrank CLO units during the financial crisis, according to Joshua Siegel, a former Citigroup executive who’s now a managing partner at New York-based StoneCastle Partners LLC. Citigroup’s CLO business, overseen in part by co-head John Clements, stayed intact and beats competitors as a result, Siegel said.

“His is the only group that maintained continuity and hence maintained customer relationships,” said Siegel, who estimated Citigroup’s gross revenue from arranging CLOs this year is about $75 million. “That’s the reason why he’s No. 1.”

Danielle Romero-Apsilos, a spokeswoman for Citigroup, declined to comment about CLO fees.

CLO Investments

Citigroup doesn’t just help arrange CLOs for clients. The bank invests in the products as well. The lender had a maximum $1.1 billion risk of loss from CLOs at the end of June, according to a quarterly filing. Because Citigroup doesn’t own controlling stakes in the CLOs, it isn’t required to report the investments on its balance sheet.

Trading in CLOs shows investor confidence in the instruments has strengthened in the past year. Yields on CLO slices rated AAA by Standard & Poor’s shrank to 160 basis points more than the London interbank offered rate in August from 265 basis points in October 2011, according to Morgan Stanley. A basis point is 0.01 percentage point.

Citigroup’s Strategic Credit Fund, a hedge fund run by Fred Hoffman, uses almost $200 million of Citigroup cash to invest in products including CLOs, people familiar with the matter said in June. Citigroup has said it plans to withdraw its cash from such internal funds before the so-called Volcker rule takes effect. The Dodd-Frank Act provision bars regulated banks from owning more than 3 percent of hedge and private-equity funds.

The firm also is seeking outside money for a new CLO hedge fund, people briefed on the plan said in July. The fund, which would not use the bank’s money, wouldn’t violate the rule named for former Fed Chairman Paul A. Volcker.

Mortgage REITs

Citigroup and other Wall Street firms also have fueled and profited from mortgage REITs, which invest in mortgage debt using funds raised through share sales and as much as 10 times that amount in borrowed money. Mortgage REITs are among the shadow-banking entities Pandit was singling out in his Singapore speech, Shannon Bell, a bank spokeswoman, said in an e-mail.

Bank of America, JPMorgan and Citigroup are the three biggest underwriters of stock in U.S. mortgage REITs this year through the end of September, as firms including Starwood Property Trust Inc. and Bethesda, Maryland-based American Capital Agency Corp. sold about $16.1 billion of shares to the public, according to Bloomberg data. Citigroup made about $49.9 million in fees underwriting the deals, the data show.

The lightly regulated REITs have more than doubled credit- market investments to $388.6 billion since 2009, according to Fed data, boosting their influence in the property market. Annaly Capital Management Inc., the biggest U.S. mortgage REIT, had assets of $128.3 billion on June 30, more than regional banks such as Regions Financial Corp. and Fifth Third Bancorp.

SEC Examination

Citigroup also provides short-term loans to mortgage REITs, known as repurchase agreements, or repos. CYS Investments Inc., a Waltham, Massachusetts-based REIT, had $7.9 billion in repo loans last year, including a $244.3 million debt to Citigroup, according to an annual filing. Deutsche Bank AG and Goldman Sachs were CYS’s biggest lenders, the filing shows.

“They’ve clearly grown a tremendous amount, and they couldn’t have grown without that capital-raising,” said Jason Stewart, a REIT analyst with Compass Point Research & Trading LLC in Washington. “They pay Wall Street a fee in order to borrow money and lever their assets.”

The resurgence of REITs has aroused the interest of regulators such the Securities and Exchange Commission, which said it’s examining whether REITs should be allowed to continue borrowing without restrictions. The SEC also is concerned that REITs could escape scrutiny of how they value their assets and that “insiders” could commingle the investment company’s assets with their own and misappropriate them, according to a document released by the agency last year.

Money Funds

REITs rely on borrowed money and funds from Wall Street- managed share sales to invest in mortgage debt, Stewart said. That gives banks including Citigroup more power than regulators to check the growth of the industry, he said.

“It’s interesting to hear Vikram talk about shadow banking and put mortgage REITs in there,” Stewart said. “He’s almost like the regulator.”

The SEC isn’t the only agency looking at shadow banking. The Financial Stability Board will issue recommendations by the end of this year, according to an April report. Among its biggest targets are money-market funds, which provide short-term loans to companies and financial firms.

Reserve Primary

The $4.7 trillion industry has drawn scrutiny since the September 2008 collapse of the $62.5 billion Reserve Primary Fund, which held debt issued by Lehman Brothers Holdings Inc. Closing the fund triggered an industrywide run that helped freeze global credit markets and abated only after the U.S. Treasury Department backstopped shareholders against losses.

SEC Chairman Mary Schapiro has since sought to tighten rules in the U.S., including forcing the funds to hold capital buffers. She dropped the plan in August after a majority of commissioners refused to back it. The Financial Stability Oversight Council, led by Treasury Secretary Timothy F. Geithner, has pressured the SEC to reconsider.

Wall Street firms including JPMorgan, Goldman Sachs and Morgan Stanley, all based in New York, are among the biggest managers of money-market funds, along with non-bank companies such as BlackRock Inc., Fidelity Investments and Federated Investors Inc., according to research firm Crane Data LLC.

While Citigroup isn’t one of the top 20 managers of money- market funds, it caters to the industry through asset-backed commercial paper, or ABCP, conduits. The bank runs a group of these entities, which get short-term loans from money-market funds and use the cash to buy debt and other assets from Citigroup clients. The lender picks up a fee as the administrator of the conduits.

Transaction Web

“Being the financial intermediary or middleman to a web of transactions is a nice way to make a living,” said Gerding, the University of Colorado law professor.

Too few people recognize how important a level playing field is for the safety of the financial system, Pandit said in Singapore. Similar rules should apply to all firms, or “all our great work could be for naught -- like a house with the finest lock on the front door, but a window open in back,” he said.

That plea is a call for regulators to do a better job addressing the risks of complex financial products in which investment banks play key roles, Gerding said.

“It’s nice to know he agrees with me,” he said.