Big banks that get into trouble should be allowed to fail, according to Citibank, the largest in the country.

"Regulators are apparently convinced that allowing a big bank to fail would shatter the perception that all big banks are safe and would destabilize the system," said Thomas F. Huertas, a vice president of Citibank, which has deposits of $97 billion.

Yet the certainty that a bank will be rescued if it gets into trouble undermines market discipline and increases the prospect for more crises, Huertas told a House Banking subcommittee considering federal deposit insurance reform.

Insurance, he said, should be for the sole purpose of protecting the deposits of the average American, not banking institutions.

Huertas supported the concept of modified payouts -- whereby depositors with uninsured funds over $100,000 in a failed bank get paid some fraction of their claim, depending on how much the government recovers.

However, committee Chairman Fernand St Germain (D-R.I.) questioned whether overseas depositors would put money into large banks knowing the U.S. government would not come to the rescue if the banks failed.

Huertas said that it would be "worse than doing nothing" to require banks to pay insurance premiums -- or adjusting their capital -- based on the risk of their operations, increasing the insurance fund, or assessing deposits at foreign branches.

Citibank, which has deposits in 91 countries, objects to counting these deposits for the purpose of calculating insurance premiums because of the increased costs involved.

Small banks, on the other hand, feel it would be fairer for Citibank and other large rivals to pay premiums on all their deposits, foreign as well as domestic.

Another witness, George Benston, accounting professor at the University of Rochester, presented a study contending that direct investment in real estate and other enterprises was not the culprit in the 202 failures of federally insured savings and loan associations between 1981 and 1985. The principal cause was high interest rates, the study argued.