Charles Dallara Markets unprepared for Grexit blood bath

Investors are too sanguine about the potential for a Greek exit from the euro zone, which could turn into a blood bath, Partners Group Vice Chairman Charles Dallara said Friday.

Dallara led earlier negotiations between Greece and its creditors as the managing director of the Institute for International Finance, a post he held from 1993 to 2013.

"I am somewhat concerned that investors are looking at this and thinking the Germans, the IMF, the Greeks, they're all rational players at the end of the day, and we can all hope that they will be," he told CNBC's "Squawk on the Street." "But right now it looks to me as if the markets are not prepared for a default and this could be a bloody bath if it happens."

Such an event would not be an isolated incident, would effect the credibility of the euro zone and would put particular pressure on a few countries in Europe's southern periphery, Dallara said.

"Let's face it. There are other economies in southern Europe, which while they are on the mend, still have massively high levels of unemployment," he said. "They still have political systems which are struggling to really gain credibility."

The word "nonsense" is "not a bad word to use right now" to describe the notion that the euro would rally if a Grexit occurs, he said. That belief is based on the premise that investors would come around to the idea that the euro zone is better off without Greece.

"Frankly, I look at Europe today and I see there are a lot of attractive companies now, but there's just so much uncertainty surrounding the integrity of the euro, you cannot simply think that Greece will leave the euro and everything else remains in tact," he said.

Euro zone leaders will hold an emergency summit on Monday after the region's finance ministers failed to agree a reform-and-aid deal with Greece, making it more likely the near-bankrupt country will default on its debt at the end of the month.

The reforms would allow Greece to receive a last tranche of bailout aid worth 7.2 billion euros, but sticking points remain over pension cuts. Without the money, Greece has said it could not make a 1.54 billion euro ($1.74 billion) debt repayment to one of its senior creditors, the International Monetary Fund, on June 30.

A Greek default is seen as paving the way for the country's exit from the euro zone. Dallara said it is important to differentiate between default and a definitive exit, noting that while Greece could default, it will not necessarily leave the euro zone immediately.

"The dilemma there is how to mange the Greek banking system, because the Greek banking system is on a lifeline right now from the ECB," he said.

The ECB has raised the funding cap on its emergency liquidity assistance for Greece's banks by 3.3 billion euros ($3.7 billion), according to a CNBC source.

The decision, made in a conference call Friday and first reported by Reuters, followed a meeting of the euro zone's finance ministers on Thursday, where the ability of the country's lenders to open up for business next week was questioned.

In order for progress to be made and Greece to avoid a full-blown banking crisis, there first needs to be political consensus at Monday's meeting that guides a more technical agreement that would take place over the next week, Dallara said.

"I do think this summit is crucial. The euro zone heads of state need to come together and they need to determine that they won't leave the room until they have some understanding," he said.