Arthur, now coach of Pakistan, also said that behaviour had sunk to "abysmal" levels in world cricket and needed rapid improvement, after a series of flare-ups in recent months.
Smith and Warner, Australia's captain and vice-captain, were banned for 12 months for a ball-tampering incident in South Africa also involving Cameron Bancroft, who was suspended for nine months.
It has been a dramatic fall for Smith, 28, who was being compared with the legendary Donald Bradman just a few months ago but who broke down in tears during an apology on Thursday.
"I feel desperately sorry for Smith. I know he eats, sleeps and drinks cricket," said Arthur.
"He loves cricket and everything he did. He loved the job, he was passionate about the job. I think he was a very good leader and an unbelievable cricketer."
However, Arthur wondered whether there would be a way back for Warner, who has been blamed for hatching the plot and has cut an isolated figure as the scandal unfolded.
The 31-year-old batsman, who has issued a statement admitting responsibility for the incident, is due to face media for the first time on Saturday.
"I definitely see the return of Smith, without a doubt. He will be there, he will serve his time, he will train hard and he will come back stronger," Arthur said.
"Davey Warner, I am not a hundred percent sure."
'Above everybody else'
Arthur, who was sacked as Australian coach in June 2013 after just 19 months in charge, said he had been concerned about the team's behaviour for some time.
The South African tried to address Australia's culture when he banned four players for failing to complete a "homework" assignment, but then fell out with Cricket Australia.
"I have been disappointed at the behaviour of the Australian team over a last couple of years, to be honest," Arthur said.
"I think that they felt they are almost above everybody else so that's been disappointing because they are a good enough cricket team, they are skilled enough cricketers to win games without resorting to the kind of tactics they have."
He added: "I am disappointed for the knock that Australian cricket is taking at the moment and world cricket in general, so it's a disappointing and sad time for world cricket."
But Arthur also said the "reality check", which comes after a number of untoward incidents on the South Africa tour, could do Australia some good.
"They need to play hard but they need to play fair. The verbal sledging and we have seen scuffles in tunnels and faux pas on the field and now the ball-tampering, and I think that has just gone a little bit too far," he said.
"I think this is a reality check for them and hopefully it does Australian cricket some good and they rebound back from it, because the cricket world needs Australia fit and firing because they are a hell of a good team when they are."
Broken window, scuffles
The International Cricket Council has announced a review into player behaviour and the spirit of the game, with chief executive David Richardson warning "cricket is itself in danger".
During Australia's tour of South Africa, Warner had to be restrained during an angry confrontation with Quinton de Kock, and South African bowler Kagiso Rabada was charged for brushing shoulders with Smith.
Australia's Nathan Lyon was also fined for dropping the ball next to a sprawling AB de Villiers. There were also a number of flashpoints during last month's tri-series between Sri Lanka, Bangladesh and India.
"I think over the last few months the behaviour has been abysmal in international cricket," Arthur said.
"We have seen Bangladesh captain (Shakib Al Hasan) calling players off the field, we have seen Bangladesh breaking a window in the dressing room, we have seen dances on the ground," said Arthur, referring to the tri-series.
"We have seen tunnel scuffles (between Warner and de Kock), we have seen Rabada... we have seen a ball dropped on AB de Villiers's head, so I think behaviours certainly need to be addressed."
First Published: March 30, 2018, 3:27 PM IST