Does a Size Limit Resolve Too Big to Fail Problems?

Does limiting the size of a large bank reduce its insolvency risk? This paper shows that the answer to this question depends on how exactly paring down of the bank size is done. In fact, the insolvency risk may go down or up depending on the composition of assets and liabilities of the bank relative to its pre-paring down composition. In addition, this study investigates mean-standard deviation efficiency of a typical Canadian large bank and its various possible paring down scenarios and finds both the original bank and its pared-down versions are inefficient. It then suggests mean-standard deviation efficient compositions of assets and liabilities, which do not depend on limiting the size of the bank. Therefore, the findings of this paper raise a serious doubt about the validity of the “limit on size” solution to the too-big-to-fail problem