UPDATE 1-Fed's Bullard-Banks should be smaller to manage failure

(Adds background) By Alister Bull

ST. LOUIS, Oct 11 (Reuters) - Big U.S. banks should become smaller to make any failure more manageable, a senior Federal Reserve official said on Thursday, supporting a suggestion that the size of banks be limited to a specific percentage of U.S. gross domestic product.

"I'm very much of a view that 'too-big-to-fail' remains alive and well and the only way to really make progress on this issue is to get firms down to a smaller size where you'd feel comfortable letting them fail if the situation arose," St. Louis Federal Reserve President James Bullard told reporters.

Bullard was referring to a situation where a bank gets so big that it is too costly to let it fail if it gets into trouble. This is a competitive advantage a big bank can exploit through access to cheaper capital, which allows it to grow even larger.

Some fed officials advocate simply breaking apart the biggest banks and Bullard has aligned himself with that camp.

"I do not think that we need firms that are so large and complicated in order to have a healthy intermediation sector in the U.S.," he said. "We would be better served by a setup that had smaller firms in a competitive landscape across the sector."

Fed Board Governor Daniel Tarullo suggested in a speech on Wednesday that Congress might want to think about new laws to cap the size of banks relative to the size of the U.S. economy. He argued this would tie their growth to the county's own growth and consequent ability to absorb the shock if they got into trouble. Bullard said that the suggestion had merit.

"Scaling by GDP (gross domestic product)... in general terms, would make sense," he said. "Of course, the devil is in the details of exactly how you would do that. But over time, as the economy continues to grow, you would have to think about what constitutes big and what constitutes small."

Big U.S. banks have been sharply critical of parts of the Dodd-Frank financial reform legislation that contains limits on financial sector concentration as too complex. Bullard said he would prefer "multi-dimensional" measures of what too big meant and then ask firms to stay beneath those thresholds.

(Reporting by Alister Bull. Editing by Andre Grenon)

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