Empirical evidence on economies of scale in banking, such as in Berger and Mester (1997), suggests that many banks grow beyond the size that minimizes average costs. One reason for this may be that size benefits managers who see their compensation increase with bank size, possibly at the expense of shareholders. Alternatively, banks increase their size beyond the economically efficient point in order to become 'too big to fail,' which reduces their costs of funding.  A bailout of a systemically large bank, i.e. a bank that is large relative to the economy, would put considerable strain on a country's public finances. This raises doubts about a country's ability and determination to bail out its systemically large banks. Systemic size thus reduces a bank's contingent claim on the financial safety net. Our estimation suggests that the average systemically large bank's share price is discounted 22.3 percent on account of its systemic size, based on estimation for a large international sample of banks over the 1991-2008 period. 

Especially at a time of financial and economic crisis, there are doubts about countries' ability to keep their largest banks afloat. For 2008, we present evidence that the share prices of systemically large banks were discounted relatively more on account of systemic size in countries running large fiscal deficits. This is evidence that systemic banks located in countries with stressed public finances saw their contingent claim on the financial safety net reduced relatively more in 2008, which is evidence that they have grown 'too big to save'. 

The problem of 'too big to save' facing systemically large banks in fiscally strapped countries is likely to change the structure of the international banking system in the years to come. Banks in all banking systems will face pressure to deleverage in order to reduce risks for themselves and for the financial safety net. However, especially systemically large banks in fiscally constrained countries have incentives to downsize in order to be able to rely on the financial safety net in the future. Our evidence suggests that this should increase bank valuation. Indeed, in 2008 we see that very large banks are deleveraging also relative to their economy's size. The downsizing that occurred in 2008 may thus in part be driven by a desire to increase stock market valuation in the face of 'too big to save' effect, even if downsizing no doubt has also been forced by reduced capital on account of losses and difficulties to raise equity as well as other capital at a time of financial crisis.  

There is an obvious policy interest in reducing bank size at least below the point where banks' national contingent liabilities are so large that there are doubts about countries' abilities to stabilize their banking system. In Europe, in 2009 downsizing of some of the largest banks that have received public assistance during the financial crisis, such as Lloyds and Royal Bank of Scotland in the UK, Commerzbank in Germany and ING in the Netherlands, has been imposed by the European Commission that has ruled that public assistance has disturbed bank competition. Thus, although the Commission's motivation has been to prevent a future occurrence of public assistance that would bring unfair competitive advantages to the recipients, the effect will be to reduce the size of some of Europe's largest banks.  

In the US the Obama administration has suggested regulation which would limit any bank's share of national bank liabilities to 10 percent, and in addition it has proposed taxing nondeposit bank liabilities at a rate of 0.15 cent per dollar per year for banks with assets in excess of $50 billion. In 2008, Switzerland already adopted a regime of higher capital requirements for its largest banks, i.e. UBS and Credit Suisse, which provides an incentive to these banks to downsize. Policy steps to downsize very large banks that have not received assistance during the financial crisis have so far not been undertaken in the EU, even though politicians in countries such as the UK and the Netherlands have at times voiced their desire to reduce their countries' contingent liabilities on account of large banks and large banking systems. Recently, Germany and the UK have shown themselves supportive of opening discussion in the G20 on international coordination on additional taxation on banks that could easily be slanted towards large-size banks, limiting the 'too big to fail' and 'too big to save' phenomena. In April 2010, the IMF completed a report advocating additional taxation of banks which will be a reference point in this debate. 

Even in the absence of additional regulation and taxation, the percentage of banks that is systemically large already declined in 2008 relative to the two previous years. Our paper shows that this trend may reflect private incentives to downsize in the face of a too-big-to-save effect in fiscally constrained countries. Additional regulation or taxation aimed at very large banks could serve to strengthen this trend.