A top adviser to presidential candidate Mitt Romney on Tuesday dismissed an idea to cap the size of big banks floated last week by a senior U.S. Federal Reserve official.

Glenn Hubbard, an economic advisor in the Republican camp, said market forces would keep the size of financial institutions in check better than difficult and arbitrary government limits on banks judged too-big-to-fail.

Last week, Fed Governor Daniel Tarullo surprised Wall Street when he called on Congress to legislate "an upper bound point of reference" for banks based on their percentage of U.S. Gross Domestic Product.

The issue of too-big-to-fail banks could resurface later on Tuesday when Romney faces off against President Barack Obama in the second of three debates ahead of the November 6 poll. The stumbling economic recovery since the financial crisis has so far dominated in the campaign.

The comments from Tarullo, appointed to the Fed board by Obama, suggest regulators are still keenly worried that massive and complex banks can threaten the financial system, four years after the worst of the crisis.

Hubbard, dean of the Columbia Business School, on Tuesday added to the criticism that has since come from Wall Street.

"I understand Dan Tarullo gave those remarks. I disagree with them. First of all I'm not quite sure what a cap would be and how I would figure it out," Hubbard said in response to a question at a National Association for Business Economics conference.

"The reason we're concerned about big banks is that they're too big to fail," he added. "If the market forces say these banks are too big and too complex, they will be wittled down to size. And I think that's a much better (solution) than arbitrary limits on bank sizes."

Hubbard made the argument as news headlines surfaced that the chief executive of the third-largest U.S. bank, Citigroup Inc's Vikram Pandit, had abruptly resigned.

Citi was among the banks to receive a bailout during the 2008 crisis. It has since been under close watch by regulators. The Fed rejected Citi's capital plans this year after administering a stress test on the bank.

TOO-BIG-TO-FAIL COULD RESURFACE IN DEBATE

Tarullo, the central bank's point person on regulation, made his surprise proposal last Wednesday as he noted the difficulties regulators face in deciding which proposed bank acquisitions should be approved.

The absence of a well-established cap on the size of banks complicates such decisions, he said at the University of Pennsylvania Law School, in Philadelphia.

An ever larger bank "increases perceptions of at least some residual too-big-to-fail quality in such a firm," bringing a possible funding advantage that "reinforces the impulse to grow," said Tarullo, a one-time aide to former President Bill Clinton. He floated tying the non-deposit liabilities of banks to a specified percentage of the country's GDP, though he did not suggest a number.

"There is, then, a case to be made for specifying an upper bound," Tarullo said, adding, "it would be most appropriate for Congress to legislate on the subject."

During the previous presidential debate, Romney reiterated his plan to repeal the landmark Dodd-Frank financial regulation bill, while Obama countered that the economic crisis was brought on by insufficient oversight of reckless behavior on Wall Street and elsewhere.

Asked about Romney's debate strategy, Hubbard told Reuters on the sidelines of the conference: "His objective is to continue the conversation with voters about what the right economic policies are for the country.

"He did that really well last time, and I'd be stunned if he doesn't do it well tonight," the adviser added.