By Steven K. Beckner

CHICAGO (MNI) – Federal Reserve Chairman Ben Bernanke expressed
ongoing concern about “tight” credit market conditions Thursday morning
and said that restoring normal credit flows remains a “central
objective” of the Fed.

Bernanke said there are “reasons for optimism” about financial
conditions, among them a “strengthening” economy. But he put greater
emphasis on continued impediments to lending, particularly by regional
and community banks to small business.

The Fed chief, addressing the Federal Reserve Bank of Chicago’s
46th Annual Conference on Bank Structure and Competition, said the Fed
is doing its best to ensure that bank examiners do not “inadvertently
impede” bank lending and to encourage banks to make “sound” loans to
“creditworthy borrowers.

Bernanke, in remarks prepared for delivery to the conference, said
the Fed is applying the lessons learned from last Spring’s “Supervisory
Capital Assessment Program’ (SCAP) — the so-called “stress tests” which
the 19 largest banks were required to take in which led to them raising
$75 billion in capital.

He called that exercise a one-time event, but said the Fed is
examining “options” for future disclosure of banks’ own stress tests.

Most of Bernanke’s text was devoted to the SCAP’s impact on the
banking system, but he digressed to consider the financial and economic
conditions in which banks must operate.

Like the Fed’s recently released April senior loan officers survey,
he suggested there is a dichotomy between large and small banks, large
and small borrowers.

“Although the banking organizations that participated in the SCAP
have significantly improved their financial positions, they continue to
face challenges,” he said. “By the same token, regional and community
banks, which also play a vital role in our financial system and economy,
are dealing with challenges of their own.”

Bernanke said “the number of regional and community institutions
considered weak is still increasing, and their loan losses likely will
remain elevated this year.”

“The most significant areas of concern are residential mortgages
and commercial real estate loans,” he said. “Also, with credit demand
tepid and the economy still under stress, profitable lending
opportunities have been relatively scarce for many of these banks….”

Bernanke anticipated that regional and community banks’
“prospective losses are such that many of these organizations may need
additional capital over the next few years.”

But “unfortunately, smaller banks generally have fewer alternatives
than large banks for raising fresh capital and thus tend to rely on
retained earnings for capital growth,” he said. Therefore, he said the
Fed “will continue to work closely with smaller banks as they rebuild
their financial strength.”

Bernanke said the Fed continue to receive “numerous proposals from
private equity investors to take stakes in regional and community
banks,” and he said that “over the past two years we have approved many
of these proposals…”

Bernanke said a key objective of the stress tests and other efforts
has been to “restore confidence in the stability of our banking system”
but also to “hasten the return to a better lending environment.”

But he said, “Clearly that objective has not yet been realized, as
bank lending continues to contract and terms and conditions remain
tight.”

“Consequently, restoring the flow of credit through the banking
system remains a central objective of the Federal Reserve,” he said.

“To achieve this outcome, we have been taking measures to ensure
that our supervisory actions do not inadvertently impede sound lending,”
he continued. “Businesses need access to credit to maintain or expand
their payrolls and make productive investments. And banks need to make
sound loans to preserve their earnings stream, absorb credit losses, and
support capital growth, as necessary….”

Bernanke said the Fed has joined with the other federal banking
agencies to issue a series of policy statements to examiners: on the
importance of bank lending to creditworthy borrowers, on small business
lending, and on commercial real estate loan restructuring. And he said
the Fed and other agencies have supplemented this formal guidance with
“for examiners and outreach to the banking industry.”

“Our message is a simple one,” he said. “Institutions should strive
to meet the needs of creditworthy borrowers, and the supervisory
agencies should do all they can to help, not hinder, those efforts. We
also are supporting sensible efforts to work with troubled borrowers to
bring them back into good standing….”

Bernanke said the Fed has been gathering information “to help us
evaluate whether banks are achieving the right balance between sound
lending and necessary prudence,” e.g. information on banks’ workout
practices and loan restructurings.

Citing a National Federation of Independent Business (NFIB) survey
of small business owners on their access to credit, which the Fed helped
developed, Bernanke said “the survey results confirm that financing
conditions are difficult for small businesses and that declining real
estate values are contributing to the difficulties.”

But Bernanke was hopeful.

“Although bank credit remains tight, I see some reasons for
optimism,” he said. “Economic activity has continued to strengthen. And
senior loan officers tell us that, at least outside of commercial real
estate, they anticipate a modest reduction in their troubled loans over
the coming year.”

“As a result, bank attitudes toward lending may be shifting,” he
went on. “In the Senior Loan Officer Opinion Survey conducted in April,
most banks reported unchanged lending standards over the previous three
months. For the first time since the crisis began in the summer of 2007,
banks reported no net tightening of lending standards for small
businesses.”

Bernanke said the SCAP stress test program “met its objectives of
reducing uncertainty about losses and ensuring sufficient capital in the
largest banking firms,” and he said “the public disclosure was an
important reason for its success.”

And he said the Fed and other regulators learned lessons from the
tests. They “showed how much can be learned by explicit comparisons of
the practices and risks of different firms, rather than focusing on only
one firm at a time, as was often the practice in the past.”

“Thus, the Federal Reserve is increasing its use of cross-firm,
horizontal examinations,” he said. “Moreover, we will be looking at all
activities within a consolidated organization that can create risk to
the firm and the financial system, not just those that increase risk for
insured depository institutions within the larger firm….”

Bernanke said “we are incorporating elements of the assessment into
our ongoing supervision of capital adequacy. We are developing and
refining the tools necessary to better gauge appropriate capital buffers
for our largest firms.”

“As a follow-on effort to last year’s stress assessment, we are now
conducting a horizontal examination to evaluate whether these banks can
effectively estimate their capital needs and identify resources to meet
those needs,” he added.

Because “one reason for the success of the stress tests was the
public disclosure of the results,” Bernanke said, “We are evaluating the
lessons of the experience for our disclosure policies.”

“The traditional supervisory view has been that confidentiality
enhances the willingness of institutions to cooperate with supervisors
and reduces the risk that a limited set of adverse findings might be
over-interpreted by market participants,” he said. “Nevertheless, in
proper context, more information about the status of both individual
banks and of the banking system as a whole should be
confidence-enhancing. We will continue to examine options for increasing
the information that supervisors make public.”

** Market News International Chicago Bureau: 708-784-1849 **

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