* Bair says low interest rates appropriate as credit tight
* Says regulators should not order banks to make loans
* Sees need to revisit economic policies that promote risk
ARLINGTON, Va., March 8 (Reuters) - U.S. banking regulator Sheila Bair said on Monday that a low interest rate policy is “clearly appropriate” to get credit flowing, while also saying regulators should stop short of ordering banks to lend.
Bair, chairman of the Federal Deposit Insurance Corp, has expressed frustration that creditworthy borrowers, including small businesses, cannot get loans.
“A policy of low interest rates is clearly appropriate given the struggling economy,” Bair said in remarks to the National Association for Business Economics. “Clearly there was too much credit leading into this crisis ... but I am concerned with it moving too far the other way.”
The Federal Reserve has vowed to keep borrowing costs ultra low for an “extended period.” Most big banks that do business with the U.S. central bank believe it will raise the benchmark rate this year from the current zero, a Reuters poll showed.
Despite the low interest rates, banks have said there is weak demand for loans, as consumers and businesses have pulled back their spending.
Total loans in the banking industry fell by 7.5 percent during 2009, the largest full-year decline since 1942.
Bair said there are plenty of instances of banks being too tight with credit, particularly large banks.
She said a public spotlight needs to be shined on banks for having pulled back too far on credit. “The smaller banks seem to be doing a better job than the larger institutions in making loans or maintaining loan balances,” Bair said.
Increasing small business lending, as a way to jump-start economic growth, is a key policy initiative of the Obama administration.
U.S. bank regulators have repeatedly issued advisory notes to banks, urging them to extend prudent loans, but Bair said they should not mandate the activity.
“If you cross a line and get into a situation where regulators are starting to order banks to lend, the history on that isn’t good,” she said.
The FDIC’s most recent banking profile showed that loan balances industrywide declined another 1.7 percent during the fourth quarter, the sixth consecutive quarter of contraction.
Bair reiterated her priorities for financial reform, but said a regulatory overhaul will not be enough to rein in excesses.
She said the United States must examine policies that have skewed economic activities toward consumption and rapid growth in housing and the financial sector.
“Examples of these policies include federal tax and credit subsidies for housing, a tax code that can unduly favor short-term profit, and implied government backstops for financial firms that have now, in many cases, been made explicit,” Bair said.
The government took the two massive companies into conservatorship in 2008 but has not yet laid out a plan to reform them.
Bair said the excesses of the past decade were a costly diversion of resources from the U.S. industrial base and public infrastructure.
She said creating a resolution mechanism to unwind troubled financial giants, regulating the shadow banking sector and enhancing consumer protection will only do so much.
“Rules and regulations can help constrain our ‘animal spirits,’ but unless economic incentives are also appropriately aligned, regulation alone will fail,” Bair said. (Reporting by Karey Wutkowski; Editing by Maureen Bavdek and Tim Dobbyn)
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