Over the coming months, "we expect banking institutions to continue to face deteriorating loan quality," Federal Reserve Vice Chairman Donald L. Kohn warned the Senate's Committee on Banking, Housing and Urban Affairs today, in a talk on the condition of the U.S. banking system.

"House prices are still declining sharply in many localities and losses related to residential real estate – including loans to builders and developers – are bound to increase further," Kohn said.

"In addition, weak economic conditions could well extend problems to other segments of lending portfolios including consumer installment or credit card loans," he said.

He emphasized that financial institutions must be prepared "for the possibility that liquidity conditions become tighter if uncertainties in the capital markets fail to subside or if credit conditions deteriorate significantly."

Due to these circumstances, the Federal Reserve anticipates that the number of banks with "less than satisfactory supervisory ratings will continue to increase from the relatively low levels that have existed in recent years."

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