Nov. 8 (Bloomberg) -- Senate Democrats are demanding that the U.S. Treasury force banks participating in the government's $700 billion financial rescue plan to show they are using the funds to increase lending.

Senators Charles Schumer of New York and Robert Menendez of New Jersey wrote a letter yesterday urging Treasury Secretary Henry Paulson to issue rules requiring banks accepting public funding to lend to companies and consumers rather than using the money to finance takeovers.

``Loans must not be used to acquire healthy banks, hoard in their coffers, or pay shareholder dividends,'' the two Senate Banking Committee members wrote to Paulson. ``We are also troubled by the fact that the Treasury Department appears to be taking a `hands off' approach to this issue, preferring instead to leave decisions solely up to the discretion of senior bank executives.''

The letter, the second the two Democrats have sent to Paulson in the last two weeks, came as the head of the Treasury's program rebuffed any suggestions to ``micromanage'' financial firms' lending decisions.

``We want this capital to be put to work, to stabilize the system, to increase lending for our businesses and our communities,'' Neel Kashkari, the interim assistant secretary who heads the program, said yesterday in New York. At the same time, he said, it's ``not appropriate'' to set targets for bank loans.

Obama Reviewing Plan

Kashkari acknowledged that the incoming administration of President-elect Barack Obama might ``go in a different direction'' than Paulson. Obama yesterday said he would review the plan.

Speaking at his first press conference since winning the presidential election, Obama said in Chicago that the program must stabilize financial markets, protect taxpayers and help homeowners ``while not unduly rewarding the management of financial firms that are receiving government assistance.''

Lawmakers are faulting Paulson for letting financial institutions finance acquisitions using some of the $250 billion the banks are receiving in capital infusions from the government. PNC Financial Services Group Inc. last month agreed to buy Cleveland-based National City Corp. after getting $7.7 billion from the government.

Clash to Continue

``Treasury needs to put together guidelines both on how the capital is allocated and how it's used,'' said Joseph Mason, a professor at Louisiana State University in Baton Rouge who previously worked at the Treasury's Office of the Comptroller of the Currency. ``I expect this clash with Congress to continue.''

Schumer's and Menendez's letter echoes earlier comments from House Financial Services Committee Chairman Barney Frank, who said he may move to block further bailout funding if institutions that have already received cash don't prove they are boosting lending. Lawmakers have the option of blocking the second half of the bailout funding because the legislation requires President George W. Bush to request the money from Congress.

``There had better be a showing of increased lending roughly in the amount of the capital infusions,'' Frank said in a Nov. 6 interview in his office in Newton, Massachusetts.

Year-end bonus payments at nine banks that received $125 billion from are being investigated by House Oversight and Government Reform Committee Chairman Henry Waxman and New York Attorney General Andrew Cuomo, who are demanding details on compensation plans.

Goldman Sachs Group Inc., Morgan Stanley and Merrill Lynch & Co. have set aside $20 billion to pay bonuses this year.

The Treasury should ``issue guidelines or best practices'' to ensure Americans ``know that their money is being used to provide maximum benefit for our economy as a whole and not to create banking empires or reward players on Wall Street,'' Schumer and Menendez wrote.

To contact the reporters on this story: John Brinsley in Washington at jbrinsley@bloomberg.net

Last Updated: November 8, 2008 00:01 EST