June 5 (Bloomberg) -- Federal Reserve officials expect some U.S. banks to report ``weak earnings'' and write down more assets while operating with insufficient reserves to cover bad loans, Vice Chairman Donald Kohn said.

The economic slump may increase problem loans for consumers, credit-card holders and corporations, Kohn testified today to the Senate Banking Committee. Banks ``must be prepared for the possibility'' that they may find it harder to borrow if financial-market turmoil continues or credit availability declines further, he said.

``We expect bank holding companies to continue to report weak earnings and further asset valuation writedowns,'' Kohn said during a hearing on the banking industry. Banks aren't increasing reserves enough to keep pace with losses, he said.

Fed Chairman Ben S. Bernanke and other policy makers are urging banks to raise capital and reduce debt. The central bank has cut the benchmark interest rate this year at the fastest pace in two decades, aiming to revive financial markets and an economy buffeted by the 10-month credit contraction.

The collapse of the subprime mortgage market has led the world's biggest banks and brokerages to report more than $386 billion in losses and writedowns. Financial-services firms have raised $283 billion to cover the losses, according to data compiled by Bloomberg.

`Worrisome Data'

``The banking industry continues to grapple with the fallout of the credit and mortgage-market turmoil and the effects of a weak economy,'' Senator Christopher Dodd, the committee chairman, said at today's hearing.

Dodd, a Connecticut Democrat, cited the Federal Deposit Insurance Corp.'s May 29 report on first-quarter bank earnings, which fell 46 percent from a year earlier to $19.3 billion.

Senator Richard Shelby of Alabama, the banking panel's top Republican, expressed concern about the growth in bank failures and banks' holdings in commercial real-estate and construction loans.

``With the list of troubled financial institutions growing, there is little doubt that bank failures will rise,'' Shelby said. ``The question for our witnesses is, how do they intend to mitigate the fallout?''

FDIC Chairman Sheila Bair said the economic slowdown brought on by the disruptions in credit availability ``is expected to exert continuing downward pressure on industry earnings over the coming quarters.''

Construction and Development

The construction-and-development segment of commercial real estate lending ``stands out as the most important short-term, credit-quality issue,'' Bair said.

Losses for homebuilders and developers are ``bound to increase further'' and the housing market has yet to bottom out, Kohn said during the question-and-answer period.

``Additional capital injections and the consideration of dividend cuts are still warranted for some of these companies,'' Kohn said. ``Stronger capital positions also will allow banking institutions to participate in and support the rebound in lending that will accompany the strengthening of the U.S. economy.''

The Fed took unprecedented steps in March to prevent a financial-market meltdown by rescuing Bear Stearns Cos. from bankruptcy and opening up lending to Wall Street dealers.

The central bank agreed to lend $29 billion against Bear Stearns assets to ease JPMorgan Chase & Co.'s purchase of the investment bank. Kohn said he wasn't aware how much of the Bear Stearns collateral is backed by bond-insurance companies.

Investment Banks `Stronger'

Responding to questions from senators, Kohn said investment banks are in ``stronger'' shape than 1 1/2 months ago. Kohn meant to say 2 1/2 months, dating from the Bear Stearns rescue in mid- March, Fed spokeswoman Deborah Lagomarsino said after the hearing.

Investment banks ``are building their liquidity, they are reducing their leverage,'' Kohn said. ``They are protecting themselves against downside risk.''

Regulations requiring banks to raise capital from other banks or financial institutions aren't too restrictive, Kohn said. There's ``ample capital'' available and easing those limits would be a ``huge change,'' he said, replying to a question from Shelby.

To contact the reporters on this story: Scott Lanman in Washington at slanman@bloomberg.net; Alison Vekshin in Washington at avekshin@bloomberg.net.

Last Updated: June 5, 2008 13:05 EDT