Fed's Kohn says banks pulling back from credit

"One consequence of the distress in financial markets is that banks are being pushed to take a greater role in financial intermediation," Kohn said in remarks prepared for delivery to a housing forum organized by the Office of Thrift Supervision.

While bank lending surged in the fall, it appears to have dropped back in recent weeks, Kohn said, "consistent with the significant tightening of terms and standards reported by bank loan officers in recent quarters as well as the weakening of economic activity."

Banks are managing losses and worried about meeting funding needs, Kohn said. While banks are taking in more deposits, deposits alone cannot make up for reduced funding from other sources, he said.

"The challenge for regulators and other authorities is to create an environment that supports greater bank intermediation, which should help to restore the health of the financial system and the economy," Kohn said.

"We want banks to be willing to deploy capital and liquidity, but they must do so in a responsible way that avoids past mistakes and does not create new ones," he said.

(Reporting by Mark Felsenthal; Editing by James Dalgleish)