Bank trade-group representatives insisted in congressional testimony today that financial institutions haven’t tightened their lending to business clients. Rather, those customers have decreased their demand for financing, they said.

Banks have increased their commercial lending by 15 percent this year, Edward Yingling, president and CEO of the American Bankers Association, told the House Committee on Financial Services. His testimony came after lawmakers grilled Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke this morning on the changing direction of the government’s $700-billion bailout plan and its promise of freeing up capital for businesses and consumers. Moreover, Yingling said, citing National Federation of Independent Businesses data, only 6 percent of small businesses say they have had trouble borrowing money.

Steve Bartlett, Yingling’s counterpart at the Financial Services Roundtable, similarly claimed that lenders are extending credit, and, in fact, have upped their level of financing this year. “As credit markets continue to unfreeze,” he said, “our members will continue to lend to qualified buyers.”

Still, Bernanke said that “overall, credit conditions are still far from normal, with risk spreads remaining very elevated and banks reporting that they continued to tighten lending standards through October.” Companies with low ratings have not been issuing bonds, he added.

Last week, Bernanke, Paulson, and the Federal Deposit Insurance Corp. urged banks to lend to “creditworthy borrowers” in an unusual joint statement. The letter did not mention any repercussions for financial institutions that didn’t make do on that request; however, Barney Frank, chairman of the House Financial Services committee, asked the regulators to enforce it. The letter “would be even better if someone gets whacked for not following it,” he said. “There’s got to be some teeth.”

Since Paulson publicly announced last week that he was scrapping his original plan to use much of the bailout funding to purchase banks’ troubled assets backed by subprime mortgages, he and bankers have been put through the wringer as congressmen waited to see the results of their bill in the marketplace. “It seems to me like the largest bait-and-switch scheme the world has ever seen,” said Gary Ackerman (D-N.Y.), accusing Paulson of not fully sharing his plans before Congress gave him the authority to spend up to $700 billion.

Lawmakers are also peeved that Paulson does not plan to use the funds to mitigate foreclosures or to save the domestic auto industry from collapsing. He said Treasury is using other programs to try to help distressed homeowners, and said the bailout money should only be used for the financial services sector.

Assuming a defensive tone, Paulson said the global markets took an unforeseen turn for the worse before Congress passed the bailout bill. He said that he has at least succeeded in stabilizing the financial markets and said the full effects of his second plan — which involves buying preferred stocks from banks — need time to show their effect. “Remember, this is in the early days,” he said. “In terms of capital, it has just gone out…to the banks.”

Treasury has disbursed about $148 billion toward 30 banks through its Capital Purchase Program, and plenty of other types of financial institutions, such as community banks and insurance companies, are knocking down its doors asking to also have access to the capital. For now, Paulson has decided that he will leave $410 billion of the bailout money aside to give president-elect Barack Obama’s “flexibility.” He is also considering proposals that could increase consumer lending.

Last week, before the Senate Banking Committee, four executives from the largest U.S. banks tried to temper senators’ expectations for getting money to flow from the bailout. They said they hadn’t yet had time to fully put the additional capital on their balance sheets to work.

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