LONDON, Jan. 13 (Xinhua) -- U.S. Fed Chairman Bernanke said in a speech given here on Tuesday that the Fed Reserve still has powerful tools at its disposal to fight the financial crisis and the economic downturn, even though the overnight federal funds rate cannot be reduced meaningfully further.

    He said that the first set of tools, which are closely tied to the central bank's traditional role as the lender of last resort, involve the provision of short-term liquidity to sound financial institutions. 

U.S. Federal Reserve Bank Chairman Ben Bernanke delivers a speech at the London School of Economics in central London January 13, 2009.(Xinhua/Reuters Photo) Photo Gallery>>>

    Liquidity provision by the central bank reduces systemic risk by assuring market participants that, should short-term investors begin to lose confidence, financial institutions will be able to meet the resulting demands for cash without resorting to potentially destabilizing fire sales of assets.

    However, on the other hand, he said that the provision of ample liquidity to banks and primary dealers is no panacea. Today, concerns about capital, asset quality, and credit risk continue to limit the willingness of many intermediaries to extend credit, even when liquidity is ample.

    Thus, the Federal Reserve has developed a second set of policy tools, which involve the provision of liquidity directly to borrowers and investors in key credit markets. The Fed has introduced facilities to purchase highly rated commercial paper at a term of three months and to provide backup liquidity for money market mutual funds. In addition, the Fed and the Treasury have jointly announced a facility that will lend against AAA-rated asset-backed securities collateralized by student loans, auto loans, credit card loans, and loans guaranteed by the Small Business Administration. This facility will be operational next month.

    The Fed's third set of policy tools for supporting the functioning of credit markets involves the purchase of longer-term securities for the Fed's portfolio. For example, the Fed recently announced plans to purchase up to 100 billion U.S. dollars in government-sponsored enterprise (GSE) debt and up to 500 billion U.S. dollars in GSE mortgage-backed securities over the next few quarters.

    The virtue of these policies in the current context is that they allow the Federal Reserve to continue to push down interest rates and ease credit conditions in a range of markets, despite the fact that the federal funds rate is close to its zero lower bound, said Bernanke.

    He emphasized that The Federal Reserve's approach to supporting credit markets is conceptually distinct from quantitative easing. The Fed's credit easing approach focuses on the mix of loans and securities that it holds and on how this composition of assets affects credit conditions for households and businesses.