Despite a more stable financial system, banks are still not lending and the quality of loans on their books continues to get worse as the U.S. housing market remains in the doldrums, a top official at the Federal Reserve said on Wednesday.

"Access to credit also remains difficult, especially for households and small businesses that depend significantly on banks for financing," said Jon Greenlee, Associate Director for Bank Supervision and Regulation at the Fed.

"Loan quality continues to deteriorate across a number of asset classes, and ... has declined further as weakness in housing markets affects performance of residential mortgages and construction loans," Greenlee said in prepared remarks to a Congressional Oversight Panel field hearing in Atlanta.

Greenlee defended the Fed's role in managing the economic crisis of the past two years and said it would continue to push for banks to make loans.

"In order to promote credit availability, the Federal Reserve is encouraging banks to deploy capital and liquidity in a responsible way that avoids past mistakes and does not create new ones," Greenlee said, noting that it will take "some time" for a full recovery.

Greenlee made his comments ahead of the Fed's decision to leave interest rates near zero and a restated vow to keep them low for "an extended period."

The Fed also repeated its pledge to end a massive effort to buy $1.25 trillion of mortgage backed securities by the end of March.

"Credit losses at banking organizations continue to rise, and banks face risks of sizable additional credit losses given the likelihood that employment will take some time to recover," Greenlee said.

Asked about borrowers who have sufficient cash flow to make payments on commercial real estate loans but are still having difficulty refinancing because of the plunge in appraised values, he urged lenders to rework loan terms with borrowers.

"We need to find a way to enable these people that have the ability and willingness to repay, at a certain level, to stay in that property. That's better for the bank and for everyone involved," Greenlee said.