(Corrects 4th paragraph to delete that Fed Governor Elizabeth Duke and Jeffrey Lacker spoke at the same conference; they spoke at different events)

WASHINGTON - Boosting credit to needy small businesses is crucial to sustain a tepid U.S. recovery but how to do so poses a difficult policy challenge, Federal Reserve Chairman Ben Bernanke said on Monday.

He said businesses need to be able to get loans when they need them to expand and to hire, especially when many are just working their way back to health from a deep recession.

To support the recovery, we need to find ways to ensure that credit-worthy borrowers have access to needed loans, Bernanke told a Fed-sponsored conference on small business financing.

Two other Fed speakers, Governor Elizabeth Duke and Jeffrey Lacker, president of the Richmond Fed, played down fears about the economy slipping back into a double dip recession but conceded that credit flow was a problem.

Lacker argued that double-dip fears were overdone, saying a recent string of softer-than-expected data -- from anemic private hiring to battered consumer confidence -- was not inconsistent with a moderately paced recovery.

Market participants seem to be overreacting to a couple of reports that have been a little bit below what people expected, he told reporters who attended an event at the Richmond Fed's headquarters.

FED QUANDARY

With a recent spate of economic data suggesting the recovery is flagging, the Fed faces a quandary. It has held interest rates near zero percent since December 2008 and pumped up bank reserves by flooding the financial system with more than $1 trillion.

While most analysts expect the Fed's next move will be to eventually tighten monetary policy, some think further easing may be needed to prevent a new downturn.

The U.S. central bank could pump more liquidity into the economy through a variety of so-called quantitative easing methods like buying assets from banks or buying mortgage securities in hope of spurring more lending.

For me, consideration of further easing steps now is very far away, said Lacker, a hawk on inflation who is not a voter this year on the Fed's policy-setting Federal Open Market Committee. It would take a very substantial, unanticipated adverse shock.

He was the only Fed speaker to directly address the policy outlook.

Like Lacker, Duke said she felt the economy was on track for continued growth. In response to a question, she said she didn't think a double-dip recession was a major worry.

It's still a moderate recovery, Duke said on CNBC television, adding that she expects credit flow to gradually loosen up, but said that will occur in response to brightening business prospects rather than because it is forced upon bankers.

But Duke told the Fed-arranged conference on overcoming obstacles to lending that it was not simple to persuade lenders that a slow-paced recovery warrants putting their money at risk by lending it out, and they can't be forced to make risky loans.

I do not believe it is appropriate or even possible for regulators to urge banks to make loans that are outside their risk tolerance or that would be unsafe or unsound, Duke said.

But she said supervisors can and should be sure that the policies they set for banks do not have the effect of pinching the flow of credit to worthy small business borrowers.

A scarcity of credit for small- and medium-sized businesses, traditionally the driving-force behind job creation, has been blamed for woes ranging from a 9 percent-plus unemployment rate to a perceived risk of a double-dip recession.

The economy has grown for three straight quarters beginning in the third quarter of 2009, but recent economic data implying softening housing markets and weak consumer confidence has led investors to fear the expansion could stumble again.

Credit availability has become a concern after the 2007-2009 crisis that hit financial firms exceptionally hard. Total loans held by commercial banks dropped 5 percent last year and lending has continued to shrink in 2010.

Bernanke said small businesses play a key role in job creation but they continue to report tough credit conditions. The Fed takes very seriously complaints from bankers that bank examiners often stop lenders from making good loans, he added.

But Bernanke also said lower loan demand and the still-weak financial position of many businesses were holding back lending.

The Obama administration backs legislation to create a $30 billion fund to boost capital at community banks to encourage small business lending, but that faces an uncertain fate in Congress where lawmakers seeking reelection in November are wary of anything that could be seen as a bailout.

(Additional reporting by Mark Pedro Dacosta, writing by Glenn Somerville, Editing by Leslie Adler)

Ben Bernanke Quantitative easing