A top U.S. Federal Reserve official on Thursday defended the central bank's decision to provide dollars for overseas banks stressed by Europe's debt crisis, saying the action was needed to protect the U.S. economy.

New York Fed President William Dudley, in testimony to Congress released on Thursday, said the Fed had put in place dollar swap lines with other central banks to help protect the U.S. economy from the potential risk of a big selloff in dollar assets.

If the access to dollar funding were severely impaired, this would necessitate the abrupt forced sales of dollar assets by these banks, which could seriously disrupt U.S. markets and adversely affect U.S. businesses, consumers and jobs, Dudley said in remarks prepared for a hearing scheduled for Friday.

The Fed collaborated with other central banks in late November to prevent a global credit crunch stemming from European turmoil, lowering the cost of existing dollar swap lines. The arrangements permit the Fed to provide dollars to the European Central Bank and four other central banks in exchange for local currencies.

The swap facilities have drawn criticism from U.S. lawmakers who say they could hand U.S. taxpayers the bill for a European financial bailout.

The swap arrangements are safe for the Fed and U.S. taxpayers, Fed Division of International Finance Director Steven Kamin said in testimony prepared for delivery to the same panel.

The announcement of the swap arrangement changes has already had a beneficial effect on dollar funding markets, Kamin said.

Dudley said while U.S. financial institutions are not directly exposed to the sovereign debt of European countries in the most trouble, they are deeply entwined with other core European countries and the European banking system as a whole.

This means that if the crisis were to broaden further and intensify, this could put greater pressure on U.S. banks' capital and liquidity buffers, he said.

The U.S. economy is on a moderate growth path and but faces a significant risk from the euro area crisis, Dudley said.

If conditions were to worsen, the U.S. central bank is prepared to put any number of tools to use to provide a liquidity backstop for any U.S. banks facing a credit freeze, he said.

Although at this time, I do not anticipate further efforts by the Federal Reserve to address the potential spillover effects of Europe on the United States, we will continue to monitor the situation closely, he said.

(Reporting by Timothy Ahmann and Mark Felsenthal; Editing by Andrew Hay and Jan Paschal)

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