* Bernanke: Fed would act if needed if debt crisis worsened
* U.S. banks well-hedged on CDS exposure-Bernanke
(Adds Bernanke quote, background)
By Pedro da Costa
WASHINGTON, March 20 (Reuters) - Federal Reserve Chairman Ben Bernanke on Tuesday welcomed an easing in Europe's financial troubles and said the U.S. central bank would be ready to act if conditions worsened again.
"In the past few months, financial stresses in Europe have lessened, which has contributed to an improved tone of financial markets around the world, including in the United States," he said in testimony prepared for delivery on Wednesday.
Bernanke said U.S. financial institutions have some potential exposure to losses from the credit default swaps they sold to protect against a possible European sovereign debt default. But he said major U.S. banks are not vulnerable.
"These (CDS) sales have been more than offset by purchases of protection, which would imply that in the event of a sovereign default, U.S. financial institutions would be net recipients of CDS payouts," Bernanke said.
European financial markets have stepped back from the brink since Greece, at the epicenter of the region's debt crisis, struck a deal with creditors to cut its large debt burden. But Greece and several other euro zone countries are still grappling with deep budget cuts and tough economic reforms aimed at making their economies more competitive.
Bernanke, in his testimony to the U.S. House of Representatives Oversight Committee, said European policymakers must follow through on fiscal reforms for the recent period of relative calm to persist.
"Full resolution of the crisis will require a further strengthening of the European banking system; a significant expansion of financial backstops, or 'firewalls,' ... and, critically, continued efforts to increase economic growth and competitiveness and to reduce external imbalances," he said.
The Fed chief reiterated the central bank's commitment to keeping the U.S. financial system stable, even if Europe's woes flare up again.
"The Federal Reserve will continue to monitor the situation closely, work with our financial institutions and foreign counterparts to enhance the resilience of our financial system, and be ready to use our tools to help stabilize U.S. markets should the situation require such action," said Bernanke.
Bernanke is set to testify alongside U.S. Treasury Secretary Timothy Geithner. In an appearance before the House Financial Services Committee on Tuesday, Geithner warned Europe against an approach that focuses too heavily on short-term budget cuts.
"The path of fiscal consolidation should be gradual with a multi-year phase-in of reforms," Geithner said.
"If every time economic growth disappoints, governments are forced to cut spending or raise taxes immediately to make up for the impact of weaker growth on deficits, this would risk a self-reinforcing negative spiral of growth-killing austerity," he added. Geithner will repeat the same prepared remarks on Wednesday.
(Reporting By Pedro da Costa and Mark Felsenthal; Editing by Leslie Adler and Andrew Hay)
((Pedro.DaCosta@thomsonreuters.com)) Keywords: USA FED/BERNANKE
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