WASHINGTON (Reuters) - Most U.S. banks have enough capital to keep lending but a pile of bad debts is fostering doubts about their health and slowing a recovery, U.S. Treasury Secretary Timothy Geithner said on Tuesday.

Testifying before the Congressional Oversight Panel, which monitors the Treasury’s efforts to bail out troubled banks, he said toxic assets were “congesting” the U.S. financial system and hindering efforts to get credit flowing normally.

“Uncertainty about the value of legacy assets is constraining the ability of financial institutions to raise private capital,” Geithner said, adding that he hoped a public-private investment program will improve the ability to put a price on troubled mortgage and other assets.

Earlier, the special inspector general for the government’s bailout effort said the toxic-asset plan offered opportunities for fraud and abuse and warned it should be bolstered by tough conflict-of-interest rules.

Neil Barofsky also said subsidies for the public-private partnerships to buy assets could expose taxpayers to higher losses without matching increases in the potential for profit. He called for tough screening of investors as well as forced disclosure of ownership stakes and any dealings by the funds.

The government has injected hundreds of billions of dollars into banks to help them weather the damage from bad mortgage loans and is running stress tests on 19 of the largest banks to see whether they are prepared to deal with a further downturn.

In a letter to panel chairman Elizabeth Warren, Geithner said the Treasury still has about $134.5 billion available out of an originally approved $700 billion for bolstering banks’ capital and said he wouldn’t need to ask Congress for more.

STOCKS GET A LIFT

“Currently, the vast majority of banks have more capital than they need to be considered well capitalized by their regulators,” Geithner said, a comment that gave stocks a lift in morning trading.

But he conceded there were persistent worries about the health of the banking system and said that was impeding a broader economic recovery.

“Concerns about economic conditions -- combined with the destabilizing impact of distressed ‘legacy assets’ -- have created an environment under which uncertainty about the health of individual banks has sharply reduced lending across the financial system,” he said.

If the stress tests -- parts of which are expected to be made public next month -- show some banks need to raise more capital, then they will have options for doing so.

“Those banks that need more capital will have an opportunity to raise that capital from private sources or request capital from the Treasury in the form of convertible preferred stock,” Geithner said.

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Some of the biggest banks have said they want to quickly repay money that they received under the government’s Troubled Asset Relief Program, or TARP, in part to avoid constraints on pay set out as a condition for getting the money.

GLAD TO TAKE MONEY

Geithner said if regulators certify that a bank would be sound without government help, the Treasury would gladly take the money back.

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“It helps to underscore the basic point that the institutions of our financial system are in very different circumstances,” Geithner said.

But he hedged on whether he thought it would be good for the banking system if some banks returned the TARP money early, and he specified that regulators, not he, would decide whether to take bailout money back.

“My basic obligation and our responsibility is to make sure that system as a whole ... has the ability to provide the credit that recovery requires,” Geithner said, “So we need to make a careful judgment about what policies are going to best promote that objective.”

Some analysts question whether letting some banks return the TARP money would add to investors’ and borrowers’ doubts about dealing with banks that still need government help, potentially making them more vulnerable to failure.

In response to questions, Geithner said it will be important for people to see what stress tests on major banks show, though he did not shed any further light on how extensive the publicly issued comments on banks’ health will be.

Transparency is vital, he said, adding “Without that, they are going to live with a deeper cloud of uncertainty over their financial health than they need to.”

Geithner said the scope of the current crisis is unprecedented, so the government has no guide to follow in its efforts to ease the situation. But he insisted there were some signs of progress.

“Indicators on interbank lending, corporate issuance and credit spreads generally suggest improvements in confidence in the stability of the system and some thawing in credit markets,” he said.