Lending to small businesses is declining, making it more difficult to counter the persistent problem of high unemployment, Federal Reserve Chairman Ben Bernanke said on Thursday.

Bernanke said policymakers have largely succeeded in stabilizing the U.S. financial system and economy over the past two years but the scarcity of jobs is a concern.

I raise this issue here because healthy small businesses, including start-ups as well as going concerns, are crucial to creating jobs and improving employment security, he told a meeting at the Chicago Fed's Detroit branch organized to discuss the financing needs of Michigan's small businesses.

Bernanke noted that loans to small businesses dropped from nearly $700 billion in the second quarter of 2008 to about $660 billion in the first quarter of 2010. He conceded it was hard to tell exactly why.

An important but difficult-to-answer question is how much of this reduction has been driven by weaker demand for loans from small businesses and how much by restricted credit availability, Bernanke said.

He said the Fed was still examining causes for the reduced flow of credit to businesses and it was vital it stay focused on discovering why it was happening and correcting the situation.

Banks, Bernanke said, need to be prudent in lending decisions but not overly restrictive toward granting loans to small business.

Bernanke, who took questions from members of the audience, said he would end his remarks with a little bit of guarded optimism about the outlook for credit conditions.

We are seeing some improvement. The survey of loan officers suggests that the tightening process is ending, that some banks are getting to loosen their terms. We are seeing loss rates stabilize, many banks are returning to profitability. Some improvement in the economy, Bernanke said.

Obviously we've still got a long way to go but I'm hopeful that we will see improved conditions for credit going forward, he said.

(Reporting by Soyoung Kim, Writing by Glenn Somerville, Editing by Andrew Hay)