The U.S. Federal Reserve must keep its ability to make short-term cash available to maintain financial stability during a crisis, a top Fed official told Congress on Thursday.

It is important ... that the Federal Reserve, as the nation's central bank, retain our long-standing authority to address broader liquidity needs within the financial system under section 13(3) (of the Federal Reserve Act) when necessary to maintain financial stability, Fed Governor Daniel Tarullo said in testimony prepared for delivery to Congress.

Tarullo said in the remarks to the House Financial Services Committee that creation of a mechanism to dissolve failing major firms would eliminate the need for the Fed to lend to specific companies. However he said the Fed's emergency lending played a vital role in preventing financial collapse.

During the recent crisis, our ability to establish broad-based liquidity facilities proved critical in containing severe pressures that threatened the financial system as a whole and in reopening key financial markets, he said.

The Obama administration has proposed taking away the Fed's ability to provide emergency bailouts to individual firms as it did with investment bank Bear Stearns and insurer American International Group Inc (AIG.N).

The Fed could make emergency loans to solvent firms during periods of stress under the administration's proposal, but would need Treasury Department approval to do so.