WASHINGTON (Reuters) - The U.S. banking industry continues to recover from the economic downturn and the 2007-2009 financial crisis, with profits rising over the past year, but the improvement can only continue if lending picks up, the Federal Deposit Insurance Corp said.

The FDIC on Tuesday released its latest quarterly report, which showed the industry earned $26.3 billion in the fourth quarter.

That marks an increase of $4.9 billion from a year earlier but a drop of $9 billion from the third quarter.

The increase in profits from a year ago was largely due to banks setting aside less money to guard against loan losses.

The amount set aside for losses in the fourth quarter was $19.5 billion, which is 40.1 percent less than a year ago.

"The industry is now in a much better position to support the economy through expanded lending," acting FDIC Chairman Martin Gruenberg said in a statement. He warned, however, that "downside risks remain a concern."

(Reporting by Andrea Ricci; editing by John Wallace)