The Federal Reserve Board on Dec. 9 stopped a proposed banking merger for fear the new entity would dominate tiny Marshall County in central Iowa.

In its ruling, the Fed argued that BancSecurity Corp.'s acquisition of Marshalltown Financial Corp. would have created excessive loan and deposit concentration in the marketplace, which has a population of about 25,000.

"The board concludes that consummation of this proposal would result in significantly adverse effects on competition in the relevant banking market," the Fed said in a 19-page order.

Executives of the two institutions expressed bitterness and repeated a complaint often uttered by community bankers: that in-market mergers by small banks in small towns are difficult if not impossible under current regulations.

The Fed earlier this year rejected a similar application in Georgia.

"It's a big disappointment to us," said Richard A. Rathke, chief executive of Marshalltown Financial. "The megamergers seem to be approved automatically; the little ones that seem to be more reasonable get turned down."

"It's irritating because we really feel they have reached the wrong decision," said BancSecurity chief executive Ronald E. Fenton. "The whole system needs reforming."

If $516.1 million-asset BancSecurity had acquired the $124.1 million- asset thrift, the combined institution would have become the ninth-largest depository in the state.

According to Fed documents, BancSecurity would have controlled about 50% of Marshalltown deposits and about 60% of residential mortgages.

When calculating the effects of a bank merger, the Fed uses a formula called the Herfindahl-Hirschman Index to determine market concentrations.

An index number over 1,800 is considered highly concentrated. The figure is already 2,183 in the Marshalltown area, the Fed said, and the merger would raise it to 3,032.

Further, the merger would have cranked up the index measuring residential mortgage concentration, the Fed said.

Mr. Fenton criticized the Fed model for not taking into account the marketplace presence of nonbanks, which compete for mortgages and deposits.

He also argued that the resources of Norwest Corp. and Mercantile Bancorp., both of which have a presence in Marshalltown, dwarf those that BancSecurity could muster.

"Can anyone seriously think that if we tried to engage in anti- competitive behavior we wouldn't receive an instantaneous response from them?" Mr. Fenton said.

Diane Casey, national director of financial institutions regulatory issues for Grant Thornton, said the difficulty of in-market mergers among small banks in small towns will become a more heated issue next year. The reason: Heightened competition from nationwide branching will press more small banks to seek combinations among themselves.

The Fed's method "is hindering the ability of small banks to move ahead into the future," Ms. Casey said.

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