Boosted by falling interest rates that improve their lending margins, gains on securities trading, and lower provisions for loan losses, U.S. banks are riding record profits.

"For banking in general, the best news is the industry renewed financial strength," says John F. McGillicuddy, chairman and chief executive of Chemical Banking Corp.

First-quarter net income totaled $10.9 billion for U.S. commercial banks, up $3.3 billion over the same quarter a year earlier and well above the previous record of $8.5 billion in the third quarter of 1992.

Endangered Species?

Second-quarter earnings continue to improve at almost all banks.

Yet, even as banks post some of the best results in years, banking in the United States increasingly appears to be an endangered species.

For one thing, the number of banks is steadily shrinking, mainly through consolidation.

As of March 31, there were 11,328 commercial banks in the United States, down from 13,139 five years earlier.

For another, bond and stock mutual funds, offering higher rates of return, are sapping deposits at banks.

Mutual fund assets, growing at around 17% a year, currently total $1.7 trillion and will probably hit $2 trillion before the end of this year.

That compares with a slight increase in bank deposits - between 2% and 3% a year.

Creditworthy companies are also increasingly turning directly to capital markets for their borrowings, bypassing banks.

"Commercial banking has migrated from a world of borrowers and savers to a world of issuers and investors," Mr. McGillicuddy observes.

Investors Skeptical

Bank stock prices, too, are languishing as investors see little growth in bank lending and believe that once the current slump in interest rates stalls, rising bank profits will level out.

"It's difficult to see where future earnings will come from," says Mark Gross, a U.S. banking analyst in New York with the credit rating agency IBCA Inc.

The Nonbank Factor

Banks also face increasing competition from nonbank institutions in everything from lending to credit cards and an ever-increasing mass of costly regulation.

At the same time, Congress has balked at broadening commercial banks' powers to engage in other activities, such as insurance and corporate debt underwriting.

This, in turn, has prevented banks from developing new lines of business and constrained them to an ever-shrinking role as a source of finance within the U.S. economy.

|A Costly Abomination'

"Whoever actually fulfills these functions isn't nearly as important as making some rational sense out of the way financial services are delivered in this country," says Robert Douglass, vice chairman of Chase Manhattan Corp.

"That rational sense isn't going to come until Congress wakes up and recognizes the current system is a costly abomination that impedes economic growth."

According to recent estimates, banks' share of total U.S. financial assets has shrunk from around 40% two decades ago to less than 25%.

Long Downward Trend

The shrinkage is likely to continue as demand for loans remains slack and creditworthy borrowers in increasing numbers are turning directly to capital markets for funding.

"The banking industry has been losing market share with respect to share of credit granted since the end of World War II," Says Lawrence Cohn, a banking analyst at PaineWebber Inc.

"I don't think that's going to change as capital markets get more efficient and the regulatory burden gets greater."

Still, no one is Prepared to Predict that U.S. banks will soon disappear.

But observers add that banks are likely in the future to focus on a more restricted range of operations where they have an inherent advantage.

"The capacity to know how to make a loan is still a skill, and banks offer the only real payments mechanism in the U.S. economy," Mr. Cohn says.

"That still offers them real opportunities."

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