California community banks are suddenly capturing more of the state's government deposits.

Though small banks could always bid for short-term public funds, only a handful of California's 350 or so banks had actually done so. But this year the new state treasurer, Peter Angelides, hit the road to encourage more small banks to bid on some of the $2.1 billion earmarked under a time-deposit program.

The result: The number of banks participating in the program has more than doubled, to 70, since last spring.

"If you want that money to stay in California and be distributed in the local communities rather than being sent out of state, there isn't any better way to do that than through the local community banks," said Craig Hudson, executive director of the California Independent Bankers.

California is not alone in offering small banks a shot at municipal funds. Nationwide, states, counties, and cities seem more willing to shop around for financial services and place deposits in smaller banks. Meanwhile, community and regional banks are getting more aggressive in courting those deposits especially from banks that have merged with out-of-state giants.

"A lot of municipalities are talking with us because they have complaints about our bigger competitors," said Sherri Giddens, vice president of retail banking at $720 million-asset First Banks America Inc. in Clayton, Mo. "Sometimes they're frustrated that they're dealing with different people than they were before the merger. We think in the next couple of years, we'll be able to garner more of this business."

Post-merger problems caused the Chicago suburb of Schaumburg to change banks.

The village board of the 75,000-person community decided in late September to move its $120 million of operating funds and investments from $256 billion-asset Bank One Corp. to the Schaumburg branch of $30 billion-asset Northern Trust Corp. The move, to be completed by April 2000, will end a relationship begun 10 years ago at First Chicago Corp., which after two mergers became part of Bank One.

"We had a lot of customer service problems following the mergers," said Steve Shields, Schaumburg's assistant finance director. "Depending on the issue, we didn't know who we were supposed to talk to. The problems just escalated."

Winning government business can be a coup for community and regional banks. Unlike consumers or businesses that might change banks at any time, governments generally tie up their business on multiyear contracts. This commitment and the large deposits they bring can increase banks' liquidity.

"Core deposits at a lot of banks no longer can cover the high level of loan demand we're seeing across the nation," Mr. Hudson said, emphasizing that that's why his association is pursuing even more governmental business for California community banks. "There's an increasing liquidity pinch because people aren't keeping their money in banks anymore."

Though some states and municipalities have retained a high level of bank loyalty, more have become willing to search for the best deal after their contracts expire, and to shorten future contracts, said Nick Greifer, senior policy analyst with the Chicago-based Government Finance Officers Association. The association is a national group for money managers at all levels of government.

But while that decreasing devotion fuels more opportunity to gain business, it also can cost local banks plum accounts. For instance, the Baltimore Employees' Retirement System moved its $3 billion custodial account to Pittsburgh-based Mellon Bank Corp. from a local bank, $7.6 billion-asset Mercantile Bankshares Corp.

Tom Taneyhill, the Baltimore systems administrator, said $48 billion-asset Mellon offered a greater ability to invest the funds internationally and to provide more comprehensive portfolio analysis.

When deciding where to put their funds, local governments must balance their desire to bank with a local institution against their need to earn the best return, said Dan Thompson, executive director of the League of Wisconsin Municipalities.

Take the central Illinois twin cities of Bloomington and Normal. Until 1996, the two cities, which have a combined population of about 100,000, previously banked at local institutions. Realizing they could reap a better deal by shedding local banking loyalties and pooling their resources, they put their combined operating account business up for bid as a package. The bank that offered the best deal would win the $2 million business.

"A lot of the banks didn't take us seriously at first, and they didn't think the local governments would stick together to get a better deal," said Brian Barnes, Bloomington's finance director and city treasurer. "Some of them wanted to dictate what they would give us rather than us telling them what we wanted and opening it up for bid."

In the end, $7.1 billion-asset Magna Group Inc. won the four-year contract. Bloomington officials say the city has earned about 10%, or as much as $40,000 more, per year in interest at the bank, which since was acquired by $34 billion-asset Union Planters Corp. of Memphis.

"When this comes up for bid again, I think all the banks will take us seriously," Mr. Barnes said. "Now that we've proved ourselves, there's been a big attitude change."

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