The head of one of the nation's largest banking firms outlined a future for his industry today that small and regional bankers long have feared.

Willard C. Butcher, chairman of Chase Manhattan Bank, told Virginia bankers that the nation's large banking institutions should merge with smaller, less efficient ones to become more competitive with mammoth nonbank financial corporations such as stock brokerages, credit card companies and some retail giants.

In an address to the Virginia Bankers Association's 88th annual convention here, Butcher questioned the need for all of the more than 1,400 commercial banks across the country and said he expects an acceleration in the decline of small banks. Butcher, whose New York firm is the third-largest commercial banker in the U.S., said it would be best for small banks to merge with "good solid American banks."

"I question the need for some 42,000 different depository institutions in over 100,000 U.S. locations," Butcher said. "Already today we have only about half the number of commercial banks we did two generations ago."

The Chase chief added that "resulting new entities will be more productive and competitive than the sum of their forerunners. It won't be a case of a few sharks swallowing up schools of little fish."

Virginia bankers have greeted his speech with polite applause, but this may have been the wrong audience for his future scenario of an industry dominated by large firms. The small Virginia banks represented at the meeting oppose mergers with large banks and interstate banking, which they fear would accelerate their demise. At most, officials of large bank holding companies in Richmond and other cities favor regional banking limited to several states.

The Virginia bankers also said their opposition to nationwide branching is in line with the feelings of a majority of the nation's banks. If federal regulators, as part of deregulation of the banking industry, permit interestate banking, "there's not a bank in Virginia that would remain," said incoming bankers association president Milton L. Drewer Jr., president of McLean-based First American Bank of Virginia.

In an interview after Butcher's speech, Drewer said he is opposed to "mammoth banks like Chase Manhattan coming down here and gobbling up banks in Virginia. Customers can best be served by local management."

Drewer claimed that only about 200 banks -- the largest in the country -- favor interstate banking.

"It is reasonable to assume that not a major bank currently operating in Virginia will be able to withstand the onslaught of the mammoths," in Drewer's view. "A few major corporations with headquarters in the money centers could probably profit by a nationwide bank, but to the vast majority of our customers the expertise and knowledge of local bank management and directors provide the greatest potential for the future. There is and will be a need for the community banker and major Virginia banking institutions to provide modern banking services," Drewer states in an address prepared for the meeting Wednesday.

Butcher recommended several ways to strengthen the banking industry in the wake of takeovers of American banks by foreign firms and incursions into banking business lines by nonbank conglomerates that aren't as restricted as banks.

One of Butcher's recommendations is to take advantage of what he called "a new mood to alter the antitrust attitude that says big is bad." He said large banks should be able to merge with other financial institutions. h

"Such mergers of significance are a key ingredient in regaining competitiveness with both domestic nonbank competitors and foreign banks," Butcher said."The universal banks of West Germany, Japan and Great Britain are growing larger and more powerful and are rapidly supplanting U.S. institutions as the dominant financial force in world markets."