Small community banks set up to serve specific minority groups are rapidly expanding their services to survive in the increasingly competitive banking industry.

Although most of the minority banks still are committed to their original goals of aiding blacks, Hispanics, other minorities and women, many have concluded that if they are to endure they must expand their programs to serve the mainstream customer as well.

The barriers that once prevented minorities and women from receiving equal consideration from other banks -- and that helped create the need for minority banks -- have fallen, to some extent. The change is good news for minorities and women in general, but it increases the competitive challenge facing minority banks.

"Times have changed," said Luther Hodges Jr., chairman of National Bank of Washington. "Our society recognizes the need to serve the total society, so there aren't the same needs for those minority banks as there once were. Banking has changed so much that there are many marketing opportunities related to minorities," he added.

There was a time when many bankers ignored the financial needs of the black community, said Samuel L. Foggie, president of United National Bank of Washington. "No longer. We now have a great deal of competition. We have to fight even harder for loans."

UNB, founded 21 years ago to serve the District's black community, is now seeking business all across the city with new automated teller machines. Last month, UNB installed ATMs in all of the District's 31 7-Eleven stores. The machines will accept cards not just from UNB customers but also from consumers who bank at other financial institutions that belong to the MOST or Network Exchange electronic banking networks. UNB, however, will receive a fee for each transaction.

This is UNB's second major move to expand beyond its initial Northeast Washington market. Eight years ago, UNB moved its headquarters to a new branch office on 19th and K streets NW in downtown Washington to compete more actively for retail and commercial business outside that community. The move helped UNB increase its deposit base by 66 percent.

While UNB intends to continue to emphasize its service to the minority community, "our philosophy is to serve the entire community," said Foggie, who repeatedly called his bank "a community bank."

"The electronic teller machine is the key. It will help open up a world of things for us to do," he added.

Two blocks east of UNB's headquarters, Women's National Bank -- under new ownership and leadership -- is turning to public-interest, nonprofit and political organizations for new business. Among other things, the bank helped finance the presidential campaigns of Democratic party contenders Jesse Jackson, George McGovern, Gary Hart and Walter Mondale.

"I doubt there is a bank in history that has ever funded -- at least in part -- all of the three Democratic candidates going into the same convention," said WNB's Barbara D. Blum, who served as one of President Jimmy Carter's chief environmental advisers. Blum was named the bank's president nearly two years ago, shortly after Washington financier Leo M. Bernstein bought the bank, with the promise that he would retain its name and unique identity.

Capital Bank N.A. -- the successor to the Hemisphere National Bank -- has been dedicated to serving Washington's Hispanic community ever since it was founded 11 years ago.

However, in the past year, the bank has gone "beyond inner-city rehabilitation, apartment construction and renovation and condominium conversions, diversifying our traditional project lending to include trade associations, franchises, motels, shopping centers and medical facilities," its annual report notes.

Capital opened its second office last year -- in Friendship Heights in Northwest Washington -- in the hope of capturing more business from suburban Maryland. Capital's headquarters is in downtown Washington on Connecticut Avenue, far from Adams Morgan or any other neighborhood with a large concentration of Hispanic residents.

The bank is not expecting to open a branch close to the community it says it is committed to serve for at least three more years, says President Abel Holtz.

"We do not locate minority banks where minorities reside. . . . We believe we have to do business first with the non-minorities to bring in business, generate growth and generate profits with which we can help minorities. If we would concentrate in the minority areas, there would be no growth and no earnings, and therefore it would be very difficult for us to assist those communities."

Holtz, a Miami banker who is Cuban-born, bought Capital in 1982 from a group of local Hispanic investors who founded the bank in 1974. Holtz changed its name from Hemisphere National Bank to Capital in part to erase the bank's old image as a Hispanic bank. Capital is also the name of Holtz's Miami bank.

Minority banks are a relatively recent phenomenon. While some were founded in the early 1900s, it was not until the 1960s that they began to grow significantly in number. Today, the Federal Reserve reports 104 minority banks in the United States -- with another 67 minority savings and loans. More than 70 percent of these were created in the last 25 years.

While these banks are owned and operated by a minority group, many say they do not give special breaks to the minority community -- other than to perhaps listen more carefully to loan requests from this community and grant those loans first, if possible.

"We prefer to do business with Indian tribes and reservations, but we don't offer concessions to them," said Alan Parker, president of the American Indian National Bank. In fact, noted R. D. Jones, the bank's chief executive officer, "we often are criticized because some of our borrowers think our rates are too high."

Capital Bank is one of the few minority institutions that says it makes some special concessions, setting aside about 2 percent of its loan portfolio -- or $500,000 -- to offer low-interest loans to customers who need assistance and who have been unable to obtain a loan from other banks.

"I think we have an obligation to the community," said Holtz. These loans, usually at about 2 percentage points below rates given for comparable loans to other customers, help permit a business to get off the ground or get over some problems, said Holtz. Without the lower interest rates, these businesses wouldn't have a chance, he added.

For the local Hispanic business community, "Capital Bank is our first stop at this time," noted Jose Antonio, president of the Ibero-American Chamber of Commerce. Nonetheless, Antonio said he was not aware of Capital's low-interest-loan program -- a fact Holtz attributed to the bank's conscious decision not to advertise it.

Although the number of minority banks is at an all-time high, many banking officials say their future is uncertain, particularly in this era of bank deregulation.

In the Washington area, at least two minority institutions already have disappeared. The Diplomat National Bank, opened in 1975 by a group of Asian investors to aid the Asian-American community, encountered problems from the very start. Not only did it never turn a profit, but also its reputation and prestige were hurt in the late 1970s when it was linked to the Korean influence-peddling scandal.

In 1980, after a group of South Korean investors failed to raise at least $1 million in new capital and win certification from the U.S. Comptroller, Washington financier Leo Bernstein bought the bank for $2 million.

As a Jew, Bernstein has considered himself a minority all of his life, noted a close associate. But when he bought the Diplomat, the bank immediately became a non-minority institution -- an event Bernstein frequently jokes about, the associate said.

Bernstein changed Diplomat's name to Washington Bank and ultimately merged it with Security National Bank.

Community Federal Savings & Loan, founded to serve the black community, was merged into Independence Federal Savings & Loan, another black-owned S&L. Independence, like the majority of S&Ls in the District, had an unprofitable year last year, with losses totaling $436,000.

Financial problems are fairly common to minority-owned institutions, banking officials note. Almost all weathered difficult times when they first opened, they said. For one thing, banking officials say they were often managed poorly -- with officers inexperienced in the banking business. Even more significant, the banks, eager to please the communities they set out to serve, often were too generous in their loan agreements and, as a result, ran into financial problems.

"New banks, in an effort to get as much business as possible, take more chances before they gain the experience they need," said Foggie, who was UNB's operations officer when the bank began in 1964. "When we first started, we suffered as most new banks do. The management felt it could be everything to everybody. But we were not experienced in running a bank, and we took a fair share of loan losses."

The same was true for American Indian National Bank, founded in 1973 to serve Indian tribes, most of which are located in the West. The bank was set up in Washington because the Indian investors believed that by being close to the seat of government it would be able to capture federal money targeted for the tribes, serving as a conduit between the government and the tribes.

"That turned out to be an unrealistic idea," said Parker. "The Indian tribes need more of that money instantly in their hands." Additionally, the bank, "trying to make a lot of loans to the Indian reservations, incurred a lot of loan losses between 1974 and 1977. The management was inexperienced and eager to make the bank work serving the Indian banking needs," added Parker, who joined the bank in 1983.

Minority banks in the Washington area do a minuscule amount of business compared with more mainstream, majority banks. The largest minority bank -- and the oldest -- is the 51-year-old Industrial Bank of Washington, with $73 million in assets and $68 million in deposits at the end of 1984, according to the Federal Reserve. By comparison, Riggs National Corp., the largest District bank, has assets of $5.1 billion and deposits of $4.2 billion.

Even so, the minority institutions say they have no desire to grow significantly.

"$100 million is probably as big as we should be," said Parker of the Indian Bank, which at the end of 1984 had $26 million in assets and $22 million in deposits.

"I hope we will never be a great big bank," echoed Blum of the Women's National Bank. "Our market niche is to be a smaller personal bank. . . . We get a tremendous number of people here that have been turned down from other banks -- not because of sex discrimination but because the loan they want is too small. There is a very special niche for banks that consider a $300,000 commercial loan a tremendous loan."

The desire to service customers seeking relatively small loans is one reason why some banking officials -- despite their doubts about the future of minority banks -- say there is a continued need for those that are well-run.

"There is a place in the future for minority institutions," said Michael F. Ryan, president of NS&T Bankshares Inc. "Minority banks better understand the needs of minority communities and will get their support" as a result, he said.

"A non-minority bank may wonder why it should grant a loan to establish a new restaurant in the black community when there are all sorts of restaurants a few blocks away," said UNB's Foggie. "But if they never lived in that community, they might not know that there is a real need there for a restaurant, where a minority bank would realize that need," he said.

There is another reason why it is advantageous to do business with minority and other small banks, noted Josephyne Hollis, consultant for Aetna Life & Casualty Co.'s minority bank program. "They can provide as good or better service to the consumer because they are smaller. For example, if you have a question about an account, you tend to get an immediate response from a minority bank. You don't have to wait two to three days" for an answer as you often have to when dealing with a larger institution, she said.

Banking officials predict that competition for minority business could grow fiercer in the coming years as banking deregulation permits other banks to enter new areas.

"Some minority banks just won't make it," predicted one government official who keeps close tabs on the minority financial institutions. However, the official noted, "Their failure won't be because they are minority banks. They are just small banks, and there aren't going to be that many around in years to come."

A major banker, who declined to be named, agreed, saying, "We have too many banks, and the economics of running a small bank makes it harder and harder for them to succeed. Some can't cover their overhead, some don't have the technology or management to make it. Business is becoming more and more difficult for them."

A good small bank should have a 15 percent return on equity and a 1 percent return on assets, the banker said. But in the case of the minority banks in this area, most have less than a 7 percent return on equity and only a 0.5 percent return on assets.

For some banks, even these returns may be harder to achieve as the federal government continues to reduce the amount of money targeted to be deposited in minority banks.

To increase the viability and soundness of minority banks, former president Richard Nixon set up a program in 1970 encouraging government agencies to increase their deposits in minority banks whenever possible. When the minority-bank deposit program began, there were 28 minority banks with federal deposits of $3.6 million. By 1983, there were more than 100 such banks, and the government's average daily balance of deposits in minority banks had grown to nearly $500 million.

However, as the Reagan administration tries to manage the government's cash more effectively -- to speed up government receipts and give the government greater flexibility in the use of its funds -- the amount of deposits in minority banks has been steadily decreasing. For the last fiscal year, which ended Sept. 30, 1984, the average daily balance of government's deposits at minority institutions had dropped to $400 million. That amount is expected to be even lower this fiscal year.

As a result, a growing number of minority banks are turning to the corporate world to obtain funds. About 60 percent of the top 500 companies in the nation have some form of minority banking program, ranging from placing small deposits in minority banks to more extensive operations at a number of banks.

Among the more extensive programs is Aetna Life & Casualty's, which, on a yearly rotating basis, selects nine minority banks to receive a biweekly deposit of $1 million. The banks can benefit from the use of this money until it is withdrawn to cover Aetna's federal tax obligations.

Similarly, Avon Products Inc. just announced a $25 million revolving credit agreement with a consortium of 45 minority-owned financial institutions, including Industrial Bank of Washington (which is supplying a $1 million credit line over the next three years), Capital Bank (which is supplying a $500,000 line of credit), Women's National Bank (with a $400,000 credit line) and UNB (with a $200,000 credit line). Avon says this is the largest single credit agreement between a U.S. company and a group of minority banks.

"Ironically, these minority-owned banks depend on the non-minority world to survive," commented one banker who declined to be named.

Among the minority banks, it is the women's banks whose future is in greatest doubt. Most were founded in the mid-1970s as women's groups tried to combat financial discrimination against women. Yet, those concerns substantially evaporated after Congress passed laws banning banks from engaging in sex discrimination in granting loans.

"Women, over the years, have come out of the dire needs they had," said Eve R. Grover, former president of the First Women's Bank of Maryland. "They are more self-sufficient, and there is not the same need as existed as in 1979," when the bank was founded. "But there is still a need for small banks like the women's banks. They just have to be more versatile and meet the needs of all consumers and small businesses," she added.

Reflecting that concern, a number of women's banks over the years have changed their name or merged with non-minority concerns. The First Women's Bank of California, for instance, was sold to a Los Angeles investment firm that changed its name to the Guaranty Bank of California. The Women's Bank of San Diego, best known for the playpen in its lobby, changed its name to California Coastal Bank two years after it opened and subsequently was merged into another bank.

In New England, the Connecticut Women's Bank has just changed its name to the Connecticut Community Bank. "They did that because they now have a different market to serve" than they did when they started, said Aetna's Hollis. "They could shortsight themselves by continuing to call themselves a women's bank."

In this area, however, the two women's banks have no plans to change their names -- even though they already have changed their focus to give greater emphasis to small businesses and nonprofit organizations.

Although Bernstein bought 51 percent of the stock of the Women's National Bank -- the first nationally chartered women's bank -- he has managed to keep it a minority bank by transferring the bulk of his stock to the women in his family, including his wife and two granddaughters, bank officials say. Bernstein now directly controls only 5 percent of the bank's stock.

Until late last year, federal banking officials barred Bernstein from playing a direct role at the bank because he was the chairman of the Security National Corp, the holding company of Security National Bank. However, his influence has been substantial since Bernstein resigned his office at Security on Nov. 30, 1984, and could become involved directly in the Women's bank. Even though he does not play a day-to-day role in operating the bank, his presence has greatly improved its financial health, Blum said, noting that by mid-March, assets had increased from $23 million to $26 million and deposits had grown from $20 million to $23 million. And for the first quarter of 1985, the company had about a $30,000 profit -- the first in more than two years.

"Bernstein brought a credibility to this bank because his involvement attracted a lot of people who wouldn't have come here because they thought it was a 'sissy' bank," said Blum.