CHICAGO -- Thomas C. Theobald, the new chairman of Continental Illinois Corp., most of whose stock is controlled by the federal government, plans to take the giant multinational bank back to its roots.

Continental, whose main subsidiary is Continental Illinois National Bank, never strayed far from its traditional customers -- large national and international businesses as well as midsized Midwestern businesses.

But Theobald has put a halt to a fledgling attempt, begun by his predecessors, to increase Continental's retail operations. That was a move to build a bigger, and presumably more stable, base of consumer deposits -- a move Theobald said cost too much.

He also said the bank will streamline its international operations, concentrating on serving foreign companies that want to invest in the United States. It also will shed its municipal bond operations.

Theobald said Continental -- like several other major banks, including his alma maters, Citibank and Bankers Trust Co. -- will try to "blend" the traditional world of commercial banking with activities commonly associated with investment banking in trying to serve the needs of its customers.

The bank will offer its corporate customers -- and a handful of private customers -- finance, risk-management, market-making and what it calls transactional support, such as cash management.

In a recent interview, Theobald said his goal is to eliminate much of the bureaucracy in what he called "an evangelical effort to focus on what the customer wants. Any organization of more than two people ends up corrupted by the need to keep the inner wheels moving and forget why you're in business."

One top executive, an ardent supporter of Theobald, said his main concern is that top officials at Continental, as at all commercial banks, will have trouble shifting from administering large cadres of employees to dealing directly with clients to determine their needs and devise "products" -- the industry's term for almost any service from a sophisticated lending facility to a checking account.

But the executive said most of his colleagues were excited last month when Theobald elaborated on his plan to the bank's top officials and announced the appointment of veteran Continental executives to three of the top four slots below Theobald -- chief financial officer, chief operating officer and the head of traditional banking operations.

A fourth post -- which will run the investment banking operations, those traditionally associated with the securities business -- will be filled later, presumably from outside Continental.

Some critics question whether Continental, or other major banks such as Citibank or Bankers Trust, can make money moving into turf traditionally controlled by securities firms -- especially at a time when Wall Street's bubble is bursting. But Theobald said the changes are not as sweeping as observers say. Continental will do what it has been doing for decades.

He said Continental, with assets of nearly $32 billion, will provide "modernized versions of what we've always sold to essentially the same customer base," composed of "600 to 800 companies and a couple of thousand institutional investors," he said.

Continental, once the nation's fifth-largest banking company and the largest commercial lender, was prevented from failing in 1984 by a multibillion-dollar federal rescue. It had made billions of dollars of bad loans, and was a major participant in hundreds of millions of dollars of loans made by Oklahoma City's Penn Square National Bank, which failed in 1982.

Today, as a result of the bailout, the Federal Deposit Insurance Corp. controls about two-thirds of the parent company's stock.

Theobald -- who was vice chairman at Citicorp and its subsidiary Citibank, the nation's biggest bank -- admits that Continental's public image has been tarnished by the 1984 debacle, a de facto failure that was by far the largest in the nation's history.

Its public image took another blow in October, when the bank said a newly acquired subsidiary, First Options of Chicago Inc., took a big loss when several of its major customers defaulted on loans during the stock market plunge.

The bank earned $60 million in the third quarter. But as a result of a $90 million hit from First Options, Continental probably will post a loss for the fourth quarter.

But Theobald said Continental's image with its customers "remains good." It is more distant relationships, say with stock market investors, that there is "less confidence" in Continental, Theobald said.

He said a recent survey of chief financial officers by Goldman Sachs, the large Wall Street investment banking firm, rated Continental among the top dozen commercial banks providing financial services to larger companies.

"We have a substantial and profitable business" among large corporations, he said. "If the question is will customers do business with us, the answer is that they do."

Theobald said that as commercial banking becomes deregulated, banks will increasingly seek niches to serve, rather than trying to serve all types of customers. Other banks have made, or will make, decisions such as Continental has to "concentrate on the lines of activity they do best," Theobald said.

Other businesses have long done that, he said. "Nobody looks at Garfinckel's {the Washington area retailer} and expects them to be a manufacturer and distributor... . Procter & Gamble is not a great consumer marketing company because it is also making industrial products.

"Continental has essentially been an industrial supplier," he said.

John Swearingen, the retired chairman of Standard Oil Co. (Indiana) who was installed as Continental chairman by the Federal Deposit Insurance Corp in 1984, directed the purchase of several Chicago area retail banks and was in the process of purchasing several more when he handed the reins to Theobald last summer.

Within weeks Theobald, a 27-year veteran of Citicorp, halted the transactions and announced that Continental would sell the banks it already had acquired.

Theobald said in a recent interview that the foray into retail banking did not make corporate sense for Continental because of its orientation toward large businesses and, given the rising costs of buying small banks, made no economic sense either.

"When we started, the banks were selling at 1 1/4 times book {value}. Now it's 2 1/2 times book. The economics didn't work. We weren't strenghtening the bank but weakening it."

Although some observers have said that Continental's reliance on large depositors rather than small customers made it vulnerable to the run that sank it in 1984, Theobald said Continental's problem then was not its depositors but its loan portfolio.

It's a "myth" that hot money caused the failure, he said. "The old Continental Illinois National Bank got into trouble because it had more bad loans than net worth. Whether that's recognized in 12 days or 180 days doesn't make a difference. The run didn't sink Continental, its insolvency did."

Continental insiders said the giant bank company still is working out the details of the plan to offer traditional banking services and to simplify the internal structure of the institution.

Theobald cited several examples of the updated versions of traditional banking functions that Continental will offer big customers:

"We used to make a loan and hold it. Now we'll hold 20 percent" and sell the rest to other investors. "We used to make fixed-rate loans. Then we found we couldn't take the volatility. Now we make floating-rate loans," but also sell borrowers services to enable them to manage their risks of rising interest rates, such as selling futures contracts or a ceiling on how high the rate can rise. "We used to haul cash around in a truck. Now we accumulate electronic information."

Everything Continental will offer has "evolved from services we've long been in. We will not become a Pepsi bottler."

Perhaps the biggest change will involve Continental's overseas activities. Like most big U.S. banks, Continental moved overseas to service U.S. corporations that were investing abroad.

Now, he said, Continental's international strategy will concentrate on companies and institutions that invest in the United States.

Instead of supporting U.S. investment abroad, Continental will aim "to support Europeans, Asians and Japanese investing in the United States -- whether directly {by building manufacturing plants, for example} or portfolio {by buying securities}. We are in a world where, like it or not, global economies are really integrated."

An avid follower of Continental's new strategy is FDIC Chairman L. William Seidman. Seidman called the plan "a very well-done document."

In an interview this week, Seidman, former dean of the business school at Arizona State University and a top adviser to President Ford, called the strategy "a textbook example" of seeking out one's customers and providing services tailored to their needs.

Seidman is rooting for Continental's plan to succeed and woo back investors. The bank company's stock is trading at about $3 a share -- less than the $4 the FDIC paid when it rescued Continental. The higher the bank's stock rises, the more the FDIC can eventually realize when it sells its stake in Continental, reducing a loss to its insurance fund that is now estimated at between $1.7 billion and $1.9 billion.