A scant seven years ago, two of the three largest banks in the world were American. Today, all of the top 10 are Japanese and only one U.S. institution, Citibank, even manages to squeak into the top 25.

Are banks becoming another American casualty of global competition? Raising that specter, U.S. bankers are urging that they be given much more freedom to compete, asking Congress to lift restrictions on underwriting corporate and other securities, selling insurance and doing business across state lines. It is an issue that is expected to be at the top of the congressional agenda next year, following recommendations later this year from the Treasury.

"We have deregulated so slowly, we have lost a national asset that we used to have," declared Lewis W. Coleman, vice chairman of Bank of America, once the largest bank in the world but now an also-ran in the global size derby.

Thomas G. Labrecque, president of Chase Manhattan Bank, told Congress recently that "growing international competitive pressures have sparked a wave of regulatory reforms in other industrialized countries" that threaten to leave U.S. banks even further behind.

Moreover, he warned, "let me assure you that these problems are just as real for community banks across the country as they are for money center banks in New York. ... Just as local car dealers have to compete with Toyota and Volkswagen, U.S. community banks will soon find themselves competing with Sumitomo and Deutsche Bank."

The banks mentioned by Labrecque have grown rapidly, particularly Sumitomo Bank -- the world's second-largest with about $350 billion in assets -- in large part because Japan and West Germany have had strong economic growth and large trade surpluses, which have provided financial institutions with plenty of cash to lend abroad. Deutsche Bank is the biggest in West Germany with about $175 billion.

For comparison, Citicorp, the holding company that owns Citibank, has just over $200 billion in assets. Chase Manhattan and Bank of America, No. 2 and No. 3, respectively, in the United States, each have just under $100 billion.

Whatever the sizes involved, however, Labrecque appears to be sounding something of a false alarm about competition for smaller banks across the United States.

There is as yet no evidence that foreign banks can outdo American banks in this country in offering retail banking services to ordinary Americans. Even on the rare occasions when they have tried, their record of success has been decidedly mixed, banking experts noted.

Certainly neither Sumitomo nor Deutsche Bank has any plan for a competitive assault on community banks across the United States, two of the banks' top officials said.

"We have been in California since 1927," said Toshio Morikawa, senior managing director of Sumitomo, while attending a recent bankers' conference in San Francisco. "Most of our customers are Asian-Americans, Japanese-, Korean- and Chinese-Americans. We did not buy a bank, we started one from scratch." Sumitomo Bank of California is only the ninth largest in that state with assets of about $3.7 billion.

Hilmar Kopper, chairman of Deutsche Bank's managing directors, indicated that his bank has no intention of launching major new retail banking operations outside Germany, not even in other countries of the European Community when in 1992 banks based in any of the EC nations will be allowed to operate freely in any of them.

"You can do business in France with a few offices. You do not need to be there to do business with French companies," he said.

Swiss Bank Corp. began U.S. operations 50 years ago in New York and has $25 billion worth of assets here. Nevertheless, as Franz Galliker, its chairman, put it, "In Switzerland, our business is retail. Outside of Switzerland, it is wholesale."

Retail vs. Wholesale

Indeed, it is in wholesale banking -- lending to businesses of all types -- that international banking competition is fierce, not retail banking. Between 1980 and 1988, the foreign share of business lending in the United States doubled to 28 percent. Among broad industries, the foreign penetration of U.S. markets is greater in only one case -- leather goods -- according to economist Herbert L. Baer of the Chicago Federal Reserve Bank.

As a result of all the competition, no one is making much money in wholesale banking, particularly since banks everywhere are butting heads not just with each other but also with finance companies, securities houses and other firms offering access to capital markets.

In a sense, banks are even competing with their own best corporate customers, who instead of taking out a bank loan often write a promissory note called commercial paper, which is sold directly to investors such as money market mutual funds.

A.W. Clausen, who retired last month as chairman of Bank of America, offered one American perspective on wholesale lending both here and abroad when he said of Coleman, who directs the bank's global banking group, "He has our toughest job. The spreads are all on the retail side."

Clausen was referring to the spread between what it costs to raise funds to lend and what a bank gets when it lends them. The spread, less a bank's operating costs, represents its profits.

Similar sentiments came from Toru Kusukawa, deputy president of Fuji Bank, another Japanese giant with more than $300 billion in assets. "Retail banking is the core of our profitability," he said in an interview. "Wholesale banking is profitable, but it is a far smaller share than retail." But Fuji Bank's retail operations are virtually all in Japan.

One business's loss can be another's gain, however. Bank profits have been squeezed by all the added competition, but businesses, and state and local governments, have benefited from the cheaper cost of credit.

Against this backdrop, sorting out the international banking competitive puzzle requires considerably more than assessing the sheer size of an institution. Innovativeness, revenue and profitability may reveal as much or more about a bank's ability to compete at home and abroad than the value of loans on its books, according to banking experts. On those scores, American banks do much better than when ranked by assets.

In terms of innovativeness in new financial products -- such as for minimizing risks associated with changes in interest rates and packaging loans as collateral for new securities -- U.S. banks are widely regarded as world leaders.

As for revenue, Citicorp may have more than any other bank in the world. That was the case between 1985 and 1988, according to a study by the New York Federal Reserve Bank. While the bank's loan growth has been curtailed, it provides an increasing array of financial products all over the world and earns fees for doing so.

Meanwhile, it has expanded its huge retail banking base in the United States, and last year it earned more than $1 billion from its credit card, mortgage lending and other retail operations.

International rankings in terms of profits also depend on which years are included and which measure of profitability is chosen. The New York Fed found that in 1985-86, U.S. banks had the second-highest return on assets among large banks in seven industrial countries. For the 1985-88 period, U.S. banks ranked much lower because of large losses on Third World loans registered in 1987.

Some close observers of the banking scene say the real key to bank competitiveness depends more on general economic conditions than on banking practices.

E. Gerald Corrigan, president of the New York Fed, argues that the fetters on U.S. banks are only one reason -- and probably not the most important one -- that U.S. banks have slipped. "High and volatile rates of inflation, low savings and our weakened external position have all contributed to a financial environment that breeds difficulties at home and contributes to slippage abroad," Corrigan said last month.

"With regard to the latter, there is simply no question in my mind that one of the key reasons for the emergence of the Japanese financial institutions as so large a force in global markets is rooted in Japan's strong overall economic and financial performance," Corrigan told the Senate Banking Committee.

The Tie-In With Stocks

The sharp run-up in the Tokyo stock market that began several years ago gave Japanese banks, which unlike U.S. banks own large amounts of corporate stocks, the world's strongest capital base. As they accumulated more and more money, the Japanese banks could make many billions of dollars worth of new loans.

Large American banks, in contrast, generally are struggling with severely depressed stock values because investors are wary after a long string of losses on Third World loans, energy projects, agriculture and now, potentially, on commercial real estate and perhaps on so-called highly leveraged transactions related to corporate takeovers and buyouts.

Fuji deputy president Kusukawa said the rapid expansion of Japanese banks and particularly their rising share of commercial loans in the United States "is rather awkward for us." But he added, "A lot of American banks are selling their loans to us. They dispose of assets and go to much more juicy business elsewhere. ...

"Maybe they are not trying to increase assets. Complaints about this are not fair," he declared.

With their stocks prices depressed and large losses sapping their ability to build up capital by retaining earnings, big U.S. banks may not have been able to raise enough capital to permit them to expand their lending activities and increase their assets, even if they wanted to do so.

The big Japanese advantage in this area may be ending. The Tokyo stock market suffered a sharp setback this spring, and while it has rebounded, it is well below its previous peak. More important, investors no longer seem to believe that the market will keep rising indefinitely.

Said Kusukawa, "We can't increase our capital base as easily as we did, which means we can't increase assets as fast as we did."

Experts also note that American banks would not be alone in reaping the benefits if banking laws are changed. Japanese and other foreign banks operating in California or other states do so under the same regulations and laws as American banks.

If U.S. banks were to get more powers, as Chase Manhattan's Labrecque urged, foreign-owned banks doing business here would get the same added opportunities. U.S. banks would not necessarily become more competitive compared with foreign banks, although they would compared with American insurance companies, securities firms and investment bankers.

Learning From Experience

Fuji Bank's Kusukawa is concerned that the Japanese not repeat the American experience with deregulation. "Watching the risks American banks face, we have got to be cautious. We are in the position of American banks 10 years ago. Then they were big in lots of places" but that was before the extensive deregulation of financial markets in the United States.

"We want to learn from their experience," Kusukawa said earnestly. "We really want to be careful about this."