Margaret Beckett, President of the Board of Trade, ruled that the takeover would be against the public interest as it would give London Clubs an 80 per cent share of the business in London's lucrative up-market casinos.
London Clubs already controls a string of these clubs including Les Amabassadeurs and the Ritz club while Capital owns Crockfords and the Colony club
London Clubs had launched its bid earlier this year but it had lapsed after the previous government referred it to the competition authorities. Regulatory clearance would have paved the way for a fresh bid.
LCI's chief executive, Alan Goodenough, said the ruling was "disappointing" and based on "flawed logic". He argued that strict regulation made it impossible for a company to exploit its dominant position. The MMC report said that the deal would give the enlarged group the opportunity to reduce the quality of services and increase prices while raising the barriers to entry.
Analysts said the decision would enable LCI to concentrate on its overseas expansion. It is set to open a casino in Las Vegas and is pitching for a licence for another in South Africa and at Niagara Falls.
The Government's decision was welcomed by Capital Corporation which has been rocked by a series of staff defections and boardroom clashes.
LCI shares closed 16p lower at 386.5p while Capital Corporation fell 19p to 165p.