With a second year of the COVID-19 pandemic under our belts, the state of US Community banks through 2021 and into 2022 has changed. They’ve gone from business as usual, leaning into their tried-and- true relationship banking model to a shake-up that kept their customers outside the branches and brought PPP small business loans in.

For these institutions, loosely defined as locally owned banks with less than $10 billion in assets, COVID-19 has challenged their way of doing business, but it’s also forced them to revamp and reimagine, with overall good results.

In this community banking update, we share what the data and bankers themselves say about the challenges and opportunities expected for 2022.

Community Banks are Only Bank in 25% of US Counties

Community banks have long marketed their value proposition as building deep and enduring relationships with customers. They’ve touted local ownership. Investment in small businesses. Civic involvement. Personalized attention. The pandemic gave them an opportunity to demonstrate this commitment.

Their importance to the banking industry and to consumers can’t be overstated. According to an article on community banking by the Kansas City Fed, in 25% of US counties, community banks are the only commercial bank available. In rural areas specifically, community banks operate 75% of the bank branches and hold 2/3 of the deposits.

Community Banks Provide Much of Small Business Lending

On the other side of the balance sheet, community banks have always been a Herculean source of credit, relative to their size, and they stepped up in a historic time of need to support small businesses.

• Prior to COVID, community banks already underwrote 40 percent of all small business loans, even though they only account for 15% of all banking assets.
• During COVID, community banks funded 60% of all PPP loans originated.
• They provided 87 percent of total PPP loans to minority-owned businesses, 81 percent to women-owned businesses, and 69 percent to veteran-owned businesses.
• Eight percent of community bank total assets were loaned out to PPP recipients compared to 2% of total assets for large lenders and 1% of credit union assets.

Larger commercial banks lagged in their response, setting up operations and procedures to originate and fund PPP loans. Community banks, on the other hand, pulled staff from other departments and manually processed the PPP applications as they came in from businesses desperate for assistance.

“In my conversations with community bank CEOs, several reported to me that early in the pandemic they directly contacted every single one of their business and consumer loan customers, taking the time to check in with each one to see how they were doing, and what they needed,” said Fed Governor Michelle W. Bowman.

Community Bank Numbers Are Shrinking  

As valuable as community banks are to the fabric of the US economy, their physical presence is, nonetheless, shrinking. Although they currently account for 97% of all bank charters, they hold a much smaller share of the market…just 40% of bank branches, 18% of bank loans, 14% of deposits and 13% of all bank assets in the country. In the past 20 years, their numbers have fallen by half.

Just 89 de novo banks have launched since 2010, (still a mere 3% replenishment of previous numbers), and 3 of 4 have been in large-population areas that, presumably, offer greater opportunity for lending and deposit growth.

There has been an uptick of de novo bank charters across the board in 2021, but the numbers are nowhere near pre-2008 numbers. So, with a smaller cohort around the country but a whirlwind of evolving concerns that include technological adaptions driven by the pandemic, changing customer behavior and expectations, fluctuating market and economic signals and emerging challengers like neobanks and non-bank players, community bank concerns are adjusting too.

Earnings, Low Net Interest Margin Lead CEO Concerns

With the influx of PPP recipients and significant deposits on their books, community bankers now find themselves with a different problem since COVID exploded – they are sitting on boatloads of cash and few takers for loans.

Today, according to Independent Banker’s Community Bank CEO Outlook 2021, community banks are holding close to $900 billion worth of deposits in transaction accounts, up from $513 billion. Core deposit growth, once cited as a top challenge, has been replaced by worries about low net interest margin, cited by 65% of community bankers as their biggest concern.

Bankers admit that competition for new sources of non-interest revenue, including fee income, is going to be intense in 2022, and measures to increase efficiency have to be weighed against their impact on the customer experience.

High-Touch Community Banks Need High Tech, Too

Mike Moderski, a 30-year veteran of community banking and founder of Digital First, LLC, a company currently working to establish the first de novo bank in the state of Wisconsin since 2008, believes community banks will need to balance “high-touch, high-tech” banking to remain relevant to consumers.

Moderski’s idea for a new bank will be focused on community involvement but offer the ease of next-generation technology built on a modern, more nimble core banking system.

“Community banks need to leverage technology and data so they can do a better job identifying and helping customers meet their financial goals,” said Moderski. “Banks that are able to do that will stand out.”

Core Banking Systems Hinder “Know Your Customer” 

Community banks boast about knowing their customers better than other financials. When it comes to taking advantage of that information, however, most legacy cores do a woefully inadequate job. Without insightful data, made available in real-time, there are missed opportunities to help clients and grow the bank by matching client needs to products and services that save them time or money.

According to the 2021 CSBS National Survey, community bankers believe legacy core systems excel at security and risk management, but fare poorly when judged on cost, contract flexibility, innovation and speed to market for new offerings. Nearly 34% of community bankers are unsatisfied to some degree with the speed of innovation offered by their core banking system. Speed to market for new products was another sore spot for 27% of respondents.

While nearly 40% of community bank executives said keeping up with technology needs or advancements was a top business challenge in 2020, only a quarter are prioritizing technology in 2021. This was nearly unchanged from the year prior, indicating that there’s a disconnect between the belief that new technology is important and taking action to implement it.

Millennials’ Inherited Wealth to Impact Community Banks

But acting on what customers want, going forward, is going to be a vital exercise for community banks. As noted a year ago in the survey, a change is coming, according to Keith Nolan, VP partner and alliance sales, FIS Payments:

“Millennials are in line to inherit $30 trillion from their Baby Boomer parents. How they decide to bank this money—or not bank this money — will largely determine the success or failure of community banks.” 

As this wealth is transferred, the community bank’s main customer base is becoming this younger segment that expects frictionless, intuitive experiences.

For example, 43% of Millennials have abandoned online banking when the experience is too slow or confusing or even if they simply can’t remember their password. A third of those are not shy in telling others about their negative experiences, filing a complaint or moving on to another financial all together when dissatisfied.

While the experience on top of the glass must be flawless for this younger generation, that’s not enough. Millennials expect more offerings that help them meet their financial goals as well. 83% of Millennials said they would switch banks for better rewards, like higher interest on checking accounts, cash back on purchases or refunds on out-of-network ATM fees.

Consumers Highly Satisfied With Community Banks & Credit Unions

Building customer relationships remains the most powerful tool community banks have in their arsenal. In the Federal Reserve’s SBSC Employer Firm Report, which focused heavily on the effect of the pandemic on the financial condition of employer firms, surveyed business loan applicants reported greatest satisfaction with credit unions (81%) and small banks (80%) compared to 68% satisfaction with large banks and just 36% for online lenders.

In the EY Consumer Index, which captures how the pandemic is changing consumer behavior toward banking, more than half surveyed said future purchasing would be influenced by banks actively supporting the community, being transparent, and doing good for society. That story is an easy win for community banks, if they are intentional about using marketing, public relations and social media channels to tell it. And yet…

Fintechs Gaining Trust of Consumers

Fintechs are making in-roads with consumer trust. Various surveys report various results, but research from EY learned that 37% of their respondents now say a fintech firm is their most trusted provider. That number climbs to 51% for Millennials.

While community bankers tend to see other community and regional banks as their biggest competitors, this research highlights the growing willingness of consumers to consider neobanks and non-banks for their financial needs.

Next: Community Bank Challenges and Opportunities in Core Banking Technology 

In our next community bank series blog post, we further examine additional data on the challenges community banks face in 2022 with some ideas on how technology can empower them to gain efficiencies, modernize their technology, minimize the need for added talent and resources while delivering personalized banking products and experiences that help attract and retain community bank customers.