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Small banks: Big challenges and big opportunities

Mary Ellen Biery
February 23, 2023
Read Time: 0 min

Relationship focus helps CFIs 

Small banks can leapfrog competitors and better serve their communities by combining their unique advantages with smart management and partnerships.

You might also like this on-demand webinar series: "Tackling common credit risk questions during challenging times"



Managing through many issues

Executive leaders of small community financial institutions face complex issues, considering the economic environment and ongoing industry and regulatory changes. Declining deposits, higher cost of funds, and ever-increasing competition are just a few challenges these executives are managing.

Meanwhile, leaders at small banks recognize that their institutions play a vital role in helping community businesses and individuals not only weather uncertainty but also thrive. The local decision-making and strong relationships with customers that are hallmarks of small community banks provide leaders with fresh chances to positively affect their towns, cities, and regions while growing a healthy institution.

How can community financial institution leaders manage their challenges and seize their opportunities at the same time? By combining the best of their banks’ unique advantages with smart management and partnerships, small banks can move ahead of competitors and better serve their communities.

Deposits leaving

Increased non-core funding

After the pandemic’s relief-related surges in deposits, no one expected community bank balance sheets to remain flush forever. However, with interest rates topping 4% for savings accounts at some direct banks, competition for deposits has ratcheted up. Balance runoff is picking up speed, according to financial consulting firm Curinos.

For smaller banks, longer-term industry consolidation trends and competition are also eroding deposit market share. According to the Federal Reserve Bank of Kansas City, community banks’ deposit market share dropped to 15% in 2022 from 22% in 2013.

At the same time, asset-based liquidity options at some community banks have been constrained by large unrealized losses in available-for-sale securities. That has led them to take on higher-cost non-core funding, primarily via short-term Federal Home Loan Bank (FHLB) borrowings and brokered deposits.

In such an environment, community banks should focus on the power of their relationships with customers, according to Kent Kirby, a retired banker with 39 years of experience in all aspects of commercial banking; lending, loan review, back-room operations, portfolio management, portfolio analytics, and credit policy. Even if a customer moves their checking or savings accounts, the bank remains connected to them via loans or other products, noted Kirby, now Abrigo’s Director of Client Experience.

“They took the deposits out because they want more money…but it doesn’t mean they don’t want to be your customer,” he said. “Think about the big picture – the relationship. That doesn’t necessarily go away because the deposits do.”

“Think about the big picture – the relationship. That doesn’t necessarily go away because the deposits do.”

However, he said, community financial institutions need to ensure they aren’t giving customers a reason to leave other than for pricing. They can do that by continuing to foster a relationship that meets the customer’s needs with quick decisions and personal attention.

Connect with customers

Fostering relationships to drive growth

Bankers can personally connect with customers to meet their needs and make fast, financially sound decisions on new loans and accounts if they aren’t manually keying in data repeatedly and chasing down documents. Technology through a trusted partner that automates those and other tasks frees up staff “for what you’re really paying for, and that’s business development,” Kirby noted.

“I don’t want my veteran bankers writing a credit memo,” he said. “I want them out spending time at the doughnut shop or restaurants talking with customers. When all of the activity around underwriting is done by loan officers, that means they are doing that when they should be on the streets getting what deals they can.”

Challenge: Growing in shrinking markets

Besides being more efficient, technology also creates the ability to grow in or out of your market, which can address another major challenge of smaller banks: demographic changes such as an aging customer base and depopulation of rural areas. Rural communities where most small banks are located have a greater share of people over the age of 65 than urban areas.

Younger customers who may have an account now at the bank could need a business loan, a mortgage, or another product the bank offers at a later date. The technology helps meet their needs for convenience and accessibility while allowing the bank to retain a more personal touch with those who need more attention. The best lending software for small banks, for example, is flexible enough that it can be customer-facing for only those product types the bank chooses.

“People have other options,” Kirby said. “If you don’t take that into account, you’re going to lose customers out the back door and never see other prospects because they might like you, but they can’t get to you.”

At the same time, the technology can reduce to seconds the time it takes for routine tasks like adding information from tax returns and financial spreading.

The result? A bank can reach more and new markets, even if it doesn’t have the total number of branches or marketing budget larger institutions have.

The result? A bank can reach more and new markets, even if it doesn’t have the total number of branches or marketing budget larger institutions have.

Worried about complying with the CFPB 1071 rule? Check out our 1071 compliance resources.

Using technology

Competition on all fronts

In addition to competition for customers, many small banks face competition for talent. “A lot of community banks are in some rural areas, so they say, ‘The real issue is I can’t bring anybody here. I can’t pay them enough to come to Henderson, Texas, or Lebanon, Missouri, for example,’“ Kirby said. “So staffing becomes a big issue, and the staff they have are getting older.”

When technology takes care of routine, non-relationship-focused tasks like spreading, the bank can continue to grow its portfolio without necessarily adding another hard-to-fill position. This growth can enable the bank to remain independent so it can continue serving its community and the businesses in it.

While consolidation is a significant trend affecting small banks and certainly an option for many, it doesn’t always best serve the needs of the community.

Community banks are “outsized providers of credit to agricultural and commercial borrowers, including during periods of economic stress — as demonstrated by the relative stability of small banks’ business lending during the global financial crisis (GFC), and the significant role they played in intermediating emergency relief funds during the COVID-19 pandemic,” according to Kansas City Fed researchers.

Community banks account for:

  • 32% of commercial real estate loans, including 78% of those for less than $100,000
  • Over 90% of commercial bank farmland loans of $500,000 or less
  • 42% of commercial and industrial loans ranging from $250,000 to $1 million

The smallest banks also accounted for an outsized proportion of approved Paycheck Protection Program (PPP) funds.

Small banks play an even more significant role in rural communities, where community banks operate 72% of all branches and have two-thirds of all deposits. When consumers and businesses in these areas either begin to feel the pain of a weakening economy or find ways to grow despite it, they count on the relationships in their communities.

“The community bank understands its community. And the worst thing you can do to your community is to go away.”

In other words, communities need community banks more than ever. With the right resources, growth opportunities are attainable despite current economic and industry challenges.

“The community bank understands its community,” Kirby said. “And the worst thing you can do to your community is to go away.”

Learn more about navigating the complex landscape of credit risk management. "Return to basics: Asking the right credit risk questions.".

About the Author

Mary Ellen Biery

Senior Strategist & Content Manager
Mary Ellen Biery is Senior Strategist & Content Manager at Abrigo, where she works with advisors and other experts to develop whitepapers, original research, and other resources that help financial institutions drive growth and manage risk. A former equities reporter for Dow Jones Newswires whose work has been published in

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About Abrigo

Abrigo enables U.S. financial institutions to support their communities through technology that fights financial crime, grows loans and deposits, and optimizes risk. Abrigo's platform centralizes the institution's data, creates a digital user experience, ensures compliance, and delivers efficiency for scale and profitable growth.

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