TLDR In the past few years, we’ve seen a decreasing number of community banks through consolidation, acquisition, and closing. In the current state of our economy, we may face larger and more beneficial collapses. Of similar importance, we may see smaller and more localized banks struggle to survive or compete already with record closings in 2021. In this article, we shed some light on the current issues facing the community banking industry and some ideas on how to solve them.
At Redbud, we are focused on assessing founders, but our team still spends a great deal of time researching industries. Customer discovery with industry experts has by far been the most invaluable source. It doesn’t make sense to keep all the research to ourselves, so we’ve decided to start a “Customer Discovery Article Series” where we take sound bites of experts and our industry commentary into a 3–5 minute intuitive read.
Community banks are locally focused as they direct their loans toward neighborhoods where their depositors live, helping local communities thrive. Community banks focus on the needs of local families, small businesses & farmers to aid in the growth of their community.
Due to the size of community banks, they are hindered from taking any or a few risky bets (i.e., community banks have a small net worth). Community banks often start syndicates (i.e., a pool of capital contributed to by more than one bank) with other community banks to attract bigger and/or riskier clients.
Large Banks are defined as the opposite. They tend to lend and take deposits in multiple states and cities. While community banks may offer a more localized and personalized service, larger banks tend to offer a more comprehensive banking experience.
Quick stats on how important community banks are:
Comprise 99% of all banks
Provide roughly 60% of all small business loans
Make more than 80% of agricultural loans
Have nearly 50,000 locations nationwide
Employ nearly 700,000 people
Higher net promoter score than large national banks
Community banks lack in areas where larger banks thrive. They are often behind on technological services, offering outdated technology. As well as offer a smaller suite of products compared to larger banks. For example, some larger banks may offer rewards or wealth management services, whereas community banks lack the talent and resources to do so.
Community banks struggle to grow due to their reliance on outdated technology providers, smaller margins due to high manual labor costs and office space, and attracting top talent. Unlike large national banks, community banks have a smaller budget to spend on in-house innovation and outsourcing new technologies. The lack of innovation impairs community banks’ ability to work with new fintech products. In addition, outdated technology increases the need for manual work and creates an archaic environment, decreasing the bank’s ability to attract top talent.
With 21% of venture capital dollars or $131.5B invested in 2021, one would assume that there are intuitive technologies for community banks to adopt. It is the complete opposite, the adoption rates are eye-dropping. Also, there is a massive opportunity for community banks to adopt external technology because less than half have in-house technology.
We spoke with representatives at multiple community banks to gain more insight into the issues within the industry and what can be done moving forward. Spencer Hockman, a loan officer at Central Bank with years of experience in the options market and lending services, agrees that a leading challenge for small banks is keeping up with current technology. They might not have the asset base that customers want.
For the latest 12 months, the Community Bank Consolidation rate has been 3.7%. Spencer has noticed this trend and believes one main reason is the technology problem. We see a rise in NeoBanks and similar offerings from larger banks, leaving smaller banks in the dust with their offerings.
Although Spencer is optimistic,
“Central Bank has done a great job of responsibly growing, increasing our asset size to 20-billion dollars, while maintaining our community focus and local decision making. An asset base of this size coupled with our community banking model, allows us to offer our customers easy to use technology and excellent customer service that help ensure an enjoyable banking experience.”
In our current economic environment, community banks may provide a substantial benefit. Central Bank plans to be there for its customers during these trying times. Looking out for borrowers as rates continue to rise and coaching them in a rising rate environment. This is a service that may not be offered widely among larger banks.
“Regulatory agencies determined this systematic risk was identified as a significant issue during the Great Recession. While these banks have more capital than in the early 2000s, they have an even larger share of deposits, creating more of a systematic risk.”
According to Chris, community banks have a significant advantage over larger banks with their ability to offer superior customer service through relationships developed over multiple years and quick local decision-making. The real issue isn’t retaining customers but acquiring and upselling them. To do this, Chris believes community banks need to leverage new technology and lean into new communities.
“Identifying the right third-party relationships (e.g., software & fintech providers) can be key to offering a full suite of products without additional risk,” says Chris.
As mentioned above, community banks must find a way to differentiate themselves from larger banks or the competition. If they struggle to offer competing technology, they could offer unique solutions to common problems within the industry. This way, they might see an influx of new customers beginning to use their products and services.
A few problems/opportunities addressed from customer discovery:
Fraud detection: Fraud seems a huge issue across all banking systems but is much more costly for community banks with a smaller margin of error. A potential solution could be AI that could sort through fraudulent transactions based on the borrower’s previous activity, there would be a massive decrease in fraud and scams. Community banks may also see this as beneficial, as this may add to the user experience during times of personal and economic crisis.
Backoffice: There could be an advantageous solution in back-office automation for community banks. Manual tasks other than providing excellent service can be developed to create a faster and more seamless workplace. A possible solution could be a product that automated certain backroom functions (e.g., IT, Compliance/Risk Management, settlements, etc.) that are still done in a very manual way. Even small features such as an online wire or ACH option as opposed to going into the bank to send a wire.
Banking Systems: Community banks use monolithic and archaic banking systems making it nearly impossible to work with various fintechs. In addition, the lack of updated technology increases the need for manual labor when adding additional products. Plug-and-play automated banking systems built for community banks with open APIs would allow small banks to move quickly and work with fintechs. Currently, 40% of banks do not have an API strategy. This also hinders consumers’ ability to link their bank accounts with various platforms.
Generally, community banks are part of state banker's associations, which the banks rely on to help drive and identify innovation. For founders building products for community banks, it’s imperative to connect with associations as community banks do not usually have the in-house team to assess technology or the ability to integrate it.
Community banking is a very important sector of our country’s SMBs, farms, suburban families, etc. Approximately 14,820 incorporated places are home to less than 5,000 people, with 6,224 having less than a population of 500, according to the United States Census Bureau. Those are communities in which smaller banks thrive and are a large portion of the fragmented US communities. With the consolidation and wind down of community banks on the rise, although some may see this as favorable, community banks are a keystone to our economic system. Therefore, solutions must develop for our community banking system to survive.
Redbud VC is an early-stage venture capital fund and studio investing monetary and social capital in early-stage tech founders.
Co-Authored by Brett Calhoun and Yahav Sal!