For Community Banks, COVID-19 Brings Existential Concerns to Fore

By Evan Sparks

Amid the COVID-19 recession, business conditions were most often called the single biggest challenge facing community banks, according to an annual survey released yesterday by the Conference of State Bank Supervisors. More than a third of banks cited business conditions, followed at some distance by regulations (16%), competition (11%) and core deposit growth (9%). By comparison, core deposit growth was the most-cited challenge in the more halcyon economic times of 2019.

In response to those challenging business conditions amid COVID-19, 79% of community banks increased lending to small businesses and farms. This was visible in the swollen community bank balance sheets reported during the survey’s administration in June, with small business loans up 40% year-on-year. After joining the Small Business Administration’s 7(a) program for Paycheck Protection Program loans, 77% of community banks said they would remain in the program.

The commercial loan growth was accompanied by a 33% surge in transaction deposits, blunting prior years’ concerns over core deposit growth. Just over 45% of banks considered liquidity risk important or very important, down more than 12 points from last year, and banks were less likely to prioritize deposit growth over loan growth. Long-term demographic trends continued to worry banks, with 28% saying in-market depopulation was an important or very important impediment to attracting and retaining core deposits. While just 2% said they had an online-only division to gather deposits or loans, an additional 19% said they were considering it or planning to launch one.

COVID-19 drives tech, operational changes

Beyond lending, community banks took other actions in response to COVID-19. Seven in 10 implemented a work-from-home policy for staff whose jobs permitted it, and 47% increased their paid and unpaid sick and family leave offerings. Only 5% of community banks reduced headcount, and 3% added staff. Nearly every community bank (98%) restricted lobby access, and 23% closed at least one branch for a time. About a third of banks reduced or eliminated late-payment penalties on loans and fees on deposit accounts.

The need to enhance remote work and banking capability drove greater tech implementation at community banks. Online loan closing availability surged in 2020; the share that offered them rose from 6% to 20%, while the share planning to offer them in the next 12 months jumped from 21% to 29%. Despite the surge, the numbers still trailed online loan applications, with about 40% of banks currently offering them and an additional 29% planning to do so in the next 12 months.

The share of banks offering remote deposit capture rose eight points to 87%. Other technologies with widespread adoption among community banks were mobile banking (95%) and electronic bill payment (81%). Among transactional and advisory services, most community banks offered cash management (69%). Smaller shares of community banks offered personal financial management (39%), prepaid cards (28%), remittances (22%) or payroll cards (8%)—although 13% said they planned to add PFM tools in the next year. About 36% of community banks offer wealth management.

Banks dissatisfied with core costs, flexibility, innovation

With community banks reliant upon core processors to offer new technologies, the survey for the first time asked about satisfaction with core processing. More than four in 10 community banks said they were dissatisfied or very dissatisfied with the cost of their core processing, compared to just 27% who said they were satisfied. Likewise, nearly half were dissatisfied or highly dissatisfied with their cores’ flexibility, compared to just 20% who were satisfied. Cores were slightly more highly rated on speed of innovation (35% satisfied/very satisfied versus 39% dissatisfied/very dissatisfied) and the ability to roll out new products and services (33% satisfied/very satisfied versus 37% dissatisfied/very dissatisfied).

While 57% of banks relied solely on their core provider for digital banking products, 30% rely on third parties in addition to the core and 12% are seeking other non-core providers. About as many community banks said they were dissatisfied with their cores’ third-party compatibility as said they were satisfied—but banks were three times likelier to be very dissatisfied than very satisfied. Four in 10 banks said that their core contracts were impediments to fintech partnerships, either because of a lack of API access, contract exclusivity provisions or both. Nearly 78% said that getting more information about core providers from the banking agencies that supervise them would be helpful—a policy priority that Federal Reserve Governor Miki Bowman raised in remarks at an ABA event earlier this year.

M&A slows down; compliance costs stay flat

The survey showed declining M&A activity among community banks, with 10% of banks receiving an acquisition offer (down from 14% in 2019) and 13% making an offer in the past year (down from 25% in 2018). Among acquirers, factors rated important or very important in making offers were achieving economies of scale (77%), and in-market expansion (65%) and exploiting underused potential (55%). Among the reasons rated important or very important for entertaining an offer to sell were struggles with economies of scale (67%), costs of regulations (61%) and costs of doing business (50%).

The share of banks citing compliance costs as a reason to sell fell 10 points from last year. With several community bank-focused regulatory relief provisions having gone into effect over the past few years, compliance costs as a share of total expenses declined or held steady in various categories. Fifty-five percent of banks said that Bank Secrecy Act risk was an important or very important risk, with 63% of banks citing burdens associated with BSA reporting as the most concerning issue.


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