By Evan Sparks
Despite the Federal Open Market Committee’s recent rate cut, banks continue to operate in an elevated rate environment — and community bankers are feeling the rise in cost of funds. Nearly nine in 10 community bankers say cost of funds is a very or extremely important external risk to their bank — up 41 percentage points from 2022 — according to the Conference of State Bank Supervisors’ 2024 community bank survey released today. The share of bankers who reported cost of funds as very or extremely important slightly edged out those reporting regulation and net interest margin as similarly important external risks. Eight in 10 respondents said persistently elevated inflation was having an extreme or moderate effect on their cost of deposits, with 59% calling inflation “extremely impactful.”
Cost of funds in 2024 had risen to 2.85% in March 2024, up from 2.24% in December 2023 and 0.74% in December 2020, according to FDIC data. Bank-to-bank competition for deposits was ranked as the biggest challenge in attracting and retaining core deposits. A growing share of community banks — 49%, up from 39% in 2023—use brokered deposits (including reciprocal deposit networks). According to FDIC data, community banks’ reciprocal deposits nearly tripled from 2020 to 2024 as clients sought to maintain higher balances of insured deposits. However, the survey showed reluctance on the part of some bankers to use brokered deposits, with a quarter reporting high or very high stigma associated with them and another quarter reporting “moderate” stigma.
Despite the challenges, community bankers felt better poised to deal with the effect of inflation on the securities portfolios, with only 36% reporting a moderate or extreme effect. About a quarter of respondents said inflation — whether it persists or fades — will be difficult to manage. More than half of community bankers said inflation was likely to persist but that it would be manageable for their banks. When asked about how long elevated inflation levels would persist, about half said it would decline to the Fed’s 2% target by the end of 2025, while a third expected it to persist beyond 2025 and the remainder were unsure.
Continuing a theme from previous surveys, cybersecurity remained community bankers’ top internal risk concern, with 96% calling it very or extremely important. Eight in 10 cited technology implementation and cost as a very or extremely important internal risk, while the share of bankers reporting liquidity as a top internal risk fell six points from 2023 (but remains elevated from 2022).
Product innovation and development
Community bank adoption of key products and services — and plans to adopt in the near future — were mostly unchanged from previous surveys. For the first time, the survey asked about plans to adopt the FedNow payment service. Nearly a quarter of community banks currently offer the capability to receive FedNow payments, and an additional 44% plan to add it within the next year. Just 9% of respondents currently offer FedNow sending capabilities, although 39% plan to offer it in the next year. A little over half of community banks said they do not plan to offer FedNow sending capabilities in the near future. More than 82% of respondents said that expansion of mobile banking capabilities would be one of the most promising opportunities for their bank over the next five years.
When looking at technology adoption, banks ranked operational efficiency tools like e-signatures (67% very or extremely important), remote deposit capture (66%) and integrated loan processing systems (57%) as most important for their banks. The lowest-ranked technology options were financial planning (17% very or extremely important), interactive teller machines (13%) and offering banking as a service through fintech partnerships (10%). Nearly half of banks cited cost and implementation complexity as the most significant impediment to adopting new technologies. About 14% said limitations of their core provider were the biggest obstacle. While respondents were generally satisfied with most of their banks’ technology tools, nearly a quarter said they were somewhat or extremely dissatisfied with their core providers, and 42% said that a cloud-based core would be a promising opportunity for the bank in the next five years.
The community bank competitive landscape
Fellow community banks remain the primary competitor for community bankers across most products and services, although regional and nationwide banks with a physical presence in-market were narrowly ranked as the top competitor for single-family mortgage loans and wealth management services, and by a wider margin the top competitor for payment services. About three in 10 community banks said that credit unions were their top competitor for small-dollar unsecured loans, and a similar share ranked the Farm Credit System as their top competitor for ag loans. Small-business loans remain a strong focus area for community banks vis a vis their larger bank competitors.
The pressure of higher interest rates on bank valuations has driven the number of mergers and acquisitions down to about two-thirds of pre-COVID levels; just 6% of survey respondents reported receiving and seriously considering an acquisition offer in the previous year. Of the limited number of banks that did receive and consider an offer, the top-cited reasons were inability to achieve economies of scale, regulatory compliance costs and costs of doing business. Meanwhile, 12% of community banks reported making an offer in the previous 12 months. By far the top-ranked reason to be an acquirer was to achieve economies of scale. A little over half cited new market entry and operational efficiency as an extremely or very important reason for acquiring.
