What Challenges Are Community Banks Facing in 2023?

Dealing with issues stemming from macroeconomic headwinds to uncertainty in the banking system, community banks have been facing a variety of challenges in 2023. To gain a clearer understanding of the industry, the Conference of State Bank Supervisors (CSBS) and state banking regulators once again conducted the Annual Survey of Community Banks (PDF) and presented the findings at the 11th annual Community Banking Research Conference in October.

 

A Wealth of Information about Community Banks

Beyond the external risks, internal risks and the look at competition in this post, the 2023 Annual Survey of Community Banks includes other in-depth data about small-business lending, funding, acquisition activity and more.

Read the full report (PDF) and individual banker insights about these topics.

More than 450 U.S. community bankers from across the country participated in the survey issued earlier this year and responded to questions about a wide variety of topics, including external and internal risks and competition. The annual survey also features insights from five community bankers who add firsthand perspective to the data.

Citing 2023’s interest-rate environment, I. Lise Kruse, board chair of CSBS and commissioner of the North Dakota Department of Financial Institutions, noted that concerns about net interest margins—net returns on banks’ earning assets—remained high along with related segments.

“The 2023 Annual Community Bank Survey shows that while net interest margins continue to be the top external challenge for community bankers for the second year in a row, their concerns in three related areas have risen dramatically,” she said in a letter introducing the survey findings. Kruse noted that cost of funds, core deposit growth and liquidity were those related segments.

External Risks

The survey responses came from banks with less than $10 billion in total assets, a benchmark for community banks under the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010. In addition, most responses came from state-chartered banks, CSBS survey findings said.

In discussing external risks, community bankers placed the highest importance on net interest margins, cost of funds, core deposit growth and regulation.

Survey question: How important are the following external risks to your bank today?

SOURCE: 2023 CSBS Annual Survey of Community Banks (PDF).

Net interest margins

The figure above shows that the largest percentage of respondents, nearly 89%, listed net interest margins as either “extremely important” or “very important.” What’s more, the overall percentage was little changed from last year’s survey (PDF).

Cost of funds

Cost of funds was identified as the second most important external risk, with nearly 86% of respondents calling it either “extremely important” or “very important.” This percentage rose sharply from the 2022 survey percentage of approximately 48% for the category.

Core deposit growth

Nearly 84% of respondents named core deposit growth as either an “extremely important” or “very important” risk. That number was significantly higher than the approximately 38% in last year’s survey.

Regulation

Regulation continued to factor heavily in the views of community bankers. In the survey, more than 81% of respondents said it was an “extremely important” or “very important” external risk, slightly higher than the 77% reported in the 2022 survey.

Internal Risks

While every bank is unique in terms of market, size and strategy, the annual survey data highlighted several internal risks that resonated with the majority of banks.

Cybersecurity

As can be seen in the figure below, bankers identified cybersecurity as the top internal risk, with nearly 92% citing it as an either “extremely important” or “very important” internal risk. Though the number is high, it is down from about 96% in 2022.

Survey question: How important are the following internal risks to your bank today?

SOURCE: 2023 CSBS Annual Survey of Community Banks (PDF).

Liquidity

Ranked No. 2 among internal risks was liquidity, with nearly 84% of respondents indicating that it was either an “extremely important” or “very important” risk, up sharply from 35% in the 2022 survey. To give a historical perspective, the CSBS report said liquidity was last seen as a top risk in the 2019 annual survey.

“Liquidity is, of course, a concern for all of us,” said Dylan Clarkson, president and CEO of Pioneer Bank & Trust in Belle Fourche, S.D., one of the five bankers interviewed to provide insight. “As best we can, we must make sure that we’ve got ample sources of liquidity and a stable core deposit base.”

Staffing and Technology

Staff retention, as well as technology implementation and costs, were virtually tied for third in terms of the bankers’ ratings of internal risk categories, with more than 76% of community bankers considering them either “extremely important” or “very important” internal risks.

Competition

Although the number of banks has continued to decline, competition for banking products and services has increased significantly. Community banks may have experienced a retrenchment, the CSBS report said, citing survey respondents who said other community banks were their primary competitors across seven of the nine product and service lines listed in the 2023 annual survey. In comparison, community banks in 2022 were viewed as the primary competitor across only six of the nine product and service lines in the survey.

In taking a closer look at the data in the table above, the share of community banks that indicated other community banks were their primary competitors for small-business loans increased by more than 6 percentage points since last year. In addition, CSBS noted that more community banks viewed other community banks as their primary competitors for small-dollar unsecured loans—a business line that, prior to 2023, primarily belonged to credit unions.

Community bankers also called attention to transaction deposit flows. About 48% of community banks named other community banks as their primary competitors in 2023 for transaction deposits—those that can be immediately withdrawn—which was about 3 percentage points higher than in 2022. In terms of nontransaction deposits, the number of community banks that viewed other community banks as their top competitors was slightly lower than last year. However, there was a small uptick in those who named in-market regional or national banks as their top competitors for nontransaction deposits.

“Loyalty that once existed in banking is eroding. All banks will be faced with challenges in raising and retaining deposits,” Orv Kimbrough, chairman and CEO of Midwest BankCentre in St. Louis, said in an interview in the report.

He noted increasing competition from “nontraditional competitors” offering attractive rates and digital experiences.

To compete, Kimbrough said, “Community banks will have to adopt technology and the right level of intensive personal service to improve the customer experience.”