By FintechOS · October 15, 2021
7 minute read

Small banks, big challenges: How can community banks better serve customers?

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Key Takeaways:

  • Community banks must start to offer digital products and learn from neobanks
  • Branch networks are both a liability and an advantage

Digital challengers have cut the cord between a bank and its location or community, offering services which can be accessed by anyone, anywhere, at any time.

In an age of decentralized finance and globally distributed workforces, the idea of a bank that sits at the heart of its community can seem a little old-fashioned.

But community banks play a vital role in the financial ecosystem, particularly in the US. Today, a bank whose identity and customer base are defined by physical location is both a liability and a strength. Digital competitors have cut the cord between a bank and its location or community, offering services which can be accessed by anyone, anywhere, at any time.

Community banks have the opportunity to learn from neobanks when it comes to serving the customers of today, yet can also combine the innovative whizz-bangs of digital technology with a strategy that incorporates the timeless appeals of location and community.

At FintechOS, we’ve been thinking about how community banks can combine their ageless strengths with the very latest digital technologies and strategies. Read on for some ideas about how these banks can better serve their customers in 2021 and beyond.

Community and Context

Although the exact definition of a community bank varies, the phrase typically refers to an institution with less than $10 billion in assets and a focus on a local community. They are particularly important in the US, providing 97% of all services to banking customers, although this market share has declined from 98.8% in 2000. The number of community banks has also been in decline for more than 25 years, falling from 6,802 in 2011 to 4,750 in 2019, according to the most recent study from the Federal Deposit Insurance Corporation (FDIC).

However, community banks still have a fundamentally important part to play in both their local areas and the wider economy. A study of community banks in the US published in 2021 found that a “community bank presence has a direct effect on rural and micropolitan counties via faster employment growth” and may even boost a region’s “resilience to macroeconomic shocks”.

“Community banks had a significant impact on regional economic resilience during the Great Recession,” authors Luke Petach, Stephan Weiler and Tessa Conroy wrote.

“Counties with greater pre-recession community bank presence experienced smaller declines in employment growth and establishment births during the recession—an effect that is most pronounced for small establishments in rural counties. In contrast, home prices were substantially more resilient in metropolitan areas that had concentrations of local capital in the form of community banks.”

Community banks experienced a “bright spot” of loan growth during the pandemic. After US congress authorised the pay cheque Protection Program (PPP loans) to support businesses during lockdown, community banks processed more than half of the funds in the first round.

People in the US and around the world still rely on community banks, which may also benefit from the good will earned from decades of loyalty. Is this enough to survive in the digital age?

Challenges to Community Banks

The pandemic prompted five years of digital banking progress in just eight weeks, McKinsey reported last year. For community banks, this has supercharged the trends they were already facing, meaning that challenges must be faced now, rather than put off. Here are some of the problems facing community banks.

Demographics: Younger customers are more likely to switch banks than older clients, some of whom will have signed up for an account as a child and stayed loyal throughout their lives. This means that community banks may face an aging demographic. Attracting young, digital-first customers should therefore be a priority.

Physical branches: A branch on a main street once sat at the centre of a community – until the pandemic struck. Now that clients have been pushed into digital banking, it is not clear whether they will want – or need – to return to the old ways, making physical infrastructure an expensive and inflexible millstone around the neck of the business.

Analog Processes: Smiling faces behind a counter have long provided the gateway to banking services for users of traditional community-based financial institutions. But today’s customers are convenience-orientated and want to access services in the simplest, most efficient way possible – which typically does not involve visiting a branch. In-person services are now a turn-off for some customers, yet still required by older demographics, leaving community banks in a double bind about how to satisfy both needs.

Unwillingness to Innovate: The old ways worked perfectly well for a long time and many banks had little need to innovate. However, the new ways are now working better, meaning that innovation is not always a matter of competitive advantage, but a matter of survival. Small banks with thin margins and little strategic appetite for innovation risk are short of options when it comes to reinventing themselves.

Five Ideas For Community Banks:

Challenger banks pose a threat to incumbents, because they are purely digital and location-agnostic straight out of the box. Whilst community banks should certainly learn from their example, transforming into a digital player is not the most likely way for them to succeed and certainly the least likely way to differentiate.

So what will a community bank look like in 2022 and, indeed, 2050? Instead of going against the grain, we suggest community banks look to their strengths and discover ways to translate these into digital forms or use new technologies to enhance them.

Local 2.0: The remote working revolution may actually benefit small towns and suburbs, with working from home increasing footfall on local main streets even as cities become less busy. Community banks can once again benefit from being at the heart of their local area – which doesn’t necessarily mean a branch-focused future. Banks could participate in the community and engage in digital initiatives which target the local area, perhaps reaching customers through physical educational drives as well as getting involved in local social media groups.

Rethink Community: Today, people from around the world are bonded together by affinity, not necessarily proximity. Banks could benefit from this by targeting groups that are bonded online by shared interests or are members of the same demographic or identity group.

Better Advice: Traditionally, advice would be delivered by friendly staff at the branch. The same ability can now be enabled by technology. Community banks should invest in video call functionality to allow customers to benefit from the human touch combined with the convenience of mobile digital banking.

Focus On Accessibility: An aging customer-base is an opportunity for community banks, who can use accessibility technology to reach vulnerable customers who may find it difficult to visit branches. Streamlined, simple digital services can help reach older demographics and introduce them to new products, particularly when delivered by a brand they already know and trust.

Lend Local: Community banks can also experiment with peer-to-peer lending or other forms of lending, as well as funding investments in the area that customers will see, appreciate and remember. Local visibility is very hard for a large multinational institution, but much easier for a community bank.

Our key advice is for banks to develop their own distinctive strategies for survival and growth into the future, and make technology and digital strategy subordinate to that overall direction. In this way the leadership can avoid trying to chase every new trend and instead focus on building value and a sustainable customer base.

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