Community Banks Face Perfect Storm of Cybersecurity, Regulatory and Funding Pressures
Community banks are navigating a complex landscape where traditional strengths meet modern challenges, according to the 2024 CSBS Annual Survey. Technology adoption is accelerating (especially given now nearly a quarter of banks now offering FedNow instant payments), but there are still mountains of pressures to overcome. The survey of 370 banks reveals an industry focused on strategic modernization while working to preserve their relationship-based business model, even as competition from fintechs and megabanks intensifies.
By Garret Reich, Editorial Operations Manager
The report: 2024 CSBS Annual Survey of Community Banks
Source: Conference of State Bank Supervisors
Why we picked it: The CSBS survey provides early warning signals about industry-wide challenges and trends, such as a growing concern about credit quality in commercial real estate, particularly office properties, with 71% of bankers expecting deterioration. It also offers unique visibility into technology adoption patterns among smaller institutions, which larger banks need to understand for competitive analysis and potential partnerships, such as AI and FedNow adoption rates.
Executive Summary
U.S. community banks are grappling with a complex web of challenges that’s reshaping how they serve their communities. The 2024 Conference of State Bank Supervisors’ Annual Survey of Community Banks reveals an industry caught between embracing innovation and managing unprecedented risks — with cybersecurity threats, regulatory burden and funding costs emerging as critical concerns.
The comprehensive survey draws insights from nearly 370 community banks across 38 states, and paints a picture of institutions working to balance traditional relationship banking with growing pressure to modernize their operations. Ultimately, community banks say they remain optimistic about their ability to serve local communities, but they also face mounting challenges from both traditional competitors and fintech disruptors in an environment complicated by persistent inflation and an inverted yield curve.
Key Takeaways
- Cost of funds and regulatory burden are virtually tied as top external concerns, with 89% of bankers rating them as "extremely important" or "very important" risks
- Nearly 96% of community banks identified cybersecurity as their most critical internal risk, while technology implementation costs rose to become the second most pressing internal challenge
- About 24% of banks now offer FedNow instant payment receiving capabilities, with another 44% planning to add this service within 12 months
- Despite broader industry excitement around artificial intelligence, community banks remain cautious, with many preferring to let larger institutions test these emerging technologies first
Technology Is A Double-Edged Sword
50% of financial institutions view existing banking technology as more of an opportunity than a liability, but implementation costs remain a significant barrier. The price tag for new technologies ranked as the largest impediment to adoption for 46% of respondents, up from 44% in 2023.
Cybersecurity risks continue to cast a long shadow over technological advancement. About 42% of bankers expect cybersecurity risks to pose their most difficult challenge in implementing new technologies over the next five years. This concern is driving many institutions to take a cautious approach to emerging technologies like artificial intelligence.
Online banking remains a focal point for innovation, with 88% of banks offering remote deposit capture and 75% providing online bill pay. The adoption of e-signature verification has increased from 56% to 58% year-over-year, while online loan applications have seen more significant growth, rising from 40% to 46% of banks offering this service.
Perhaps one of the most significant technological developments in 2024 is the adoption of the FedNow Service, the Federal Reserve’s instant payment system. Approximately 24% of surveyed banks currently receive instant payments through FedNow, with an additional 44% planning to implement this capability within the next year. The sending capability shows lower current adoption at 9%, but 39% of banks plan to add this service in the coming year, indicating a strong commitment to modernizing payment infrastructure.
Straight From the Bankers:
'It is easy to get caught up in all the hype about AI’s potential. However, we’ve not yet adopted generative AI. We believe we are currently better off exercising a dose of caution and skepticism when it comes to generative AI. ' — Cathy Owen, Eagle Bank and Trust Co.
Core service providers remain the primary source of digital banking products and services, with almost two-thirds of respondents relying exclusively on their core provider for these capabilities. However, a growing number of banks are exploring partnerships with fintech firms, particularly in areas such as mobile banking support (29%), loan origination and underwriting (29%) and process improvements (30%).
Banks express varying levels of satisfaction with their technology services. Asset liability management and interest rate risk technologies receive the highest satisfaction ratings, with 87% and 84% of respondents respectively reporting being "extremely" or "somewhat" satisfied. However, workflow processing and core service provider services show room for improvement, with less than 70% of banks expressing satisfaction with these areas.
Dig deeper:
- Will Nonbank Intermediaries Tip the Balance Towards Instant Payments?
- Why Banks Should Rethink ‘Every Company is a Software Company’
- Can Digital Check Deposit Survive in the Face of Rising Fraud?
Regulatory Pressures Will Continue to Mount
The percentage of bankers citing regulation as an "extremely important" or "very important" risk has risen steadily, from 77% in 2022 to 89% in 2024. This increase reflects growing concern about numerous regulatory initiatives, including proposed changes to capital requirements, small business lending data collection and Community Reinvestment Act revisions.
Compliance costs continue to consume a significant portion of bank resources. Legal and accounting/auditing expenses related to compliance saw notable increases, with both categories rising nearly 4 percentage points as a share of total expenses. The implementation of the current expected credit loss (CECL) accounting standard has contributed to these rising costs.
Straight From the Bankers:
'As far as partnering with fintechs, the most important thing is being on the same page right upfront. We are going to follow all the rules, we are going to be a pain in the butt to make sure all the rules are followed, we are going to make sure all client funds are tracked, we are going to make sure advertising is done correctly, and we are going to make sure consumers are made whole if they are harmed.' — John Blizzard, Seattle Bank
The prolonged inverted yield curve environment has created significant challenges for community banks’ traditional business model. Banks report growing pressure on net interest margins and increasing competition for deposits. About 84% of respondents identified core deposit growth as a major external risk, reflecting the challenging funding environment.
In response to these pressures, community banks are increasingly turning to wholesale funding sources. The survey indicates that 56% of bankers are using or planning to use brokered deposits at or near current levels, representing a 5 percentage point increase from the previous year. Federal Home Loan Bank advances and public funds remain popular funding sources, with banks viewing these options as carrying lower stigma compared to other wholesale funding alternatives.
The Credit Quality Concerns Plaguing Banks
Looking ahead, bankers express significant concern about credit quality across various loan categories. Nearly 65% of respondents expect credit quality of loans to individuals for household, family and personal expenditures to worsen over the next 12 months. Commercial real estate loans are also a source of concern, with 62% anticipating deterioration in credit quality.
Office properties emerge as a particular area of concern, with 71% of bankers expecting credit quality to worsen in this sector. Retail properties also face significant headwinds, with 59% of respondents projecting declining credit quality.
Community banks continue to face competition from multiple fronts, with regional banks, credit unions and fintech firms all vying for market share. However, community banks maintain their competitive edge in small business lending, where they hold a significant market share advantage over larger institutions. Small business loans comprise 8% of total assets at community banks, compared to only 2% at larger institutions.
The average size of small business loans at community banks ($106,300) significantly exceeds that of larger banks ($17,300), suggesting community banks’ continued focus on meaningful business relationships rather than high-volume, low-value credit card lending.
Learn more:
- High-Performing Credit Unions All Share This One Trait — And It’s Critical to Loan Growth
- More Community Banks Tap Treasury Management for Non-Interest Income
Looking Ahead
As community banks navigate these challenges, many are focused on strategic technology investments while maintaining their traditional strength in relationship banking. The survey indicates that 83% of banks view expanding mobile banking services as a promising opportunity over the next five years, while 66% plan to implement fully integrated loan processing systems.
Cloud-based core systems represent another area of potential transformation, with 42% of bankers seeing opportunity in this technology. However, respondents show little interest in more experimental initiatives such as creating online charters or acquiring online banks.
"The banking industry is at a crossroads," notes Brandon Milhorn, President and CEO of CSBS. "While community banks face significant challenges, their fundamental strength in relationship banking and local market knowledge continues to provide a strong foundation for future success."
