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Community What?

As someone working in European fintech, credit unions and community banks and their importance in the US banking system are one step removed from my day to day context. Nevertheless I find these institutions incredibly interesting and believe they will play their specific role in the age of digital-first fintech. This is why I wanted to take a look at these banking players from perspective of a European.

Credit unions are financial institutions are effectively co-owned by their customers (also known as members in credit union lingo). These institutions typically re-distribute profits to their members via discounted fees or preferential conditions not available from high street  banks.

In this article, I will be taking a quick look at community banks – distant cousins to credit unions. In particular, I will look into the United States market where community banks play an important role in the financial services ecosystem.

Profiling the Community Bank

Unlike credit unions, community banks are obviously commercial institutions. What they have in common is  their focus on understanding the needs and pains of local customers and communities.

A typical community bank could not be more different from an American megabank. On average, a community bank manages $545 million in assets, has 99 employees, 7 locations and its loan book of small business loans averages at $66 million. In the world of megabanks, these figures are akin to a rounding error. But that does not lessen the importance of these institutions. In fact, quite the opposite is true.

In the US, there are more than 5,500 active community banks. Even though their share on overall assets under management hovers somewhere around 15%; their role in the American financial system is indispensable because they serve the otherwise unbanked.

According to Independent Community Bankers of America (ICBA), these institutions comprise 99% of all banks and provide the majority of all small business loans issued in the U.S. Not only that – community banks are acting as an important financial inclusion force. More than a third of US counties – over 900 in total – rely exclusively on community banks for extension of local credit. In other words, 16 million people in the US would have had severely limited access to the financial system without community banks.

Case in Point: Small Business Loans

Lending to small businesses is an excellent showcase of what sets community banks apart from the mega banks. Despite the recent declines, community banks still represent somewhere between 50% to 60% of all small business loans made by banks in the U.S.

Additionally, 79 percent of independent businesses that used community banks report they were satisfied with their overall experience, compared with 67 percent for large banks and just 49 percent for online lenders. 

Why is that though?

“Community banks generally are relationship banks; their competitive advantage is a knowledge and history of their customers and a willingness to be flexible.”

— Harvard Kennedy School – The State and Fate of Community Banking

Firstly, they understand the local milieu. Community banks really understand the local businesses and their credit needs are able to tailor their credit offerings to them. This is the key community bank advantage.

Furthermore, turnaround times for underwriting can be quicker than with the megabanks – community banks offer nimble decision-making on business loans because decisions are made locally. Big multi-state banks don’t have this flexibility and deep local knowledge. In turn, they are left with standardized credit scoring mechanisms and loan approval mechanisms several levels removed from customers’ day-to-day business.

Not Everything Is Rosy

Not everything is rosy in the world of community banking though. The total share of U.S. lending by community banks has fallen by 50% in the last two decades, whilst the biggest five national banks’ share has increased from 17% to 41%, according to Harvard Kennedy School study.

It appears that there are two chief reasons driving the community banking plunge. 

First, there is the regulatory aspect. Community banks have had to endure a dramatic increase in regulatory oversight and enforcement of more stringent rules. This was a direct result of the 2008 financial meltdown; ironically caused to a significant degree by the mega banks. Aptly named article When Community Banks Die explains that community banks are..

“Being regulated like big banks, taxed like big banks…The uneven playing field extends into the FinTech space as well. FinTech lenders – online lenders that boast next-day approvals and automated underwriting processes – provide the same services as banks, but don’t have to endure the same crushing regulations that community banks need to.”

— When Community Banks Die

There is not much we can do to influence the regulatory environment in the U.S. But it is precisely where the second big cause comes into play – technology . Unsurprisingly, keeping up with the advancements from the back-end to the front-end customer experience is difficult for these small players.

In his excellent presentation, Joshua Siegel points out two key technology challenges for community banks – inefficiency in bringing desirable products to market and losing out on gains in operational efficiency.

As for the former, this spans user experience on the front-end, natively digital value propositions for customers and cooperation with third parties for the benefit of the customer. In other words, the bread and butter of today’s leading fintechs.

The back-end is equally important. Antiquated core banking back-end systems as opposed to modular, scalable and nimble cloud-based architecture are a key inhibitor in banking innovation.

Given their small size, I think community banks are well positioned to progress and win on both of these fronts – provided they put smart strategies in place.

Innovation Response

It would not be fair to say that no innovation is happening in the community banking world though. Even the smaller banks with assets under management around 1 billion are aggressively pursuing partnership strategies with fintech companies for their customers’ benefit.

For example, Lincoln Savings Bank, a $1.3 billion bank has partnered with some of the fintech heavy-hitters in the savings and investment space including well known startups such as Acorns, Qapital or Cash App. 

National Bank of Kansas City has established partnerships with fintechs laser-focused on solving customer pain points and creating new value for specific customer segments. These include Joust (a banking platform focusing on self-employed professionals, small business owners and freelancers) or Digs (a savings product that helps renters transition into homeownership).

The bank has also rolled out Fountain City Fintech, a 75-day accelerator programme laser-focused on creating tangible partnerships between the bank and startups enrolled in the programme. NBKC hails this as a

“Vertically integrated partnership accelerator, providing fintech startups with a forward-thinking bank partner, compliance expertise, and a solid infrastructure for scale”

— Fountain City Fintech, https://www.fountaincityfintech.com

Even on the back-end side, we are seeing spurs of activity. Innovative vendors such as Dwolla, Railsbank and Synapsefi have all partnered with U.S-based community banks recently.

Similarly to credit unions, community banks are a personification of bottom-up banking. They are fairer and more sensitive to the needs of the communities than the gargantuan megabanks. 

Regulation Opportunity

Curiously, one of the biggest opportunities for credit unions and community banks right now lies in providing a ‘bank of record’ services to startups and fintech companies. There is an increasing demand to issue various types of financial services and products by the newcomers and several community banks are already hotspots for these services.

Naturally, the leading neobanks and fintech disruptors are leading the change in financial services. At the same time though, I believe helping niche banking players with authentic customer relationships become digital-first is an opportunity with an immense positive impact potential. 

Monitor this space as I will be bringing you more insight into our work in this space soon.