The Current Top Threats to Community Banks, Now and Future

Offering personalized services that larger institutions often overlook, community banks play a crucial role in supporting local businesses and individuals. However, the landscape is shifting rapidly, presenting unique challenges for these banks. Increasingly, community banks find themselves vulnerable to external threats. 

In fact, 40% of financial institutions have reported a rise in financial crime, including fraud and money laundering activities. At the same time, 84% of financial institutions are planning to allocate significant internal resources for mitigating credit risks. These emerging risks place added pressure on community banks to enhance their security measures while maintaining the personal touch their customers expect. As they navigate these challenges, community banks must stay ahead of the curve, balancing innovation with strong defenses to protect themselves and their customers in an evolving financial ecosystem.

Community Bank Threats and Challenges

Here are the top threats community banks must reckon with for the foreseeable future.

1. Persistently High Interest Rates

Persistently high interest rates are straining community banks — federal interest rates topped 5.25% in July 2023, marking an historic high since 2001 — driving pressure on net-interest margins (NIM) and liquidity. With funding costs rising, banks face shrinking NIMs as deposit rates fail to keep up with higher loan interest income. 

This discrepancy creates additional risks for smaller banks, as deposit outflows increasingly shift toward larger institutions offering more competitive rates. According to recent data, 70% of respondents reported falling NIMs due to these rising funding costs. This trend threatens both profitability and liquidity, forcing community banks to adapt by exploring alternative funding strategies.

2. Cybersecurity and Technology Risks

As community banks increasingly adopt digital-first banking models and permanently incorporate remote work, cybersecurity risks have surged. The growth in digital transactions — combined with a broader attack surface from remote operations — has exposed these banks to more sophisticated cyber threats. In 2023, 93% of community bankers identified cybersecurity as an “extremely important” or “very important” risk to their long-term operational health.

Cyberattacks such as phishing, ransomware, and social engineering pose significant risks, targeting both bank employees and customers. As a result, community banks must strengthen their defenses and implement advanced cybersecurity protocols to mitigate these vulnerabilities. With digital channels now a primary means of delivering financial services, ensuring the security of customer data and financial transactions is critical to maintaining trust and stability. Cyber resilience must become a top priority as the frequency and sophistication of attacks continue to rise in an increasingly digitized banking landscape.

3. Liquidity and Funding Challenges

Driven largely by the rising cost of funds and competition for deposits, community banks are presently grappling with significant liquidity and funding challenges. As interest rates remain elevated, community banks face increasing pressure to attract and retain deposits while managing higher funding costs. In March 2024, the cost of funds for community banks rose to 2.85%, up from 2.24% in December 2023, and dramatically higher than the 0.74% seen in December 2020. This sharp increase has forced many banks to turn to brokered deposits to maintain liquidity​

This environment has led nearly 49% of community banks to rely on brokered deposits, up from 39% in the previous year​. Brokered deposits offer a temporary solution to liquidity issues, but they carry a certain stigma among bankers, with a notable percentage hesitant to use them due to perceived risks​.

4. Credit Risks and Economic Uncertainty

Credit risks and economic uncertainty are becoming major challenges for community banks, particularly in the wake of tighter lending standards and rising interest rates. In the third quarter of 2023, lending to small businesses experienced an 18.1% year-over-year decline, reflecting the impact of these stricter lending practices​.

Higher borrowing costs are making it difficult for small businesses to access affordable credit, further straining community banks — which hold 22.2% of total small business loans despite representing only 14.9% of the total industry’s loans​. 

This economic uncertainty fueled by inflation and unpredictable interest rate hikes has prompted community banks to be more conservative in their lending practices, which in turn has constrained credit availability for small businesses. As economic conditions remain uncertain, community banks must navigate these risks carefully while continuing to support local businesses that rely on them for funding. Failure to balance these risks could result in exacerbated liquidity issues and reduced profitability in 2025.

5. Talent Shortages and Hybrid Work

Community banks are grappling with significant challenges related to talent shortages and the shift to hybrid work environments. A staggering 9 out of 10 HR teams within financial institutions report difficulties in hiring and retaining skilled employees, particularly those with a combination of technical and business skills.

This shortage is compounded by the growing demand for workers with digital expertise as community banks undergo technological transformations to stay competitive. Moreover, hybrid work models — now an established feature of the post-pandemic workplace — add complexity to these challenges. While 60% of job seekers in financial services prefer hybrid roles, many employers are still adjusting to the expectations and logistics of maintaining productivity and collaboration in such environments​.

Community banks must strike a balance between offering the flexibility employees seek and ensuring operational efficiency, which often requires in-person collaboration. Addressing these issues requires a two-pronged approach — investing in upskilling existing staff to bridge the talent gap and adopting hybrid work policies that align with employee preferences. Without a strategic focus on these areas, community banks risk falling behind in both talent retention and customer service.

6. Competitive Pressure from Fintech and Larger Banks

As fintech companies and larger banks, continue to leverage advanced technologies and larger capital supplies to attract customers, community banks face increasing competitive pressures in the market. Fintech firms have revolutionized financial services by offering seamless, user-friendly digital platforms appealing to a tech-savvy customer base. This has placed community banks at a disadvantage, as many struggle to keep up with the rapid pace of technological change. As 41% of bankers see digital account opening as a top investment priority for 2025, community banks must modernize their offerings to compete effectively​.

In addition to the technological edge of fintech, larger banks have the resources to offer more competitive interest rates and higher-yield products, drawing customers away from community institutions. As deposit growth becomes increasingly important, community banks must find ways to differentiate themselves, whether through personalized customer service or niche market specialization. Without adapting to these pressures, community banks risk losing market share and struggling to maintain profitability in an industry that is becoming increasingly dominated by tech-driven innovation and scale.

Tackling Community Bank Challenges with Secure Technology 

In summary, community banks face significant challenges, both now and in the future. Persistently high interest rates, cybersecurity risks, and liquidity issues threaten their ability to maintain profitability and stability. Economic uncertainty and talent shortages add further pressure, while the growing competition from fintech and larger banks puts their market share at risk. 

To navigate these challenges, community banks must invest in both technology and talent to stay competitive. Solutions like FileInvite can be crucial in helping community banks streamline operations and improve client experiences. With features like secure document collection, digital signatures, and smart notifications, FileInvite enables banks to securely manage sensitive information while maintaining customer trust. By embracing such tools and focusing on modernization, community banks can continue providing personalized service while staying competitive in an evolving financial landscape.

To learn more and receive a personalized demo, contact FileInvite today.

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