Maintaining the spread between interest income and interest expense, deposit growth, liquidity, and cybersecurity lead a list of community bankers’ top concerns, according to an annual survey. Several of these concerns spiked from their rankings in the 2022 survey, an indicator of how much the banking environment has changed over the last year.

The findings are part of the 2023 Conference of State Bank Supervisors (CSBS) Annual Survey of Community Banks (PDF). The survey, now in its 10th year, is conducted annually by CSBS and state bank regulators. More than 450 community bankers—those running institutions with less than $10 billion in assets—answered questions about the challenges and opportunities they face in the industry. The report also contains extensive comments from five community bankers from around the country on survey topics.

Key Challenges

Among both internal and external risks, cybersecurity was the top challenge for community bankers, with almost 93% of surveyed bankers naming it an “extremely important” or “very important” risk. This was followed by net interest margins, with nearly 89% of bankers reporting them as extremely important or very important. Rising interest rates and inflation have driven up the cost of funds—almost 87% of bankers listed the cost of funds as extremely important or very important in this year’s survey, up substantially from the 48% it garnered last year. Closely related top challenges include core deposit growth (nearly 84% in 2023 versus 38% in 2022) and liquidity (more than 83% in 2023 versus 35% in 2022).

Liquidity had not been named a top five challenge since the 2019 survey. In 2023, liquidity and other top challenges largely stem from the sharp fall in deposits from federal-stimulus-related, COVID-19-era highs. A drop-off in deposits means banks are more reliant on more expensive sources of funds, such as brokered deposits, advances from the Federal Home Loan Banks and other borrowings. While the cost of deposits and personnel expenses have increased, most respondents say these challenges—though likely to persist—are manageable.

Technology and Competition

Technology continues to present challenges as well as opportunities for community banks. While 59% of bankers say the adoption of new and emerging technologies is extremely important or very important, impediments include cost, cybersecurity risks and implementation challenges. Limitations of core service providers—companies that provide banks with back-office services such as payment processing—are another consideration.

About two-thirds of all respondents said they rely on core service providers for digital banking products and services, and most are not seeking partnerships with other digital providers, such as fintech firms. Less than half of all banks surveyed have a relationship with a fintech firm. Of the banks that do use them, fintech firms support mobile banking and lending products the most.

Survey respondents noted that the competition for most products and service lines—especially small-business loans—is increasingly coming from other community banks. This represents a shift from prior year surveys. Commercial real estate loans and transaction deposits are other products for which competition from other community banks is particularly strong. Respondents expect relationship lending—the bread and butter of community banks—to grow more than transactional lending at their institutions in the future, which suggests small business and commercial real estate loans will maintain or increase in importance for these institutions.

Looking Ahead

The CSBS Annual Survey of Community Banks offers a snapshot of the opportunities and challenges facing small banks. In addition, the survey offers insights beyond those we can glean from other data sources and, over its 10 years, has allowed us to see how banks respond to changes in the economic and regulatory landscape.

The survey is also supplemented by the quarterly release of the CSBS Community Bank Sentiment Index (CSBI). Although the latest CBSI reading suggested that overall sentiment is improving, we continue to closely monitor credit quality, liquidity and overall profitability in the banking system.