Mitigating Banking’s Headwinds

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The events of 2023, both within the banking industry and beyond, are chilling traditional growth opportunities and providing new challenges for banks. We are seeing adverse trends in the areas of asset quality, litigation, liquidity, third-party relationships and compliance that are headwinds for banks. Nevertheless, many of these issues can be mitigated in 2024 by enhancing risk management practices and engaging in traditional safe and sound banking practices.

Asset quality measures. With higher interest rates and economic uncertainty, loan workouts are steadily increasing. We are seeing proactive banks reviewing their borrowers and their collateral, bolstering protective provisions in their loan documents to prevent surprises and taking actions now to limit their risk, rather than risk surprises.

Aggressive litigation against banks. In the past year, we have seen the number and type of aggressive litigation against banks continue to rise, as banks continued to be seen as sources of monetary recovery. These include class action lawsuits based on alleged illegal overdraft and account-related matters, employment issues, commercial customer issues (such as lender liability, speculative bankruptcy trustee litigation and other lawsuits where the bank is named as a party based on a customer’s bad acts or business practices) and third-party vendor related issues. Although banks are always litigation targets, the number and type of lawsuits continue to rise given current uncertainty.

Banks can mitigate these risks through careful contract review, knowing their customers and preserving relevant documents through systemic document retention policies. Additionally, many of these lawsuits make identical allegations and often are filed by the same plaintiff law firms, so knowing the right approach from experience can lead to a quicker and more positive outcome.

Third-party relationships. Third-party relationships are causing greater contractual and regulatory issues for banks. On the contractual side, we are seeing increased disputes between banks and their third-party vendors, whether technology providers, fintechs or banking as a service partners. On the regulatory side, we are seeing regulators scrutinize these third-party relationships more heavily in examinations because of increased skepticism that banks are properly managing them. In response, we are working with banks to describe these relationships to regulators more thoroughly and obtain any necessary feedback before they are implemented. Proper and involved vendor management practices and contracting, along with the understanding that the regulators are increasingly scrutinizing these relationships and agreements, can help minimize potential issues.

Liquidity. Recent publicized large bank failures have led to lower depositor confidence, which sometimes results in slow deposit walks — versus deposit runs — and related liquidity uncertainty. We see banks performing sophisticated concentration analyses and monitoring and running tabletop exercises (like cybersecurity scenarios) to identify and limit potential liquidity issues and prepare for any uncertainties.

Compliance. We are seeing increased regulatory focus on consumer compliance. For example, regulators are increasingly scrutinizing fair lending issues and frequently involve the U.S. Department of Justice, with related negative consequences. Banks are limiting their exposure by analyzing lending data carefully and evaluating risk for any potential disparate treatment of protected individuals throughout the entire lending process. Banks are also reviewing and acting proactively in other compliance areas to avoid any undue regulatory scrutiny, such as enhancing their real-time customer complaint data analysis process. Additionally, proactive regulator engagement is helping banks avoid potentially larger issues down the road.

We continue to work with financial institutions to find ways to mitigate these risks before these problems occur. Doing the basics of banking well — strong compliance, strong operations and strong leadership (both board and management) — is critical. If an issue arises, whether with a borrower loan workout, litigation, fair lending, a consumer compliance referral or any other customer issue, dealing with that issue both quickly and strategically is key to a successful outcome.

3 Strategies for Cultivating Strong Connections Among Hybrid Teams

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Whether out of necessity or by choice, in recent years, a large portion of companies have adopted a hybrid or remote-first approach to work. In a 2022 Gallup poll, workers cited improved work-life balance, more efficient use of time, control over work hours and work location, burnout mitigation and higher productivity as the top advantages of hybrid work. However, about one-third of those surveyed said they feel less connected to their organization’s culture since beginning a hybrid work arrangement, and 24% reported impaired working relationships with their colleagues.

A distributed workforce can make it more challenging for leaders to maintain consistent employee engagement and uphold the organization’s culture across the workforce. As a result, organizations that offer hybrid work policies need to be more intentional than ever about facilitating connections between employees and creating a sense of purpose.

Here are three key strategies that keep team members engaged, whether they come into the office regularly or work remotely full-time.

1. Involve Executive Leadership in Welcoming New Employees
Making sure team members feel connected from their first day forward is an important component of fostering a strong corporate culture. Sending care packages and emails about what to expect in advance of their official start date, inviting (but not requiring) people to come into an office space for their first day and surveying new employees after 90 days to ensure they feel connected and have the support they need helps create an onboarding process that starts new colleagues off on the right foot.

For new employees who are working remotely, executive access and transparency during the onboarding process can go a long way toward establishing a sense of connection. Panel discussions with the leadership team are a great way to demonstrate cohesion and collaboration at the executive level and get new team members onboard with the organization’s strategic vision, particularly in a remote environment. These sessions are especially valuable when there’s an opportunity to open the panel for questions and engage new team members in dialogue.

2. Empower Leaders to Cultivate Relationships With Remote Team Members
In a hybrid or remote work setting, people don’t experience the kind of spontaneous interactions with their colleagues that happen in a traditional office: for example, saying hello as they pass each other in the hallway or chatting during a coffee break or elevator ride. As a result, organizations need to empower leaders to develop strategies for building strong connections with teams and direct reports who don’t work in proximity every day. Ways to do this include encouraging leaders to introduce check-ins at the top of team meetings, having regular 15-minute stand-up calls to give updates, scheduling coffee chats once a week with the team and sharing guiding questions that can help team members get to know each other on a more personal level.

Keep in mind that people in different roles benefit from different degrees of training when it comes to relationship-building skills. First-time leaders need different support than experienced leaders — but it is important to provide guidance for leaders at every level. Investing in development for frontline leaders is especially valuable.

3. Recognize and Respect Individual Needs and Preferences
While the past few years have shown that many people prefer to work remotely because of the flexibility, there are also many who still deeply value in-person connection. Maybe they’re just getting started in their careers and are actively seeking camaraderie and mentorship, or maybe they’re just more productive in an office setting. For a myriad of reasons, some people may not flourish in their position working from home all the time — and it’s important not to overlook their needs and preferences.

From a culture standpoint, this often means holding events in two different formats: in-person and remote. Coordinating twice the number of events requires a larger investment from the human resources team, including a heavier lift when it comes to planning and budgeting. The payoff of creating opportunities for connection and engagement that accommodate everyone in the organization is worth the additional effort.

Why Community Banks Are Delisting From Exchanges

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There’s been a noticeable shift in the behavior of community and local banks in the United States: More and more banks are choosing to voluntarily delist from major exchanges like Nasdaq and the New York Stock Exchange, and deregister with the Securities and Exchange Commission (SEC).

Delisting is typically considered a cost-reduction measure or way for banks to reduce the complexity that comes with SEC registration. It’s clear that this trend is being driven by the economic environment: Higher interest rates, lower loan demand and slowed growth are driving community and regional banks to reconsider their exchange listings. Banks are looking at ways to maximize shareholder value, and are seeking alternatives to the traditional exchange model.

The pursuit of shareholder value and the impact of the 2023 Russell of its index have emerged as the primary drivers of banks switching trading venues. Community banks are scrutinizing the complexity, risk and the costs and benefits of being listed on major exchanges. Additionally, the June 2023 Russell Reconstitution set the entry point for inclusion in the index at a market capitalization of $160 million. As a result, many regional banks now fall just within the threshold for inclusion. Issuers that compose a relatively small share of the index and those that are not eligible face a real challenge in building visibility through their exchange listing. The banks that changed trading venues were all eligible to deregister from the SEC, as they were under the 2012 JOBS Act threshold of 1,200 shareholders of record. As profit margins continue to compress, banks are questioning the time and cost of being listed on an exchange.

Benefits of Voluntary Delisting
Voluntarily delisting allows community banks to transition their listing while maintaining their SEC registration and the accessibility of their financial statements and disclosures. Others choose to deregister and delist simultaneously. The transition to the OTCQX Market offers banks a more streamlined trading experience akin to that of an exchange, with the same strategies aimed at maximizing shareholder value. Further, a broker-driven market provides community banks with an improved trading experience, offering more time to react to orders and better price execution.

The trajectory of voluntary delisting and deregistration in the banking sector is poised to undergo even further evolution.

  • We anticipate the stability of trading volumes to persist, particularly for banks under $1 billion in assets. Competitive bid/ask spreads are also likely to endure, maintaining a favorable trading environment that caters to the interests of investors.
  • Community banks with a market capitalization under $500 million can expect to attract a similar pool of institutional investors, regardless of what market their shares trade. This consistency in investor interest contributes to the overall stability and appeal of the market.
  • Banks can streamline the format of their quarterly and annual reports while maintaining a commitment to transparency and disclosures to institutional investors. This can significantly reduce the administrative burden of reporting but maintains investor confidence with regulatory standards.
  • We expect that increasing shareholder value to remain a compelling factor for banks contemplating a transition. This approach can significantly bolster a bank’s financial position and enhance its strategic flexibility.

Banks choose to trade on the OTCQX Market, a viable alternative to Nasdaq, which enables them to maintain their public market status without the burden of SEC registration. The OTCQX Banks Index, which tracks the performance of U.S. banks traded on OTCQX, increased 34% between June 2020 and June 2023. compared with a 10% increase in the ABA Nasdaq Community Bank Index (ABAQ) over the same period. Banks have options to choose where they trade that best serves their shareholders while raising capital in their community, building their business and diversifing their investor base.

Obstacles to M&A in 2024

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The pace of bank M&A is poised to accelerate in 2024, with continued funding struggles likely compelling some banks to sell. But some obstacles — such as acquirers’ stock valuations and regulatory approvals — could hinder dealmaking. Dory Wiley, CEO of Commerce Street Capital, says the banks that will be best positioned to navigate 2024’s challenges will have sufficient tangible capital at the holding company. 

Topics discussed include: 

  • Balance Sheet Considerations 
  • Credit Quality 
  • Non-Traditional M&A 

The Secret Weapon for Growth? Compliance

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In this difficult operating environment, bank directors are constantly assessing how their institutions will navigate the troubles ahead. Outside of defensive maneuvers to protect deposits and shore up credit, many boards are also reviewing growth plans: M&A opportunities, expanding the bank’s footprint into new markets or rolling out new products.

The process for prioritizing growth initiatives typically involves market studies, competitive positioning, staffing plans, communications and marketing, and the pro forma financial impact on areas like credit, deposits and efficiency. Occasionally, there will be a consideration of the potential regulatory impact — but many boards may be of the view that compliance is a necessary evil, the tax for operating a bank. They may be tempted to allocate little attention or budget toward compliance, directing management to “keep the bank out of trouble.”

However, many of the fastest-growing banks have a common secret weapon: a high-quality compliance function that is integral to assessing and implementing their strategic initiatives.

Why include compliance in growth plans? Because compliance teams are ultimately responsible for data integrity and can best help a board understand the operational and regulatory impacts of any new initiatives. Further, these teams are critical to successful — and timely — implementations, and frequently act as a check on risk and progress against stated goals. There are five areas where high-performing institutions leverage their compliance function to achieve growth initiatives.

1. Acquisitions
Any bank acquisition invites increased regulatory scrutiny of existing operations. Too many acquisition efforts get derailed due to poor existing operational deficiencies, both at the target and the acquirer.

Strong compliance teams have a good grasp on existing operations and can help diligence the target’s processes and data. Further, they can identify deficiencies proactively so that, during post-close integration, the team can quickly assume the target’s operations and fold in reporting requirements into their existing structure.

2. New Products
Some of the best-performing banks have successfully coupled a new product offering with the opportunity to better achieve fair lending targets. For example, San Antonio-based Frost Bank recently reentered the residential mortgage market after a 20-year break. Their first two products are specifically tailored to lower-income applicants in their core Texas markets, which is brilliant, given the dramatic rise in home prices in recent years. Naturally, these loans also qualify for CRA credit and allow Frost to achieve its goal of creating more equitable communities.

For banks to pull off this type of growth, the compliance team must have a clear view of existing fair lending data and the ability to quickly stand-up new processes to support the additional reporting.

3. New Markets
Just like launching a new product, the biggest noncommercial risk banks take when moving into a new market is the impact on fair lending. Screwups in fair lending reporting typically derail growth — to add insult to injury, the data is public for competitors to see. The best compliance teams have a strong handle on their existing fair lending data and can forecast various scenarios associated with moving into a market.

4. Automation and Artificial Intelligence
AI is all the rage right now; every bank board is wrestling with how to incorporate more automation into existing operations. Surprisingly, the compliance team is best suited to take the lead here. Given their role as data stewards and typically held accountable for reporting accurate data to the appropriate agencies, strong compliance teams can clearly articulate the areas of the bank where process improvement will best impact operations. Compliance teams acutely feel the pain of poor data management practices and should be the first group management consults when implementing new automation technology.

5. Data Analytics
To accurately assess potential growth plans, the bank needs a clear set of operating data that everyone trusts. Very few bank executives believe their data is clean, accurate and easily accessible. Many banks don’t use the data they collect, as it lives in disparate systems and can be hard to analyze.

When prioritizing future growth initiatives, it’s critical that directors involve the compliance team. This group has some of the clearest insights into existing performance and areas of risk, due to their strong handle on the bank’s data. The best-performing banks understand this and use their compliance function as a hidden superpower to successfully execute growth plans.

Turning 2024’s Industry Challenges Into Opportunities for Growth

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Experts are calling 2024 a “crossroads year” for the financial industry. That’s because the banking industry is facing a number of disparate challenges at a time when it’s in the throes of change.

Savvy banks are viewing these challenges as opportunities to better serve their account holders, staying open to innovation and planning their growth strategies to ride out this time of flux.

Banks need to know what they’re facing in order to craft an effective strategy. Here are some of the opportunities on the horizon as 2024 nears.

Challenge: The Economy
It’s not shaking out to be as bad as was predicted, but households are still dealing with higher costs of basics like food, gas and rent. According to Bloomberg, U.S. households are experiencing financial stress as well, as evidenced by increases in delinquencies, foreclosures and charge-offs.

In this time of economic uncertainty, consumers need financial advice. Should they take out a home equity loan to pay off high-interest credit cards? Is there a way to save in tough economic times? Increasingly, online personalities are doling out financial advice on social media sites. But customers should be getting their financial advice from their primary financial institution, not the influencer of the moment. One powerful way to do that is to build financial tools into your digital banking platform, so customers can access financial advice from you as easily as they do online. 

Challenge: The Growing Sophistication of Fraudsters
Cybersecurity and the protection of account holder data continue to be an uphill battle, especially when it comes to payment systems like the Automated Clearing House (ACH). Fraud is increasing as ACH use is skyrocketing. The ACH Network processed 30 billion payments valued at $76.7 trillion in 2022, fueled in part by the growth of Same Day ACH. The recent direct deposit glitch at Wells Fargo hasn’t helped consumer confidence. The 2023 AFP Payments Fraud and Control Survey by J.P. Morgan revealed that 65% of organizations were victims of payments fraud attacks or attempts last year.

As you’re budgeting for 2024, plan to invest in cybersecurity. Three must-haves are:

  • Secure digital account opening requiring a minimal amount of personal identification
  • Monitoring, including dark web monitoring, and alerts
  • A layered security approach featuring two-factor authentication, one-time passcodes and behavioral biometrics

Challenge: The Expansion and Contraction of the Industry
Branch closures, which spiked during the pandemic, are continuing now, affecting Americans’ access to physical banks and credit unions. But it’s not just branches. There are fewer than 4,500 brick-and-mortar financial institutions today, per the FDIC, down from around 15,000 at their peak in the 1990s. Fintech is also feeling the pinch of consolidation through acquisitions, mergers and even shifting their model to acquire banks. According to FinTech Magazine, there will be a “tidal wave of consolidation” in the fintech industry over the next year, driven by the need to scale and a struggle to raise capital.

To retain or attract account holders due to this shift, offering easy to use digital banking will provide an alternative channel for consumers affected by branch closures and may prevent them from opting for digital-only neobanks and fintechs who are aiming to steal share of wallet. Banks that are on the cusp of acquisitions or mergers or have gone through one, should be using data about account holder transaction and channel usage.

There is a double benefit here. First, that data helps in mapping spend patterns to determine the best locations for new branches or ATMs, forecasting branch traffic and discovering where money is leaving the institution. Another powerful benefit: It deepens your insights into account holder activity, allowing you to personalize relationships with consumers by providing relevant marketing and offers when they need it.

Challenge: The Battle for Deposits
Increasing deposits is a top concern for financial institutions heading into 2024, according to a new survey by Jack Henry. Nearly half of respondents said deposit growth was first on their list of priorities. This deposit battle is the result of the younger generation not being loyal to a primary financial institution, economic woes and stress eating into savings and tech giants offering no-fee high yield accounts.

It’s incumbent on banks to focus on growing deposits, and that means a strategic plan to focus on reaching, attracting and retaining younger account holders. It requires a shift in mindset and tactics. Gen Z, born between 1996 and 2010, is proving to be a tough nut to crack for traditional financial institutions. Gen Z consumers are estimated to have $360 billion in spending power, and are expected to inherit $11 trillion of wealth over the next 10 years.

Why are they proving to be so elusive? They don’t quite get the concept of a primary financial institution when there’s an app for everything at their fingertips. Neobanks and fintechs are marketing directly to them on their mobile devices, and it’s easy and immediate to do things like apply for a loan online. Financial institutions should be reaching out to Gen Z through online marketing campaigns. Not only will it increase deposits that are now lagging, but it will create loyalty among the elusive Gen Z.

Directing 2024 budget dollars to technology and strategies that empower banks to quickly and easily develop and launch the right digital banking solutions, products, services and experiences to their customers or members is critical. But it’s just as important for banks to have an open mind and be willing to integrate, adapt and evolve budgets and strategies in ways they previously would not have considered.

Working With Regulators Toward Growth in 2024

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Between the regulatory environment and the mismatch on pricing expectations between buyers and sellers, organic growth may be preferable to M&A for many banks in 2024. But organic growth is not without its own unique challenges. Adam Maier, a partner with the law firm Stinson LLP, explains in this video that growth-oriented banks looking to enter new markets or launch new products will need to demonstrate to their regulators that they have the experience and capital to undertake that new effort.

Topics discussed include:

  • Market Uncertainties
  • Implementing New Technology
  • Shifting Community Reinvestment Act Guidance

Rethinking the Small Business Checking Playbook

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This Viewpoint first appeared in Bank Director magazine’s fourth quarter 2023 issue.

Even before interest rates rose, community banks and credit unions were battling megabanks, regional banks and the new wave of digital banks and fintechs to keep and attract traditional retail and small business checking account customers.

This battle is for only a small percentage of account holders that are interested in moving their primary accounts— about 11% of accounts, per Morning Consult research.

To acquire new market share, it’s critical to commit to funding an external acquisition strategy over time. Even the megabanks realize that winning the deposit war requires a marketing investment war chest — something most community banks don’t have.

Refocus on Primary Accounts
New high-interest savings accounts are increasing the cost of funds and siphoning off surplus deposits parked at banks. Plus, the digital banks’ and fintechs’ focus on product featurization has materially decreased new account openings at traditional banks.

So, where should community financial institutions turn with this ever-increasing competition? Broadly speaking, the smart place to look isn’t outward, but inward.

There has been a lot of talk recently about the resurgence of relationship banking as the best way to navigate these current market conditions. Organically growing business from existing customers is much less expensive and yields much better results for banks compared to hunting for new customers. The growth that comes from relationships already at the bank are a sweet spot, given bankers have historically delivered more personalized services to their customers compared to larger and digital banks. A prioritized focus on existing customers can be a hedge growth strategy, given the challenges of external account acquisition.

But getting back to relationship banking doesn’t stop with just retail accounts.

Reinventing Business Checking
There is a $400 billion market sector that community banks still maintain a powerful influence over that has largely been untapped: small business checking accounts. Unfortunately, many community banks haven’t upgraded these products in quite a while. The result is they’re not delivering the kind of product experience that modern small and medium businesses (SMBs) want.

We’ve found very encouraging data that shows community banks have what it takes to reassert their relevance in this sector, which we detailed in a recent white paper looking at what modern small businesses want in a checking and banking relationship.

Many small businesses report that they are open to new banking relationships. Overall, two-thirds of SMBs are somewhat or very likely to look for new banking relationships in the next 12 months. Among SMBs with annual revenue between $10 million and $100 million, that percentage rises to 77%.

Many are looking for better business checking account features. When asked why they might consider a new banking relationship, nearly 40% of respondents indicated they wanted to get better business checking account product features and capabilities.

They’re also increasingly open to borrowing from their primary checking account provider. Roughly 80% of SMBs say they will consider their primary business checking account provider for their borrowing needs over the next two years.

What this data underscores is that a relationship banking approach that’s focused on serving existing retail and small business checking customers is more important than ever. And offering small businesses something different and more relevant to their needs is a smart way to pursue deposit growth.

Reinvented SMB checking accounts also have the potential to deliver a lot of interchange revenue and fee income. These accounts will increase a bank’s primacy and market share without needing to go toe-to-toe with megabanks, digital banks and fintechs to land new customers. Megabanks and fintechs will continue to fund and find ways to acquire new customers. Traditional smaller banks can combat this by growing their retail base organically and revamping their small business checking products to keep and acquire new SMB customer relationships.

4 Strategies to Navigate Banking’s Talent Shortage

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Recent years have seen a wave of pandemic-induced early retirements and a national game of house-swapping as remote work encouraged people to move farther away from physical offices.

Many companies are struggling to rebuild teams; this includes financial institutions that need to replace employees with decades of specialized expertise. In BAI’s Banking Outlook 2023 survey, financial institutions named attracting and retaining talent a top business concern. Nowhere is this complex challenge starker than in the primary revenue center for banks: the lending department. This article will explore ways your lending team can navigate banking’s talent shortage.

1. Leave the Paper Jam
Collecting and filing physical documents is like sand in the gears of your loan origination process. It’s cumbersome for applicants and can lead to errors during data entry. By some estimates, loan officers spend as much as 30% of their time collecting personal financial statements and other documents. Your bank won’t be able to eliminate the documents, but it can reduce paper touches and data entry.

Perform an audit of your institution’s lending process. Map it on a whiteboard and flag where paper handling or manual data entry happens. Then discuss ways to optimize those steps digitally.

The less time your lending team spends on menial tasks, the more time they can spend serving your borrowers and applying their skills for higher-value tasks. This can also become a selling point when interviewing job candidates; making people feel efficient and productive at their jobs can make them more likely to stick around.

2. Create a Mature Data Ecosystem
Financial institutions handle large volumes of data through a variety of software and vendors. However, this leads to fragmentation: the software systems and various databases don’t communicate easily, or they require a lot of manual intervention before data is ready for processing.

Consider auditing your institution’s data ecosystem and mapping it on a whiteboard. Highlight workflows where data can’t be exchanged easily and consult with your technology team to identify solutions and tools to automate data processing. It may feel like you’re taking time and talent away from the business of lending, but making a one-time investment in process improvements can generate compounding returns in the future.

Make automation and data maturity a foundation that allows your lending team to move quickly and deliver a seamless experience for your borrowers. Loan officers who feel like they have all the tools they need may experience a higher level of job satisfaction too.

3. Foster a Growth Mindset
There are two ways to gain experience: Hire someone who already has it or hire someone willing to learn. The first option is faster, but the second option allows your bank to select from a much wider pool of candidates.

Hiring people with a growth mindset allows the bank to train and mentor employees on its processes and values. Removing the requirement for years of role-specific experience will allow your bank to recruit people who fit your culture. Building out a robust training program for the tactical aspects of the job gives your financial institution the best of both worlds.

Some leaders may worry about training inexperienced people and watching them leave for higher-paying jobs at other companies. That’s a valid concern — but one that you can mitigate by proactively rewarding people and responding to their desire for workplace advancement.

4. Embrace a Hybrid Workplace
Fully remote work isn’t a good fit for every company or employee; many people crave flexibility. What if your bank offered the option for people to choose one or two days where they work from home? This allows them to manage family and personal responsibilities more easily, and it can also provide precious “focus time” for important projects.

There’s nothing wrong with designating some roles as fully in-office and others as fully remote — for example, credit analysts. The key is to collaborate with employees on policies that serve the needs of the institution and their personal needs. Whatever work policy your institution goes with, it’s worth investing in technology solutions that make your institution more nimble and less reliant on in-person interactions for critical business processes.

While there is no silver bullet to win a war for talent, there are concrete strategies you can use to attack the challenge from multiple sides. The same growth mindset that you want to cultivate in your employees is the same mindset that will help your institution succeed, regardless of the talent crunch.