How Banks Kept Customers During the Pandemic, Even Commercial Ones

Digital transformation and strategy are examined as part of Bank Director’s Inspired By Acquire or Be Acquired. Click here to access the content on BankDirector.com.

Despite closed branches and masked interactions, the coronavirus pandemic may have actually improved customers’ relationships with their banks. They have digital channels to thank.

That’s a shift from the mentality pervading the industry before the pandemic. Business lines like commercial lending seemed firmly set in the physical world: a relationship-driven process with high-touch customer service. The Paycheck Protection Program from the U.S. Small Business Administration completely uprooted that approach. Banks needed to deliver loans “as fast as possible” to their small commercial customers, says Dan O’Malley, CEO of data and loan origination platform Numerated during Bank Director’s Inspired By Acquire or Be Acquired. More than 100 banks are currently using the platform either for PPP applications or forgiveness.

The need for rapid adoption forced a number of community banks to aggressively dedicate enough resources to stand up online commercial loan applications. Sixty-five percent of respondents to Bank Director’s 2020 Technology Survey said their bank implemented or upgraded technology due to the coronavirus. Of those, 70% say their bank adopted technology to issue PPP loans. This experiment produced an important result: Business customers were all too happy to self-service their loan applications online, especially if it came from their bank of choice.

“Self-service changes in business banking will be driven by customer demand and efficiency,” O’Malley says, later adding: “Customers are willing to do the work themselves if banks provide them the tools.”

Digital capabilities like self-service platforms are one way for banks to meaningfully deepen existing relationships with commercial borrowers. Numerated found that borrowers, rather than bankers, completed 84% of PPP loan applications that were done using the company’s platform, and 94% of forgiveness applications. That is no small feat, given the complexity of the application and required calculations.

Those capabilities can carve out efficiencies by saving on data entry and input, requesting and receiving documentation, the occasional phone call and the elimination of other time-consuming processes. One regional bank that is “well known for being very relationship driven” was able to process 3,000 “self-service” PPP loan applications in a morning, O’Malley says. Standing up these systems helped community banks avoid customer attrition, or better yet, attract new customers, a topic that Bank Director magazine explored last year. Already, banks like St. Louis-based Midwest BankCentre are reaping the gains from digital investments. The $2.3 billion bank launched Rising Bank, an online-only bank, in February 2019, using fintech MANTL to open accounts online.

The impetus and inception for the online brand dates back more than three years, says President and CFO Dale Oberkfell during an Inspired By session. Midwest didn’t have a way to open accounts online, and it wanted to expand its customer base and grow deposits. It also didn’t want to replicate the branch experience of opening an account — Midwest wanted to compress the total time to three minutes or less, he says.

Creating the brand was quite an investment and undertaking. Still, Rising Bank has raised $160 million in deposits — as many deposits as 10 branches could — with only two additional employees.

“We didn’t spend the dollars we anticipated spending because of that efficiency,” Oberkfell says.

Midwest BankCentre is exploring other fintech partnerships to build out Rising Bank’s functionality and product lines. The bank is slated to add online loan portals for mortgages and home equity lines of credit — creating the potential for further growth and efficiencies while strengthening customer relationships. He adds that the bank is looking to improve efficiencies and add more tools and functionality for both customers and employees. And how are they going to fund all those technology investments?

Why, with the fees generated from PPP loans.

How to Prepare for an Unprecedented Year

Could anyone have prepared for a year like 2020?

Better-performing community banks, over the long run, generally anchor their balance sheet management in a set of principles — not divination. They organize their principles into a coherent decision-making methodology, which requires them to constantly study the relative risk-reward profiles of various options, across multiple rate scenarios and industry conditions over time.

But far too many community bankers look through the wrong end of the kaleidoscope. Rather than anchoring themselves with principles, they drift among the currents of economic and interest rate forecasts. Where that drift takes them at any given moment dictates their narrowly focused reactions and strategies. If they are in a reward mindset, they’ll focus on near-term accounting income; if the mood of the day is risk-centered, their framework will be liquidity. At Performance Trust, we have long argued that following this approach accumulates less reward, and more risk, than its practitioners ever expect.

Against this backdrop, we offer five decision-making principles that have helped many banks prepare for the hectic year that just closed, and can ensure that they are prepared for any hectic or challenging ones ahead.

  • Know where you are before deciding where to go. Net Interest Income and Economic Value of Equity simulations, when viewed in isolation, can present incomplete and often conflicting portrayals of a bank’s financial risk and reward profile. To know where you are, hold yourself accountable to all cash flows across multiple rate scenarios over time, incorporating both net income to a horizon and overall economic value at that horizon. Multiple-scenario total return analysis isn’t about predicting the future. Rather, it allows you to see how your institution would perform in multiple possible futures.
  • Don’t decide based on interest rate expectations — in fact, don’t even have expectations. Plenty of wealth has been lost by reacting to predictions. Running an asset-sensitive balance sheet is nothing more than making a levered bet on rising rates. So, too, is sitting on excess liquidity waiting for higher rates. The massive erosion in net interest margin in 2020 supports our view that most community banks have been, intentionally or not, speculatively asset sensitive. Banks that take a principle-based approach currently hold sufficient call-protected, long-duration earning assets — not because they knew rates would fall, but because they knew they would need them if rates did fall. As a result, they are in a potentially better position to withstand a “low and flat” rate environment.
  • Maintaining sufficient liquidity is job No. 1. Job No. 2 is profitably deploying the very next penny after that. In this environment, cash is a nonaccrual asset. Banks with a principle-oriented approach have not treated every bit of unexpected “excess liquidity” inflow as a new “floor” to their idea of “required liquidity.” One approach is to “goal post” liquidity needs by running sensitivity cases on both net loan growth and deposit outflows, and tailoring deployment to non-cash assets with this in mind — for instance by tracking FHLB pledgeability and haircutting — and allowing for a mark-to-market collateral devaluation cushion. Liquidity is by no means limited to near-zero returns.
  • Don’t sell underpriced options. Banks sell options all day long, seldom considering their compensation. Far too often, banks offer loans without prepayment penalties because “everyone is doing it.” Less forgivably, they sell options too cheaply in their securities portfolio, in taking on putable advances or when pricing their servicing rates. The last two years were an era of very low option compensation, even by historical measures. Principle-based decision-makers are always mindful of the economics of selling an option; those who passed on underpriced opportunities leading into 2021 find their NIMs generally have more staying power as a result.
  • Evaluate all capital allocation decisions on a level playing field. Community banks, like all competitive enterprises, can allocate capital in just four ways: organic growth, acquisitions, dividends or share repurchases. Management teams strike the optimal balance between risk and reward of any capital allocation opportunity by examining each strategy alongside the others across multiple rate scenarios and over time. This approach also allows managers to harness the power of combinations — say, simultaneously executing a growth strategy and repurchasing stock — to seek to enhance the institution’s overall risk/return profile.

So what about 2021 and beyond? This same discipline, these same principles, are timeless. Those who have woven them into their organizational fabric will continue to benefit whatever comes their way. Those encountering them for the first time and commit to them in earnest can enjoy the same.

The Secret to Increasing Wallet Share

Quick, name a bank.

Did you name your bank, or another local or national bank? It is often easier for people to think of a national bank than a local one, thanks to name recognition through advertising and branches.

But as important as top of mind awareness is, staying top of wallet is even more important. When your organization comes to both customers and prospective customer’s minds, you increase the chances at becoming their primary financial institution (PFI).

At Wallit, we define PFI as a customer having an active checking account, a debit card and direct deposit with a financial institution. There are five ways banks can accomplish this objective, increase deposit growth and boost non-interest income in a way that maintains healthy, growing customer relationships.

1. Elevate the debit card. The debit card isn’t just a payment card, method or option. It is a powerful and valuable lifestyle tool that many community banks underutilize.

At the point of sale, consumers decide whether to use a credit or debit card, based on their own needs. They make this decision multiple times each day.

I’m sure that most community bank customers that have a checking account also have that bank’s debit card in their wallet. But do they use it? Do they use a competitor’s card? Do they reach for a credit card?

2. Be Visible. Consumers have more options than ever when choosing financial services providers. So many, in fact, that consumers actively avoid marketing and advertising. Community banks have to be more visible, but not pushy.

Look for opportunities to connect your brand to things your customers value by linking it to places that your customers already think deliver value. Connect your brand to local businesses in the communities you serve, building and growing relationships with these businesses.

Promoting local businesses and providing information people need extends your bank’s reach and gets your name out there. This also borrows the brand halo of those businesses and makes your brand top of mind and top of wallet in the process.

3. Capitalize on Connections. The best businesses succeed through collaboration. Leveraging current relationships and connecting local merchants to local consumers unlocks the trapped value of your bank in the digital age.

Your bank can create a sense of belonging for members of your community, with your institution at the center. Think about it this way – Connecting buyers and sellers is far more valuable than merely connecting the bank accounts of buyers and sellers.

4. Generate Word of Mouth. Consumers will always share what they think of brands, products and services with others in their network across a wide range of communication channels. These recommendations are highly credible and relevant; they’re generally more effective than the marketing and advertising your bank currently pays for.

The best tactic to generate word of mouth is to impress current customers with a card-linked, cash back offer when they visit one of your local businesses. Your customers already have your bank’s debit card with them, making it a tool for spreading positive word of mouth, building your brand and driving revenue by offering and rewarding unique, highly personal, share-worthy experiences.

5. Experiment. Create a culture of experimentation. Start small and learn fast. Having the courage to apply new technologies and reinvent existing ways of working can improve financial performance.

Develop and improve your bank’s ability to be hyper-relevant and serve customers more effectively by sensing and addressing their changing needs. Consider starting a pilot with employees, then extending to scale with a portion of your customers.

Increasing share of wallet and becoming a primary financial institution requires intention, commitment and experimentation.

By leveraging your bank’s current strengths and investing in your debit card and merchant services programs, such as offering and marketing cash back rewards to local businesses and consumers, you can tip the scale in your favor.

The Overlooked Fee Opportunity for Community Banks

While many community banks offer some sort of foreign exchange or international payments capabilities to their customers, these experiences often leave a lot to be desired — and could be leaving business, and fee income, on the table.

A competitive and scalable payments program doesn’t have to be a giant undertaking for community banks. But in order to offer a competitive program, banks should ensure reasonable pricing, transparency and reliability. Bank Director chatted with Cara Hayward, director of strategic partnerships for North America at CurrencyCloud, to explore what banks are missing out on and how they can grow this business. This conversation has been lightly edited for length and clarity.

BD: Where are community banks when it comes to foreign exchange and the digitization of payments? Is this an area they should bother competing against bigger banks or non-bank financial companies?

CH: Community banks usually have some sort of foreign exchange offering, but it’s usually an afterthought and they often rely on a large correspondent bank for their service offering. Correspondents do provide a good service, but offer uncompetitive rates that don’t leave a lot of margin for banks to be competitive.

That means, a lot of community banks may not realize what demand for international payment or foreign exchange actually exists among their customers. Missing out on this fee income really hurts in an environment like we’re in today, since it’s harder to make money through lending.

BD: What kind of opportunities exist for community banks when it comes to foreign exchange and what does a modern offering need to be competitive?

CH: If a community bank wants to invest in this space to drive income, they need to think about scalability, reliability and cost.

When it comes to cost, there’s both the cost of goods sold and costs around supporting the business. Banks make money by marking up the rate they receive from their provider by a certain amount of basis points. The second cost is around supporting the business line. International payments do require the ability to manage payments in an operationally efficient and compliant way, and it’s important that partners are able to create processes that can be scalable and repeatable.

Reliability and transparency are related. Banks should look for partners that have technology that allows for as much transparency as possible, so when something goes wrong, there’s a robust support network.

BD: What do customers want from their community bank when it comes to international payments and transfers? Can community banks offer this?

CH: Customers that aren’t doing a ton of international payments or foreign exchange may not be sensitive to price or experience, and might just suffer through it. But customers that want or demand a better experience are moving away from community banks to fintech apps or larger banks. They’re looking for reliability and repeatability, competitive costs and transparency. They want to know their money is going to get where it’s going, and they want that to happen consistently.

Foreign exchange can often feel like a black box to customers. There are a lot of fees, they’re in tiny little prints and customers don’t know if what they’re getting is competitive. They want honesty and transparency about what the process is, what they should expect and what that cost is going to be.

Because businesses are doing more of their business online and cash flow is more important than ever, they require more when it comes to cross border transactions. Especially in the e-commerce market, technology, and imports and exports, there’s a need for that digitization of payments.

As community banks grow and try to move up market, they may go after larger and more-profitable corporate or industrial customers. That’s where they’ll see the demand for volume when it comes to international payments, and where costs start to make a difference to customers.

BD: What prevents foreign exchange from being a bigger part of community bank offerings? How do they change this?

CH: Oftentimes, its other competing projects. I totally understand that foreign exchange and international payments is not the biggest part of these banks’ business, but I don’t think they realize what they’re actually missing or where this potential business could go.

There’s a perception that foreign exchange and international payments are complicated and scary, but there are partners out there that do this. Community bankers should spend some time educating themselves on what is out there, and what are the costs and benefits of investing in a project like this as far as potential revenue.

For those that don’t offer it, starting small is the way to go. Do a proof of concept. Talk to different providers in the network, including fintechs and correspondent banks. Make sure to do your due diligence. Start with a small project: a couple of your best small- or medium-sized business customers that need this. Pick a partner that is going to handhold you through the process, support you and help you grow.

It’s a similar process for those looking to expand. They should think about the evolution of their current business in chunks — where do they want to be in one year, five years, 10 years — and pick partners that will support you through that process.

Recommendations for Banks Prepping for LIBOR Transitions, Updated Timelines

While much of the focus this summer was on Covid-19, the decline in GDP and the fluctuating UE rates, some pockets of the market kept a different acronym in the mix of hot topics.

Regulators, advisors and trade groups have made significant movement and provided guidance to help banks prepare for the eventual exit of the London Interbank Offered Rate, commonly abbreviated to LIBOR, at the end of 2021. These new updates include best practice recommendations, updated fallback language for loans and key dates to no longer offer new originations in LIBOR.

Why does this matter to community banks? Syndicated loans make up only 1.7% of the nearly $200 trillion debt market that is tied to LIBOR — a figure that includes derivatives, loan, securities and mortgages. Many community banks hold syndicated loans on their balance sheets, which means they’re directly affected by efforts to replace LIBOR with a new reference rate.

A quick history refresher: In 2014, U.S. federal bank regulators convened the Alternative Rates Reference Committee (ARRC) in response to LIBOR manipulation by the reporting banks during the financial crisis. A wide range of firms, market participants and consumer advocacy groups — totaling about 1,500 individuals — participate in the ARRC’s working groups, according to the New York Federal Reserve. The ARRC designated the Secured Overnight Financing Rate (SOFR) as a replacement rate to LIBOR and has been instrumental in providing workpapers and guidelines on SOFR’s implementation.

In April 2019, the ARRC released proposed fallback language that firms could incorporate into syndicated loan credit agreements during initial origination, or by way of amendment before the cessation of LIBOR occurs. The two methods they recommended were the “hardwired approach” and the “amendment approach.” After a year, the amendment approach was used almost exclusively by the market.

In June 2020, the ARRC released refreshed Hardwired Fallbacks language for syndicated loans. The updates include language that when LIBOR ceases or is declared unrepresentative, the-LIBOR based loan will “fall back” to a variation of SOFR plus a “spread adjustment” meant to minimize the difference between LIBOR and SOFR. This is what all other markets are doing and reduces the need for thousands of amendments shortly after LIBOR cessation.

In addition, the ARRC stated that as of Sept. 30, lenders should start using hardwired fallbacks in new loans and refinancings. As of June 30, 2021, lenders should not originate any more loans that use LIBOR as an index rate.

As the market continues to prepare for LIBOR’s eventual exit, BancAlliance recommends banks take several steps to prepare for this transition:

  • Follow the ARRC’s recommendations for identifying your bank’s LIBOR-based contracts and be aware of the fallback language that currently exists in each credit agreement. Most syndicated loans already have fallback language in existing credit agreements, but the key distinction is the extent of input the lenders have with respect to the new rate.
  • Keep up-to-date with new pronouncements and maintain a file of relevant updates, as a way to demonstrate your understanding of the evolving environment to auditors and regulators.
  • Have patience. The new SOFR-based credit agreements are not expected until summer 2021 at the earliest, and there is always a chance that the phase-out of LIBOR could be extended.

FinXTech Special Report: Mobile Banking

Mobile-Report.pngIn September 2017, Amazon.com’s patent for “1-Click” checkout lapsed. It was a foundational moment in e-commerce. Waves of digital retailers streamlined their purchasing processes. The moment reframed customer expectations. And meeting those expectations became a matter of survival.

Simplifying the checkout process, Amazon chairman and CEO Jeff Bezos believed, would reduce cart abandonment and increase conversion rates — the percentage of shoppers who complete the purchasing process. Cart abandonment is a huge problem in retail, where an estimated 69.5% of digital carts go unclaimed.

Online merchants of books and sweaters aren’t the only businesses that need to care about this; banks do too.

Customer expectations are fluid, flowing from one industry to the next. Amazon and other tech giants set the standard for the digital experience; banks and other companies must now follow it. Customers expect to acquire their new credit card as easily as they can download the latest Taylor Swift album.

Banks may not obsess about cart abandonment and conversion rates to the extent that other e-commerce companies do, but the same concepts apply to making loans and attracting deposits over digital channels. That’s why the principles of modern design are so important. Taking cues from companies like Amazon isn’t just a best practice; increasingly, it’s a matter of success and failure.

Nowhere is design more important than on mobile devices, which have emerged as the primary channel banks use to serve customers and is the purpose of this FinXTech Intelligence Report, Mobile Banking: How Leading Banks Make Modern Apps That Drive Sales.

The report unpacks mobile bank design: why an attractively designed experience will be critical to growing engagement, and the processes that have guided regional and community banks in creating their respective apps. It includes:

  • The rise of mobile banking
  • An overview of key features and functions
  • How modern design affects usability
  • Q&A with USAA’s chief design officer
  • A digital checklist to evaluate a bank’s offerings and approach

To learn more, download our FinXTech Intelligence Report, Mobile Banking: How Leading Banks Make Modern Apps That Drive Sales.

To access our earlier report on APIs, click here.

FinCEN Files: What Community Banks Should Know

Big banks processed transactions on the behalf of Ponzi schemes, businesses accused of money laundering and a family of an individual for whom Interpol had issued a notice for his arrest — all while diligently filing suspicious activity reports, or SARs.

That’s the findings from a cache of 2,000 leaked SARs filed by banks such as JPMorgan Chase & Co, Bank of America Corp., Citibank and American Express Co. to the U.S. Treasury Department’s Financial Crimes Enforcement Network, or FinCEN. These files, which media outlets dubbed the “FinCEN Files,” encompassed more than $2 trillion in transactions between 1999 and 2017.

Community banks, which are also required to file SARs as part of Bank Secrecy Act/anti-money laundering laws, may think they are exempt from the scrutiny and revelations applied to the biggest banks in the FinCEN Files. Not so. Bank Director spoke with two attorneys that work with banks on BSA/AML issues for what community banks should take away from the FinCEN Files.

Greater Curiosity
Community banks should exercise curiosity about transaction trends in their own SARs that may add up to a red flag — whether that’s transaction history, circumstances and similarities to other cases that proved nefarious. Banks should ask themselves if these SARs contain details that indicated the bank should’ve done something more, such as not complete the transaction.

“That is probably the biggest go-forward lesson for banks: Make sure that your policies and procedures are such that — when someone is looking at this in hindsight and evaluating whether you should have done something more — you can demonstrate that you had the proper policies and procedures in place to identify when something more needed to be done,” says James Stevens, a partner at Troutman Pepper.

Although it may be obvious, Stevens says banks should be “vigilantly evaluating” transactions not just for whether they merit a SAR, but whether they should be completed at all.

Size Doesn’t Matter
When it comes to BSA/AML risk profiles and capabilities, Stevens says size doesn’t matter. Technology has leveled the playing field for many banks, allowing smaller banks to license and access the capabilities that were once the domain of larger banks. It doesn’t make a difference in a bank’s risk profile; customers are its biggest determinant of a bank’s BSA/AML risk. Higher-risk customers, whether through business line or geography, will pose more risk for a bank, no matter its size.

But banks should know they may always be caught in between serving customers and regulatory activity. Carleton Goss, counsel at Hunton Andrews Kurth, points out that changing state laws mean some financial institutions can serve cannabis businesses that are legal in the state but still need to file SARs at the federal level. Banks may even find themselves being asked by law enforcement agencies to keep a suspicious account open to facilitate greater monitoring and reporting.

“There’s definitely a tension between serving customers and preventing criminal activity,” he says. “You don’t always know the extent of the activities that you’ve reported — the way the SAR reporting obligation is worded, you don’t even have to be definitively sure that a crime has occurred.”

“Front Page of the Newspaper” Test
Reporting in recent years continues to cast a spotlight on BSA/AML laws. Before the FinCEN Files, there was the 2016 Panama Papers. Stevens says that while banks have assumed that SARs would remain confidential and posed only legal or compliance risk, they should still be sensitive to the potential reputational risks of doing business with certain customers — even if the transactions they complete for them are technically compliant with existing law.

Like everything else we do, you have to be prepared for it to be on the front page of the newspaper,” he says.

Media reports mean that regulatory pressure and public outrage could continue to build, which could heighten regulatory expectations.

“Whenever you see a large event like the FinCEN files, there tends to be pressure on the regulators to ‘up their game’ to avoid giving people the perception that they were somehow asleep at the wheel or missed something,” Goss says. “It would be fair for the industry to expect a little bit more scrutiny than they otherwise would on their next BSA exam.”

How Innovative Banks Capitalize on Cryptocurrency

This summer, three new developments in the relationship between banks and cryptocurrency players signaled a shift in attitudes toward digital assets.

In May, JPMorgan Chase & Co. began providing banking services to leading crypto exchanges Coinbase and Gemini Trust Co., — a notable change given that Chairman and CEO Jamie Dimon called the seminal cryptocurrency Bitcoin “a fraud” just three years ago. In July, the acting comptroller for the Office of the Comptroller of the Currency, Brian Brooks — who served as the chief legal officer for Coinbase prior to his appointment — released an interpretation letter confirming that financial institutions can bank cryptocurrency clients and could even serve as digital asset custodians. And this month, the popular crypto exchange Kraken secured a special purpose banking charter in Wyoming, marking the first time a crypto company gained banking powers, including direct access to payment rails.

Cryptocurrency is gaining wider acceptance as a legitimate commercial enterprise. But, like other money services businesses, these companies still find it difficult to obtain basic banking services. This is despite the fact that crypto is becoming more mainstream among consumers and in the financial markets. The industry is booming with a market capitalization equivalent to over $330 billion, according to CoinMarketCap, but it’s currently served by just a handful of banks.

The best-known institutions playing in the cryptocurrency space are New York-based Signature Bank and Silvergate Capital Corp., the parent company of La Jolla, California-based Silvergate Bank.

Signature’s CEO Joseph DePaolo confirmed in the company’s second-quarter earnings call that $1 billion of the bank’s deposits in quarter came from digital asset customers. And at just $1.9 billion in total assets, Silvergate Bank earned over $2.3 million in fees in the second quarter from its crypto-related clients. These gains weren’t from the activity taking place on the banks’ respective payment platforms. They came from typical commercial banking services — providing solutions for deposits, cash management and foreign exchange.

One community bank hoping to realize similar benefits from banking crypto businesses is Provident Bancorp. The $1.4 billion asset institution based in Amesbury, Massachusetts, which recently rebranded as BankProv, aims to treat crypto companies as it would any other legal commercial customer. Crypto customers may have heightened technology expectations compared to other clients, and present heightened compliance burdens for their banks. But the way CEO David Mansfield sees it, these are all things BankProv needs to address anyway.

It really pushes traditional, mainstream corporate banking to the next level,” he explains, “so it fits with some of our other strategic goals being a commercially focused bank.”

Before BankProv launched its digital asset offering, it did a lot of groundwork.

The bank revamped its entire Bank Secrecy Act program, bringing in experts to help rewrite procedures and new technology partners like CipherTrace to provide blockchain analytics and transaction monitoring. It retooled its ACH offerings, establishing a direct connection with the Federal Reserve and expanding its timeframe for processing transactions to better serve clients on the West coast. And BankProv’s team met with crypto-related businesses for insights about what they wanted in a bank partner, which led the bank to upgrade its API capabilities. BankProv is working with San-Francisco-based fintech Treasury Prime to make it possible for crypto clients to initiate transactions directly, instead of going through an online banking portal.

At the same time, BankProv made plans for handling the new deposits generated by the business line; crypto-related companies often experience more volatility in market fluctuations than typical commercial clients.

“It’s definitely top of the regulator’s mind that they don’t want to see you using these funds to do long-term lending,” Mansfield says.

For BankProv, part of managing these deposits is deploying them toward the bank’s mortgage warehouse lending business; those loans are short-term, maturing within seven to 15 days. “[Y]ou need to find a good match on the asset side,” Mansfield explains, “because just having [deposits] sit in Fed funds at 10 basis points doesn’t do you much [good] right now.”

While BankProv officially announced that it would begin servicing digital asset customers in July 2019, the onset of Covid-19 made it difficult to get the program into full swing until recently. With travel being severely limited, BankProv made it a priority to hire new business development talent earlier this month that came with a pre-existing Rolodex of crypto contacts. The digital asset business hasn’t appeared in the company’s 2020 earnings releases so far.

Banking crypto-related clients will only make sense for some of the most forward-thinking banks; but for those that are successful in the space, the upside is significant. Mansfield believes BankProv has the attributes needed to thrive as a part of the crypto community.

“You have to be open minded and a little innovative. [I]t’s certainly not going to be right for the vast majority of banks,” he says, “and I think that’s why there’s really only two that are dominating the space right now. But I feel there’s at least room for a third.”

Community Risks That Community Banks Should Address

States and counties are starting to reopen after a prolonged period of sheltering in place due to the Covid-19 pandemic.

Many community banks that function as the primary lenders to small businesses in the rural Midwest have yet to see a significant negative financial impact because of the shutdown. In fact, many community banks stand to receive significant loan origination fees from the U.S. Small Business Administration for participating in the Paycheck Protection Program. They’re also flush with cash, report the community bank CEOs I’ve asked, as many borrowers haven’t used their PPP loan funds and consumers have been holding their stimulus payments in their checking accounts.

But just because things look stable from a financial perspective doesn’t mean there isn’t risk in your community and to your bank. Let’s take a brief look at some issues community banks should be monitoring today:

Increasing personal debt caused by prolonged unemployment. Unemployed Americans received an unprecedented amount of unemployment benefits that for the most part ended on July 31, 2020. What are Americans doing now? Some furloughed employees have been recalled, but others weren’t. When income is scarce, the use of credit cards, overdraft protection, and personal loans increases. What is your bank doing to monitor the increasing financial pressure of your individual borrowers and account holders?

Delayed business closures. Small businesses without a significant online presence are finding it difficult to operate in this new environment. “Nonessential” small businesses survived the shutdown by using government funds, furloughing employees, drawing on credit lines, or using personal savings. The lost sales may not have been deferred to a later date. Instead, they are truly lost and won’t be recaptured. Without a fast and heavy recovery for small businesses, they may be forced to close and may not be able to support their current debt load. How is your bank monitoring the performance of your small business customer?

Reduced need for office and retail space. With the increase in employees working remotely, especially at businesses that typically use commercial office space, the perceived need for office space is declining. Once a lease term expires, community banks should expect some commercial borrowers to experience reduced rental income as tenants negotiate for less square footage or overall lower rates. Are you tracking the going rate for rent per square foot in your market?

Increased fraud risk. When people experience all three sides of the fraud triangle (rationalization, opportunity, and pressure), they’re more likely to commit fraud. Identification of the fraud can be significantly delayed. A bookkeeping employee whose spouse has been laid off can rationalize the need for the company’s money, has the opportunity to take it, and feels the financial pressure to use it for personal needs. This person may be able to cover it for a short time; but, covering it becomes more difficult as it grows. That can happen within the bank or at any of your commercial borrowers.

Community banks have yet to see a dramatic increase in past dues or downgrades in loan ratings; it’s likely too early to see the financial stress. Several community banks are adding earmarked reserves to the allowance for loan losses in each loan category as “Covid-related.” However, community banks should carefully evaluate loans that were “on the bubble” prior to the shutdown, were granted some form of deferral by the bank, or are in certain industries like hospitality. Interagency guidelines permit banks to not account for these loans as troubled debt restructures (TDR) if they meet certain criteria, but banks are still responsible for maintaining a proper allowance. A loan in deferral may need an increased reserve, even if it isn’t accounted for as a TDR. The time it takes for that stress to show (called “loss emergence period” in accounting) is longer than many think.

Two other significant financial impacts to banks relate to overdraft fees and interchange fees. As spending decreased, so did overdrafts and associated fee income. And without the discretionary debit card swipes, interchange fees fell significantly as well.

How much of the above information will you use as you prepare the 2021 budgets this fall? What will your baseline for 2021 be: 2019 or 2020? Regardless, assess the risks to the bank and plan accordingly.

This article is for general information purposes only and is not to be considered as legal advice. This information was written by qualified, experienced BKD professionals, but applying this information to your particular situation requires careful consideration of your specific facts and circumstances. Consult your BKD advisor or legal counsel before acting on any matter covered in this update.