Technology and Innovation in Community Banking: Opportunities, Challenges, and the Fed
by Raphael W. Bostic, President and Chief Executive Officer, Federal Reserve Bank of Atlanta
Community banks are beset by challenges on numerous fronts. Foremost among them is the relentless advance of technology and, along with it, heightened customer expectations for convenience and instantaneous service.
At a time when consumers and business customers can readily turn to digital offerings for all manner of financial services, traditional financial institutions must keep pace to remain relevant. This can be particularly tough for community banks, which typically face resource constraints — human, financial, and otherwise. As a result, meeting customer demands for technology-enabled services often means seeking help from partners. Partnerships with third-party firms can entail supplying services such as mobile banking directly to customers or, in some cases, offering services inside a physical branch.
Often these service providers are financial technology companies, or fintechs. These sorts of companies normally have roots in the information technology industry and thus may not instinctively understand the regulatory and fiduciary obligations that are second nature to banks.
In this space, I would like to share a few thoughts on the Federal Reserve’s role in helping community banks address both the opportunities and the challenges that technology and innovation present. In particular, I will discuss third-party partnerships because they are especially important for community banks in today’s financial services marketplace.
Facilitating Community Bank Engagement with Innovation
What role can the Fed play as community banks seek to navigate this new and challenging competitive landscape? Most important, in our capacity as a safety-and-soundness supervisor, we are committed to helping community banks pursue technology innovation, and thus engage with service providers, in a safe, sound, and responsible manner.
In my view, this work dovetails perfectly with our Reserve Bank’s strategic priority to build an economy that works for everyone by promoting economic mobility and resilience because community banks are pillars of our local economies.
Let me mention an example. Just before the pandemic, the Federal Reserve Bank of Atlanta hosted an event that the Federal Reserve System calls Innovation Office Hours. We connected two dozen Sixth District fintech entrepreneurs and bankers with experts from the Atlanta Fed and the Federal Reserve Board to discuss payments security, regulation, financial inclusion, and other relevant matters. The fundamental aim of outreach like this is to influence the direction of innovation so that fintech firms are more likely to incorporate security, sound risk management, and financial inclusion into their development processes. Innovation is essential to a healthy financial system, but we want innovators to think about risk in a very fundamental way.
Likewise, we want community bankers to understand both the opportunities and the risks inherent in engaging with third-party service providers that are often very different culturally from financial institutions. To that end, we have taken numerous steps to help community banks navigate the complexities of third-party partnerships.
In 2021, the Federal Reserve Board, along with the Office of the Comptroller of the Currency and the Federal Deposit Insurance Corporation, proposed guidance to help banking organizations manage risks associated with third-party relationships.1
The three federal financial regulatory agencies also published a guide to assist community banks in conducting due diligence on fintech firms.2 Seeking a partnership with a newer fintech company — and many are relatively new — may introduce particular complications. For example, a less experienced technology partner may offer a suitable product but may not understand the bank’s regulatory obligations or have fully developed operational or compliance frameworks. To help address concerns of this nature, the Federal Reserve published a paper in September 2021 on the evolving dynamics of community bank–fintech partnerships.3
Built around insights from bankers, fintechs, and other stakeholders, the paper outlines the strategic and tactical decisions that support effective partnerships. Notably, the paper makes clear that a community bank’s strategic goals and those of its fintech partners should align and that banks need to embrace a culture of ongoing innovation.
Ultimately, it is the banks’ responsibility to ensure that outsourced activities are carried out safely and soundly. So, to form fruitful partnerships, bankers need to clearly understand the potential pitfalls upfront.
For many community banks, significant service providers (SSPs) will be the conduit through which technology and innovation are introduced. Thus, it will be important for community banks to be aware of the strength and health of SSPs. The Federal Reserve and other federal financial regulatory agencies exercise regulatory oversight of SSPs. One important focus of our SSP supervision is information security. As one example of how seriously we take this issue, the Federal Reserve System is hiring more than two dozen cybersecurity specialists to help ensure that service providers deploy sound cyber defense technologies, staff, and practices.
Based on their SSP supervision activities, the agencies issue regular examination reports on the condition of service providers, which are broadly similar to an exam report for financial institutions. Therefore, I suggest that community bankers review reports on the significant service providers with which they have contractual relationships. These examination reports provide valuable information for a bank in monitoring its service providers and can be requested from the bank’s primary federal regulator.
Honing Our Analytics Capabilities to Help Community Banks
Applications of technology and innovation are not limited to customer-facing interactions. We in the Federal Reserve System are also embracing the use of new tools and techniques to supervise and engage with community banks. We have long been working to reduce regulatory burden, and we continually refine our regulatory approach and tailor our supervision to the size and complexity of institutions. Technology has played an important role in advancing the efficiency and effectiveness of our supervisory process. A good example of this is that we use technological tools to conduct significant portions of our examinations remotely, from our offices, something that we started before the pandemic.
Another way the Atlanta Fed is doing this is by honing our data analytics capabilities, something our peer Reserve Banks are also pursuing. In our efforts to assess potential risk and thus target our supervisory efforts appropriately, we analyze numerous data streams, including commercial real estate metrics, residential housing metrics, and commercial risk scores from leading data providers such as CoStar. We also employ a variety of analytical tools and modeling techniques, including open-source tools such as R Programming and data visualization software such as Tableau and PowerBI.
We also build analytical tools that community bankers can use. To cite a couple of examples, one of our economists developed the GDPNow tool, which synthesizes a great deal of data to estimate coming quarters’ gross domestic product growth.4 GDPNow is publicly available for anyone to better understand macroeconomic currents. Additional macroeconomic Atlanta Fed tools offer insights on inflation, labor markets, and more.5 Further, analysts in our Supervision, Regulation, and Credit division built data analytics engines that track home affordability — the Home Ownership Affordability Monitor6 — and commercial real estate conditions — the Commercial Real Estate Momentum Index.7
These tools represent an important aspect of our work beyond traditional monetary policy and financial supervision. Through these tools, all of which are available on our website, we provide expertise, evidence-based research, and analytics to help community banks as well as nonprofits, local governments, and community organizations fortify economic growth and the mobility and resilience of the families they serve and the communities in which they operate.
Our Economy Needs Community Banks
There is no doubt that community banks are essential institutions in so many of our towns and cities across this country. These institutions often know customers better than a larger bank might, which can be critical for expanding access to banking services in rural, urban, and underserved communities. And while many consumers and businesses have an array of financial services options, community banks are important providers of key services to niche populations and business sectors.
In cities, community banks, including minority-owned institutions, support businesses and households that may not be a focus of larger institutions. Community banks are flexible for business loans and nimble with loan requests. Indeed, community banks account for an outsize share of loans to important sectors, including commercial real estate, small business, and agriculture, according to the FDIC’s 2020 Community Banking Study.8
Even as we wrestle with elevated inflation and uncertainty across the global economy, the Federal Reserve is paying close attention to community banks. These institutions face numerous challenges, but the industry and regulatory agencies can and must devise creative ways to support them. In particular, the agencies need to continue to support community bankers in their efforts to incorporate the latest technology into their products and services. Community banks bring unique economic benefits to the communities where they operate. Those communities and our economy need them.
- 1 See “Proposed Interagency Guidance on Third-Party Relationships: Risk Management,” available at www.federalreserve.gov/newsevents/pressreleases/files/bcreg20210907a1.pdf.
- 2 See Conducting Due Diligence on Financial Technology Companies: A Guide for Community Banks, available at www.federalreserve.gov/publications/conducting-due-diligence-on-financial-technology-firms.htm.
- 3 See Community Bank Access to Innovation Through Partnerships, available at www.federalreserve.gov/publications/files/community-bank-access-to-innovation-through-partnerships-202109.pdf.
- 4 More information about GDPNow is available at www.atlantafed.org/cqer/research/gdpnow.aspx.
- 5 The tools are available at www.atlantafed.org/research/data-and-tools.aspx.
- 6 The Home Ownership Affordability Monitor is available at www.atlantafed.org/center-for-housing-and-policy/data-and-tools/home-ownership-affordability-monitor.aspx.
- 7 The Commercial Real Estate Momentum Index is available at www.atlantafed.org/center-for-housing-and-policy/data-and-tools/commercial-real-estate-momentum-index.aspx.
- 8 The study is available at www.fdic.gov/resources/community-banking/report/2020/2020-cbi-study-full.pdf.