Community Banks - Challenges and Opportunities

Community banks have long been the backbone of the American financial system, providing essential banking services to local communities, small businesses, and agricultural enterprises. While larger banks and FinTech companies have expanded their reach, community banks continue to thrive by focusing on relationship banking and personalized services. As of 2023, there are 4,000 community banks in the United States, each holding less than $10 billion in assets. These institutions play a vital role in supporting local economies in rural and underserved areas, by offering tailored financial solutions and fostering close ties with their customers.

However, community banks face significant challenges in today’s dynamic financial environment. Rising interest rates, increased cybersecurity threats, and the rapid pace of technological change are just obstacles they must navigate. Yet, these challenges also present opportunities for community banks to innovate, improve operational efficiency, and enhance their customer service offerings.

Size, Numbers, and Segmentation of Community Bank

The number of community banks in the U.S. has declined over the past decade, because of mergers and acquisitions. Despite this trend, the remaining community banks have proven resilient and hold significant market share in key sectors, such as small business lending, agricultural finance, and residential mortgages.

• Asset Segmentation: Most community banks operate with assets ranging from $100 million to $1 billion. 32% of these banks fall within the $300 million to $1 billion range, 22% between $100 million and $300 million, and a smaller percentage exceeds $1 billion in assets. These banks serve specific geographic regions, focusing on local markets.
• Branch Distribution: Community banks operate a few branches. About half of these institutions have between one and five branches, with 13% operating with no branches at all, relying on their headquarters.18% of community banks have over ten branches, showing their regional significance in certain areas. This limited branch network allows community banks to maintain a localized focus, catering to the unique needs of their communities.
• Market Share: Community banks hold a significant portion of the market in specialized lending sectors. For instance, they account for 36% of all small business loans in the U.S. and around 70% of agricultural loans. Despite holding less than 15% of total banking assets, their impact on local economies is substantial, in rural areas where larger banks may not have a powerful presence.

Major Challenges Facing Community Bank

1. Interest Rate Challenges

The rising interest rate environment poses a significant challenge for community banks, affecting their profitability and operational stability.

Net Interest Margins (NIM): Net interest margin, a key measure of bank profitability, is under pressure because of the Federal Reserve's rate hikes aimed at controlling inflation. The NIM of community banks, which is based on the interest difference between loans and deposits, is becoming harder to sustain. In the 2023 CSBS survey, 89% of community bankers identified NIM as a top external risk. Many of them are struggling to adapt to the rapid changes in the interest rate environment.

Cost of Funds: The cost of funds has surged, with 87% of community bankers highlighting it as a significant risk. This increase is dramatic compared to 2022 when only 48% viewed it as a critical concern. Many banks are struggling to increase lending rates as the rising cost of deposits, driven by the need for competitive rates, outpaces their ability to do so, leading to compressed margins. For example, the average cost of deposits increased from 0.56% at the end of 2022 to 1.49% by March 2023.

Case Study – Bank of New Glarus, Wisconsin: The Bank of New Glarus has navigated the interest rate challenges by implementing an aggressive asset-liability management strategy. The bank diversified its loan portfolio by increasing its focus on variable-rate loans, which adjust with market interest rates, protecting the bank’s margins. The bank has invested in long-term liabilities to lock in lower interest rates, reducing the impact of rising deposit costs on its overall profitability.

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Solutions:

Advanced Asset-Liability Management (ALM): To navigate the challenging interest rate environment, community banks must enhance their ALM strategies. This includes diversifying their loan portfolios, extending the duration of liabilities, and using hedging strategies to mitigate interest rate risk. Banks can also leverage tools like interest rate swaps and options to manage exposure to fluctuating rates.

Digital Transformation for Cost Management: By adopting digital banking solutions, community banks can attract more deposits and reduce operational costs. By implementing a mobile banking platform, First State Bank of the Southeast in Kentucky could increase customer engagement and deposits. This platform also offered competitive digital services and reduced the reliance on high-cost physical branches.

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2. Fraud Detection and Cybersecurity Risks

As community banks embrace digital transformation, they face increasing risks from cyber threats. The shift towards digital banking has expanded the attack surface for cybercriminals, making cybersecurity the top internal risk for community banks in 2023.

Cybersecurity Concerns: The 2023 CSBS survey shows that 93% of community bankers identified cybersecurity as either “important” or “very important.” The rise in sophisticated cyberattacks, such as ransomware, phishing, and denial-of-service attacks, has forced banks to invest in cybersecurity infrastructure. However, smaller banks often struggle to allocate sufficient resources to these critical areas.

Internal Fraud: Besides external threats, internal fraud remains a significant concern. Their smaller operational scale and limited resources heightened the vulnerability of community banks for implementing extensive internal controls. The 2023 survey highlights that 76% of bankers view staff retention and technology implementation as critical areas tied to managing these risks.

Case Study–Southern Bank, Missouri: Southern Bank has enhanced its cybersecurity posture by partnering with a FinTech firm specializing in AI-driven fraud detection. This partnership has enabled Southern Bank to deploy real-time monitoring systems that detect and prevent fraudulent transactions. The bank offered comprehensive training to employees, equipping them with the knowledge to defend against cyber threats and lowering the possibility of fraud from both internal and external sources.

?Solutions:

AI-Powered Fraud Detection: Community banks should invest in AI-powered fraud detection tools that can monitor transactions in real time and identify suspicious activities. These systems can adapt to emerging threats and reduce the risk of both external cyberattacks and internal fraud.

Training employees on the best ways to stay safe online is crucial. Community banks, like Southern Bank, have found success in reducing fraud by ensuring that all staff are aware of the latest threats and know how to respond.

Third-Party Security Assessments: Conducting regular third-party security assessments can help community banks identify vulnerabilities in their systems and processes. These assessments provide an external perspective and often uncover risks that internal teams might overlook.

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3. Process Re-engineering to Reduce Costs

Faced with rising operational costs and tighter margins, community banks are turning to process re-engineering to reduce costs and improve efficiency.

Operational Efficiency: Process re-engineering involves analyzing and redesigning workflows to eliminate inefficiencies. For community banks, this can mean automating back-office processes, streamlining customer service operations, and reducing reliance on manual tasks.

**Case Study–Mercantile Bank of Michigan: Mercantile Bank embarked on a process re-engineering initiative that focused on digitizing loan origination and approval processes. By implementing an end-to-end digital loan processing system, the bank reduced the time required to approve loans by 40%, cutting operational costs by 25%. The bank’s ability to process loans faster not only improved customer satisfaction but also allowed it to compete more effectively with larger institutions.

**Case Study–PeoplesBank, Pennsylvania: PeoplesBank has successfully reduced costs by adopting a lean banking approach. This involved re-engineering their branch operations to focus on self-service kiosks and online banking services, need for extensive branch staffing. As a result, the bank could reduce branch operating costs by 30% while maintaining high levels of customer satisfaction.

?Solutions:

Automation of Back-Office Processes: Implementing automation in back-office processes can reduce operational costs. For example, automating loan underwriting, compliance reporting, and transaction processing can reduce resources.

Lean Banking Practices: Adopting lean banking practices can help community banks streamline operations and reduce waste. This includes simplifying processes, eliminating steps, and empowering employees to identify areas for improvement.

Digital Customer Service Solutions: By integrating digital customer service platforms, community banks can reduce the need for extensive in-branch staff and still provide high-quality service. Chatbots, mobile apps, and online portals can handle routine inquiries, and reduce human resources for more complex customer needs.

?Opportunities for Community Bank

Despite the challenges, community banks have unique opportunities to innovate and enhance their service offerings, positioning themselves for future success.

1. Leveraging Technology for Growth

Adopting new technologies presents significant opportunities for community banks to enhance their operations and customer service. The 2023 CSBS survey shows that all community banks recognize prizing technology adoption, with 49% as “very important”.

Digital Banking Solutions: Offering digital banking services such as mobile banking, online account opening, and digital lending platforms can help community banks compete more effectively with larger institutions. For instance, Live Oak Bank, based in North Carolina, has become a leader in digital banking solutions for small businesses. Live Oak Bank’s exclusive focus on digital banking has allowed them to reduce branch expenses and serve customers all over the country. They also provide specialized lending services to niche markets such as veterinary practices and funeral homes.

Automation and AI: Implementing automation in back-office processes can significantly reduce operational costs and improve efficiency. AI-powered tools can enhance loan underwriting, fraud detection, and customer service. Option 2: Southern Bancorp, a CDFI, successfully implemented AI-powered credit scoring models. This initiative increased loan approvals by 20%, improving credit accessibility for underserved communities.

Data Analytics for Personalization: Leveraging data analytics can provide community banks with insights into customer behavior, enabling more personalized service offerings. This can lead to increased customer satisfaction and loyalty, and improved cross-selling opportunities. By employing data analytics, the United Bank of Alabama effectively segmented its customer base and offered tailored products and services, resulting in a 15% increase in cross-sell ratios.

Solutions:

Partnerships with FinTech Firms: Collaborating with FinTech firms can provide community banks with access to the latest technological innovations with no significant upfront investment. These partnerships can help banks offer competitive digital services and stay ahead of technological trends.

Investing in Core System Upgrades: Community banks should prioritize upgrading their core banking systems to support new technologies. Modern core systems enable banks to integrate various digital services, enhancing the customer experience.

Customer Education on Digital Banking: Educating customers on the benefits of digital banking can drive adoption and increase the use of online and mobile platforms. This is important in rural areas where digital literacy might be lower.

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2. Strengthening Relationships and Community Engagement

Community banks have a unique advantage in their deep-rooted relationships with local customers. By focusing on relationship banking, they can differentiate themselves from larger competitors and build long-lasting customer loyalty.

Personalized Service: Community banks excel in providing personalized service, which is valued by customers. This approach involves understanding the specific needs of customers, offering tailored financial solutions, and maintaining a high level of customer engagement. According to the 2023 CSBS survey, 76% of community bankers view customer service as a critical component of their success.

Community Involvement: Engaging with the local community through sponsorships, volunteer activities, and support for local businesses strengthens the bank’s brand and fosters loyalty. Community banks’ involvement in local affairs reinforces the perception that they are pillars of the community, which is often seen by the local community.

Case Study–Bank of Ann Arbor, Michigan: Bank of Ann Arbor has become a model for community engagement. The bank has launched several initiatives that support local businesses and non-profits, including a “Sonic Lunch” series that provides free concerts in downtown Ann Arbor. This program has not only enhanced the bank’s brand but also strengthened its ties to the local community, resulting in increased customer loyalty and business growth.

?Solutions:

Enhanced Customer Relationship Management (CRM): Implementing advanced CRM systems can help community banks manage customer relationships more effectively. These systems provide insights into customer preferences and behaviors, enabling banks to offer more personalized and relevant products and services.

Community-Centric Marketing: Developing marketing strategies that emphasize the bank’s role in the local community can enhance brand loyalty. Highlighting success stories, such as helping local businesses thrive or supporting community projects, can resonate with customers and differentiate the bank from larger competitors.

Financial Literacy Programs: Offering financial literacy programs to the community can position the bank as a trusted advisor. These programs can help customers make informed financial decisions, which can lead to increased loyalty and customer retention.

3. Expanding into Niche Markets

Community banks are well-positioned to serve niche markets that are often overlooked by larger institutions. By focusing on specific sectors, such as small business lending, agricultural finance, and affordable housing, community banks can capture a loyal customer base and generate sustainable revenue streams.

In the U.S., community banks play a crucial role in small business lending, accounting for 36% of all loans. These loans are essential for local economic development, and community banks have the expertise and local knowledge to assess the creditworthiness of small businesses effectively.

Agricultural Finance: With 70% of agricultural loans originating from community banks, these institutions play a vital role in supporting the agricultural sector. Community banks understand the unique challenges faced by farmers and can offer customized financial solutions that larger banks might not provide.

Affordable Housing: Community banks can expand their services to include affordable housing finance, a sector with growing demand. By offering mortgages and construction loans for affordable housing projects, community banks can address a critical need in many communities while diversifying their loan portfolios.

Case Study – Pinnacle Bank, Georgia: Pinnacle Bank has focused on agricultural lending, leveraging its deep understanding of the local farming community. By offering specialized loan products tailored to the agricultural sector, Pinnacle Bank has become a trusted financial partner for local farmers, leading to a steady growth in its loan portfolio.

Case Study – HomeStreet Bank, Washington: HomeStreet Bank has made significant strides in affordable housing finance. HomeStreet Bank’s tailored construction loans and mortgages have expanded its reach, contributing to affordable housing projects in the Pacific Northwest.

?Solutions:

Developing tailored financial products for small businesses, farmers, and affordable housing developers can help community banks strengthen their market position in these niches. For example, offering flexible loan terms, competitive rates, and personalized service can attract and keep customers in these sectors.

Collaboration with Government Programs: One way to collaborate is by partnering with government programs, such as the Small Business Administration (SBA) or the U.S. Department of Agriculture (USDA). Department of Agriculture (USDA) can provide community banks with additional resources and support for their lending activities. These partnerships can also help mitigate risk and expand the bank’s lending capacity.

Targeted Marketing: The bank must customize marketing efforts to meet the specific needs and challenges of its niche markets. Highlighting the bank’s expertise and success stories in these areas can attract new customers and build trust with existing clients.

?The Role of FinTech in Community Banking

In the developing financial landscape, FinTech companies have emerged as powerful players, offering innovative solutions that enhance customer experience, streamline operations, and reduce costs. For community banks, partnering with FinTech firms offers a chance to benefit from advancements with no significant in-house investments. This is especially important considering their limited resources compared to larger institutions.

FinTech partnerships can help community banks enhance their digital offerings, improve operational efficiency, and better compete with larger banks and online-only financial institutions. These collaborations enable local banks to incorporate advanced technology into their current systems, offering customers the modern and hassle-free banking experience they expect in today’s digital world.

Benefits of FinTech Partnerships for Community Bank

Enhanced Digital Banking Services

One of the most significant benefits of partnering with FinTech firms is the ability to offer enhanced digital banking services. FinTech companies specialize in creating user-friendly, advanced platforms that can improve the customer experience. For community banks, this means the ability to offer services such as mobile banking, digital wallets, online account opening, and remote deposit capture with no extensive in-house development.

Case Study–Radius Bank, Massachusetts: Radius Bank, a Boston-based community bank, transformed itself into a leading digital bank by partnering with various FinTech firms. These partnerships enabled Radius Bank to offer a digital banking experience, including mobile banking apps, online account management, and high-yield savings accounts. As a result, Radius Bank expanded its customer base nationwide, far beyond its original geographic footprint, and LendingClub gained it, highlighting the success of its digital transformation strategy.

?Improved Operational Efficiency

FinTech partnerships can also drive significant improvements in operational efficiency. FinTech solutions often include automation tools, artificial intelligence (AI), and machine learning (ML) technologies that can streamline processes such as loan underwriting, compliance, fraud detection, and customer service. By automating routine tasks, community banks can reduce operational costs, minimize errors, and allocate human resources to more strategic activities.

Case Study–Southern Bancorp, Arkansas: Southern Bancorp, a community development financial institution (CDFI), partnered with a FinTech company to implement AI-driven credit scoring models. This partnership allowed Southern Bancorp to process loan applications more quickly and, reducing the time from application to approval by 30%. By using AI models, the bank could offer credit to a wider range of customers, including those with limited credit histories. This allowed the bank to expand its customer base and fulfill its mission of financial inclusion.

?Access to Advanced Data Analytics

Data analytics is another area where FinTech partnerships can provide community banks with a competitive edge. FinTech firms offer sophisticated data analytics platforms and can analyze customer data to uncover insights about customer behavior, preferences, and needs. This information can tailor products and services, improve customer engagement, and increase cross-selling opportunities.

Case Study–Live Oak Bank, North Carolina: Live Oak Bank, known for its focus on small business lending, leveraged a FinTech partnership to enhance its data analytics capabilities. The bank implemented a platform that analyzed customer data to identify patterns and trends, allowing Live Oak Bank to offer personalized financial advice and product recommendations. This personalized approach resulted in higher customer satisfaction and loyalty, and it positioned Live Oak Bank as a leader in the small business lending market.

?Expanding Market Reach

FinTech partnerships enable community banks to reach new markets and customer segments that were inaccessible. By offering digital banking services, community banks can extend their reach beyond their physical branch network, attracting customers from different regions and demographics.

Case Study–Aspiration Bank, California: Aspiration Bank, a conscious community bank, partnered with FinTech companies to offer a suite of digital banking services aimed at conscious consumers. Through its partnerships, Aspiration could provide features like carbon footprint tracking, automated donations to environmental causes, and investment portfolios focused on sustainability. Aspiration’s unique offering attracted customers from across the country, enabling the company to grow with no need for many physical branches.

Regulatory Compliance and Risk Management

Compliance with regulatory requirements is a significant challenge for community banks, especially as regulations continue to grow. Community banks can benefit from FinTech companies, as they offer tools and platforms to streamline compliance, mitigate regulatory risks, and stay current with regulatory changes.

Case Study–Peoples Bank, Ohio: Peoples Bank partnered with a FinTech company to implement a compliance management platform that automates the tracking and reporting of regulatory changes. The platform also provides real-time risk assessments and generates reports for regulatory bodies, reducing the burden on the bank’s compliance team and minimizing the risk of non-compliance. As a result, Peoples Bank could enhance its risk management framework and reduce compliance-related costs.

FinTech partnerships with community banks illustrate how these collaborations can drive innovation, improve efficiency, and enhance customer experience.

1. Citizens Bank of Edmond and TeslaFi

Location: Edmond, Oklahoma Partnership aim: Enhancing financial product offerings through a FinTech platform.

Citizens Bank of Edmond, a small community bank with deep local roots, partnered with TeslaFi, a FinTech company specializing in financial analytics and tracking for electric vehicle (EV) owners. This partnership allowed Citizens Bank of Edmond to offer tailored financial products, such as loans for EV purchases, to Tesla owners. The bank collaborated with TeslaFi to tap into the growing market of conscious consumers. This collaboration enabled them to leverage TeslaFi’s data analytics platform, which provides insights into EV usage patterns. As a result, the bank could assess creditworthiness more effectively.

2. Sutton Bank and Cardlytics

Location: Attica, Ohio Partnership aim: Improving customer engagement through personalized rewards programs.

Sutton Bank, a community bank with a focus on small-town banking services, partnered with Cardlytics, a FinTech firm that specializes in purchase-based marketing solutions. Through this partnership, Sutton Bank integrated Cardlytics’ technology to offer a personalized rewards program to its customers. The platform analyzes customer spending behavior and offers tailored cash-back rewards from participating merchants, enhancing the bank’s debit card offering.

3. Radius Bank and Aspiration

Location: Boston, Massachusetts Partnership aim: Expanding digital banking services and reaching conscious consumers.

Radius Bank, a traditional community bank, partnered with Aspiration, a FinTech, focused on sustainable and responsible banking. This partnership allowed Radius Bank to offer Aspiration’s suite of digital banking products, including high-yield savings accounts and responsible investment options, under its platform. Aspiration's mobile app, which features tools like "Plant Your Change" that round up purchases and uses the difference to plant trees, attracted a new demographic of conscious customers. The collaboration expanded Radius Bank’s customer base, attracting conscious consumers nationwide. The bank could grow its deposits and lending activities with no physical branches, positioning itself as a leader in digital banking and sustainability. This successful partnership led to acquiring Radius Bank by LendingClub, underscoring the value created by the FinTech collaboration.

4. NBKC Bank and Q2

Location: Kansas City, Missouri Partnership aim: Digital transformation and expanding nationwide reach.

NBKC Bank, a community bank based in Kansas City, partnered with Q2, a FinTech provider of digital banking solutions, to transform its online banking platform. Through this partnership, NBKC Bank could offer a full suite of digital banking services, including online account opening, mobile banking, and loan applications, to customers across the United States. Q2’s platform provided the infrastructure to scale NBKC’s services beyond its regional footprint. NBKC Bank saw significant growth in its customer base, especially among tech-savvy millennials and small business owners looking for robust online banking options. The bank’s ability to offer nationwide services with no additional branches helped reduce operational costs while increasing deposits and loans.

5. Midwest Bank Centre and Auto books

Location: St. Louis, Missouri Partnership aim: Supporting small businesses with integrated financial management tools.

Midwest BankCentre, a community bank serving the St. Louis area, partnered with Auto books, a FinTech that provides financial management tools for small businesses. Through this partnership, Midwest BankCentre offered its small business customers an integrated platform that combines invoicing, payment acceptance, and accounting services within their existing online banking interface. The partnership enabled Midwest BankCentre to deepen its relationships with small business clients by providing essential tools that streamline financial management. This not only enhanced customer loyalty but also attracted new small business clients who valued the convenience of having banking and financial management services in one place.

6. Cross River Bank and Affirm

Location: Fort Lee, New Jersey Partnership aim: Offering "Buy Now, Pay Later" (BNPL) services.

Cross River Bank, a tech-driven community bank, partnered with Affirm, a leading FinTech in the “Buy Now, Pay Later” (BNPL) space. This collaboration allowed Cross River to serve as the bank partner behind Affirm's consumer financing products, handling the underwriting, regulatory compliance, and fund disbursement aspects of the BNPL loans. The partnership with Affirm positioned Cross River Bank as a key player in the fast-growing BNPL market. It allowed the bank to expand its lending activities and revenue streams with no an extensive branch network. The collaboration also showed how community banks can partner with FinTech firms to tap into emerging financial trends.

7. Coastal Community Bank and Finastra

Location: Everett, Washington Partnership aim: Enhancing lending capabilities through cloud-based solutions.

Coastal Community Bank partnered with Finastra, a global FinTech leader, to implement cloud-based lending solutions. This partnership aimed to enhance the bank’s ability to offer real-time loan processing, automated compliance checks, and streamlined loan origination processes. Finastra’s platform provided Coastal Community Bank with the scalability and flexibility needed to meet the increasing demand for small business and consumer loans. Implementing Finastra’s cloud-based lending solutions enabled Coastal Community Bank to reduce loan processing times by 50%, improve compliance efficiency, and scale its lending operations without significant increases in overhead. This positioned the bank as a more competitive lender in its region, attracting more small business clients and expanding its loan portfolio.

8. NBH Bank and Kasasa

Location: Greenwood Village, Colorado Partnership aim: Offering reward-based checking accounts.

NBH Bank, which operates under the Community Bank of Colorado and Bank Midwest brands, partnered with Kasasa, a FinTech company known for its reward-based checking accounts. Through this partnership, NBH Bank introduced Kasasa’s products, which offer high interest rates, cash-back rewards, and ATM fee reimbursements, to its customers. The Kasasa partnership helped NBH Bank attract a younger customer demographic interested in high-value checking accounts. The bank saw a significant increase in account openings and customer retention, as the reward-based accounts motivated customers to use NBH Bank as their primary financial institution.

FinTech partnerships represent a powerful opportunity for community banks to enhance their digital offerings, improve operational efficiency, and compete more effectively in today’s financial landscape. Community banks can benefit from collaborations by handpicking the right partners, aligning FinTech solutions with their goals, and prioritizing their customers. Despite the challenges, the benefits of FinTech partnerships far outweigh the risks, offering community banks a path to growth, innovation, and continued relevance in an digital world.

Community banks that embrace FinTech partnerships will thrive in the strengthening financial services industry, delivering enhanced value to customers and supporting local economies.

Community banks are facing a complex and challenging environment characterized by rising interest rates, increasing cybersecurity risks, and intense competition. However, by leveraging technology, re-engineering processes to reduce costs, strengthening customer relationships, and focusing on niche markets, these banks can turn these challenges into opportunities for growth and success. As the financial landscape continues to develop, community banks must remain agile, innovative, and committed to serving their communities. By doing so, they will continue to be a vital component of the U.S. financial system, supporting local economies and contributing to the well-being of Main Street America.

This article has explored the challenges and opportunities facing community banks, with detailed case studies and examples illustrating how these institutions can adapt and thrive in a changing environment. By prioritizing their strengths and embracing innovation, community banks can continue to play a crucial role in both the financial lives of their customers and the overall economic health of their communities.

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References:

1.??????? 2023 CSBS Annual Survey of Community Bank

https://www.csbs.org/sites/default/files/2023-09/CSBS%202023%20Community%20Bank%20Survey%2010.04.2023.pdf

?2.??????? The community banking landscape

https://go.csiweb.com/rs/996-ERF-896/images/WP_NPT_MER_BankingPriorities24.pdf

?3.???????? Small banks: big challenges and big opportunities

https://www.abrigo.com/blog/small-banks-challenges-community-lenders/

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