The Evolving Landscape of Community Banking

As a CPA who has spent over three decades working with community banks, I recently had the opportunity to host an enlightening banking update webinar covering several critical issues facing our industry. What stood out most was how community banks are navigating an increasingly complex environment of operational risks while adapting to shifting market conditions. I'd like to share some key takeaways that I believe will be valuable for financial professionals in community banking.

The Rise of Check Fraud: A Growing Concern

One of the most pressing operational challenge facing community banks today is the alarming surge in check fraud. While many might assume check usage is declining (and it is, with Federal Reserve data showing daily check processing dropping steadily as of the second quarter of 2024), the average value per check has actually increased significantly, creating a more attractive target for fraudsters.

Of particular concern is how crime rings have shifted their focus from PPP and unemployment fraud to sophisticated check fraud schemes. The numbers are eye-catching, with potentially 550,000 to 600,000 check fraud SAR filings this year. This isn't just random individuals attempting isolated fraud, but the result of coordinated efforts involving groups of fraudsters working together systematically.

One case study shared during the webinar particularly caught my attention: A Texas company's $1.2 million check to the Bazooka Gum Company was intercepted in Manhattan. Within just three days, fraudsters had created a fake company called "Bazooka Gum One Company," opened a fraudulent checking account, and begun moving the money through various channels. By the time the original company realized what had happened, $250,000 had already been extracted. This exemplifies how quickly these sophisticated operations can move.

Regulatory Focus and ALCO Risk Management

From my work with community banks, I'm seeing increased regulatory scrutiny around interest rate risk management. Examiners are particularly focused on several key areas that deserve attention:

The validation of deposit beta and decay assumptions have become a significant focus, with regulators inquiring about bank-specific data rather than sole reliance on historical or industry averages. This requires more sophisticated analysis of how your institution’s deposit costs and levels respond to rate changes.

Model backtesting has also come under additional scrutiny, particularly margin simulation results. While variances exceeding 10% might be considered acceptable, significant discrepancies should be supported by clear documentation, analysis, and reporting to both ALCO and corporate governance. The atypical deposit patterns observed during and after COVID have made this particularly challenging, as many traditional modeling assumptions were disrupted.

Conclusion

As we move forward, community banks face a complex set of challenges and opportunities. The rise in sophisticated fraud schemes requires enhanced vigilance and robust controls. Meanwhile, the evolving rate environment demands careful attention to interest rate risk management and investment strategies. Success will require a balanced approach that addresses both operational risks and strategic opportunities.

For those of us serving community banks, our role increasingly involves helping institutions navigate these interconnected challenges while maintaining their competitive edge in local markets. The key is staying informed, maintaining strong risk management practices, and ensuring that strategic decisions are made with a comprehensive understanding of both risks and opportunities.