Top 4 Internal and External Risks Impacting Community Banks

Risk Rankings at a Glance

The following table summarizes the top external and internal risks as they were ranked in the 2025 CSBS Annual Survey, along with their primary drivers.

External Risks

Internal Risks

External Risks Impacting Community Banks

Community banks face a challenging external environment shaped by economic conditions, regulatory shifts, and market dynamics. The 2025 CSBS Annual Survey of Community Banks highlights four significant external risks:

Net Interest Margins

Net interest margins (NIM) rank as the highest external risk in the 2025 survey. After tying for the top external risk in 2024, regulatory burden fell to sixth place and NIM moved into the top spot as margin compression became the defining financial challenge of the current rate cycle.

With the yield curve inversion now resolved, the dynamics have shifted. However, loan repricing still lags deposit costs in many community bank portfolios, keeping pressure on spreads. The Federal Reserve held its funds rate at 3.50%–3.75% at the June 2026 meeting, and core PCE inflation at 3.3% as of April 2026 has reduced confidence that further easing is imminent.

Community banks are increasingly exploring fee-based revenue streams, treasury services, and wealth management offerings to offset margin pressure while adjusting their asset-liability mix.

Core Deposit Growth

Core deposit growth ranks second among external risks in 2025. The challenge has persisted since rising rates in 2022 began driving depositors toward higher-yield alternatives. While community bank funding costs declined 24 basis points from 2.95% in 2024:Q4 to 2.71% in 2025:Q1 competition for stable deposits remains intense.

The survey found that nearly 49% (up from 43%) of respondents plan to continue using purchased federal funds as a supplemental funding source. Relationship-based deposit strategies and expanded digital account opening capabilities are among the tools community banks are deploying to strengthen core funding.

Economic Conditions, Cost of Technology, and Cost of Funds

Three risks are essentially tied as the third-highest external concern in 2026:

• Economic conditions
• Cost of technology
• Cost of funds

Persistent inflation, uncertainty about the Federal Reserve’s rate path, and rising technology investment requirements are converging to create a challenging operating environment.

Cost of funds, which ranked as the top or near-top external risk in both 2023 and 2024, has eased modestly as the rate cycle turns. The 24-basis-point decline in funding costs between Q4 2024 and Q1 2025 reflects this improvement.

Regulatory Burden

Regulatory compliance, which tied for the top external risk in the 2024 survey, fell to sixth place in 2025. The shift reflects reduced regulatory uncertainty in the current political environment, though community banks continue to absorb compliance costs from prior-cycle rulemaking in areas including:

• Liquidity management
• Capital adequacy
• Risk governance

Institutions that invested in regulatory change management and policy management infrastructure during the 2023–2024 tightening cycle are better positioned to absorb new requirements with lower marginal cost.

Internal Risks Affecting Community Banks

Community banks must manage internal risks impacting operational stability, regulatory compliance, and long-term resilience. The 2025 CSBS Annual Survey of Community Banks highlights four primary internal risks:

Cybersecurity Risks

Cybersecurity remains the top-ranked internal risk. 58% of community bankers cited it as ‘extremely important,’ surpassing all other risks by a notable margin.

The threat environment continues to evolve. The most common attack vectors targeting community financial institutions remain:

• Ransomware
• Business email compromise
• Third-party vendor breaches

The growing adoption of cloud banking, AI-assisted services, and digital payment platforms increases the attack surface, while community banks typically face tighter security budgets than their larger peers.

In response, community banks are investing in threat detection systems, employee cybersecurity training, and incident response planning. Regulators continue to emphasize cybersecurity maturity as a core examination focus, with particular attention to third-party risk controls and multi-factor authentication.

Technology Implementation and Operational Costs

Technology implementation and related costs rank second among internal risks in 2025. The demand for digital banking capabilities requires ongoing capital investment that strains smaller institutions.

Community banks frequently compete with larger institutions and fintech firms for digital product capabilities while operating with significantly smaller technology budgets. Vendor-hosted, cloud-based platforms have helped reduce some infrastructure costs, but integration complexity and total cost of ownership remain significant concerns.

Credit Risk

Credit risk has replaced liquidity as the third-ranked internal risk in the 2025 survey, reflecting the changing macroeconomic environment. As the rate cycle turns and some borrowers encounter stress from the cumulative impact of elevated rates over 2022–2024, loan delinquency and charge-off trends have attracted increased attention.

Community bank loan portfolios are concentrated in commercial real estate, agricultural lending, and small business credit. Monitoring credit quality in these portfolios, maintaining adequate allowances for credit losses, and managing loan concentrations are priority risk management activities in 2026.

Staff Retention

Talent retention remains a concern for community banks, though the intensity has eased from its 2022 peak. 75% of banks cited staff retention as a critical risk in the 2024 survey. Competition with larger financial institutions and fintech firms for compliance officers, technology professionals, and relationship bankers continues.

Community banks are addressing retention through:

• Enhanced benefits
• Career development programs
• Flexible work arrangements
• Regional compensation benchmarking

Managing Risk with Technology-Driven Solutions

Managing risks effectively requires a structured, technology-driven approach that allows community financial institutions to enhance risk oversight, standardize processes, and streamline operations.

Predict360 Essentials is designed specifically for community banks and growing institutions, providing preconfigured tools for risk and compliance management that simplify complex operational and regulatory challenges.