Home > Second Issue 2022 > The Case for the Community Banking Business Model: Lessons Learned from COVID-19

The Case for the Community Banking Business Model: Lessons Learned from COVID-19
by Jessica Olayvar, Supervisory Analyst, Supervision, Regulation, and Credit, Federal Reserve Bank of Richmond

In March 2020, community bankers across the country began to realize the threat posed by COVID-19 and were forced to quickly make myriad decisions. Management teams carefully considered their options before deciding to close lobbies, deploy remote technology to employees, and hold board meetings virtually. These decisions were only the tip of the iceberg for what was to come. Outside of the operational logistics, community bank leaders began to implement contingency plans and carefully watch liquidity metrics, and increased loan loss reserves in anticipation of deterioration in credit conditions. The prompt and conservative response of community banks during this critical time has since been recognized by many. For example, in September 2020, Esther George, president of the Federal Reserve Bank of Kansas City, spoke about the way community banks remained vigilant at the outset of the pandemic by strengthening their balance sheets in preparation for a downturn.1

In response to the anticipation of a potential downturn, the Federal Reserve System and other regulatory agencies released a joint statement on March 26, 2020, encouraging banks to work with customers adversely affected by the pandemic, through either responsible small-dollar lending or loan modifications and workout strategies.2 Many community banks took immediate action by accommodating affected borrowers with loan deferrals or modifications. Just a couple weeks later, these same banks would play an instrumental role in implementing the Paycheck Protection Program (PPP), following the passage of the Coronavirus Aid, Relief, and Economic Security Act (CARES) Act.

Today, as the economy continues to rebound from two years of fluctuations and unknowns, one thing is certain: Community banks continue to support their customers and advance the strength of their local economies. As competition, mergers and acquisitions, regulatory burden, and margin compression threaten the future of the community banking business model, the need for it has never been clearer. The pandemic posed enormous challenges to community banks, and it was because of not despite — their business model that they were able to support small businesses.

Financial Resilience

Community banks have long established their ability to weather economic downturns, in many cases more successfully than much larger banks. A 2012 analysis by the Federal Reserve Bank of Dallas indicated that during the Great Recession, community banks in all but six states (Nevada, Arizona, Florida, Georgia, Michigan, and Illinois) had, on average, fewer loan problems than their largest competitors.3 In addition, in June 2012, community banks held around twice as many business loans as a percentage of total assets as the nation’s largest banks (28 to 31 percent for community banks, 12 percent for large banks). Nevertheless, those community banks generally had a smaller percentage of business loans (nonfarm, nonresidential, plus commercial and industrial) that were noncurrent or charged off.

A recent study in Research in International Business and Finance found that FDIC–chartered community banks with assets under $1 billion were more financially resilient than their large bank counterparts in various ways during the first three quarters of 2020.4 The study used return on assets (ROA), return on equity (ROE), and net interest margin (NIM) as metrics for comparison and found that both the ROA and ROE declined significantly less at community banks with assets under $1 billion. Furthermore, during the affected periods, the study found that community banks’ NIM declined less than large institutions’ NIM. In both this recent study and the plethora of analyses conducted on community banking performance during a recession, financial resilience is credited largely to one key characteristic: Community banks know their borrowers and the local business environment, and this knowledge is a significant advantage over large institutions during challenging economic periods.

Commitment to Small Businesses

As noted above, many retrospective studies note that high-quality loan portfolios are the foundation of successful community bank performance. Some researchers have ascribed this to the community banks’ noncomplex hierarchies and ownership structure, meaning each individual in a business line is closer to the customer, tends to have more at stake, and thus takes fewer risks. This was further illustrated in the aforementioned study in which the researchers found that, at the start of the pandemic, community banks’ risk-weighted assets declined more quickly than those of larger banks, suggesting a more conservative risk management approach at community banks.

Furthermore, community bankers most often live in or near the communities they serve, giving them a strong, personal knowledge of both their customers and market conditions. This deep understanding of the local economy and focus on relationship banking, rather than transactional banking, gives community banks unique insights in assessing the potential risks of a given transaction. Additionally, the focus on building a relationship with borrowers is attractive to prospective customers, specifically small businesses. In a September 2020 speech, Governor Michelle W. Bowman noted that, prior to the pandemic, community banks accounted for over 40 percent of all small business lending despite accounting for only 15 percent of total assets in the banking system.5

Throughout the pandemic, community banks have shown the importance of relationship banking. In her speech, Governor Bowman noted that in her discussions with community bank CEOs, she heard stories about how bankers conducted extensive customer outreach, including bankers who personally reached out to every one of their bank’s business and consumer loan customers to offer deferrals as needed. Later, as the CARES Act was passed, community banks played an important role in implementing the PPP and, to a lesser extent, the Main Street Lending Program. Nationwide participation for these programs totaled $799.8 billion and $17.5 billion, respectively.6,7 As large banks turned away customers, often due to overwhelmed systems and call centers, community banks stepped in to help small businesses.8 According to the FDIC, as of June 30, 2020, community banks held 31 percent of PPP loans held by the banking industry; this is a significant share given that community banks held 12 percent of total industry assets and 15 percent of total industry loans.9 Relationship banking, more so than sophisticated banking systems or unlimited resources, allowed community banks to effectively implement these stimulus programs.

For many community banks, administering the multiple rounds of the PPP loans was an “all-hands-on-deck” effort. The responsibility to help neighbors and local businesses was a heavy burden for community bank employees, as many worked around the clock under difficult circumstances to manually process applications. Nevertheless, many community banks were able to process PPP applications for small businesses at a faster pace than larger banks could.10 With less red tape and shorter queues, community banks exhibited greater PPP processing agility than larger banks.

Contributions to the Financial System

The long-term effects of the CARES Act are still unclear. However, a study by two Federal Reserve economists published in January 2021 estimated that PPP loans saved 13 million jobs.11 As we have seen, community banks played a big role in processing PPP loans. Beyond their support to the economic recovery from the pandemic, community banks contribute to the health of the economy in other ways.

In 2018, the Federal Reserve Bank of Philadelphia published a paper that considered the impact of mergers and acquisitions of community banks on small businesses’ access to credit.12 The results of the study noted that the overall impact of community bank mergers is dependent upon where the acquirers and target institutions were located prior to the merger. When these institutions became targets of a merger or acquisition by a nonlocal acquirer, the study found, small businesses in the targeted bank’s market area experienced lending gaps that were not filled by the remaining banking sector. This suggests the importance of community banks’ lending activities and the potentially adverse economic externalities of merger activity.

In 2012, the Federal Reserve Bank of Dallas published a series of essays written by financial experts highlighting the links between a robust financial system and a strong community banking sector. In the essay series, the authors contend that compared with larger firms, community banks had stronger underwriting practices and asset quality, focused on small businesses, and were supportive of customers during times of financial crises. To quote the end of one essay, “Recent experience suggests that reestablishing a more prominent role for traditional banking, as exemplified by community banks, could help the nation achieve greater financial stability. Policymakers should take note.”13


The pandemic resulted in an unprecedented shock to the U.S. financial system. In April 2020, more than 20 million jobs were eliminated, and unemployment reached 14.7 percent. By comparison, during the Great Recession job losses in one month peaked at 800,000 in March 2009 and unemployment reached a record high of 10 percent in October 2009.14 Yet, during the past two years, community banks have continued to demonstrate their financial resilience and commitment to serving small businesses. As the memories of the initial shock from the pandemic fade, we will continue to recognize the importance of community banks in providing banking services and credit to their communities in a safe and sound manner.

System Outreach

The Federal Reserve System provides various resources for training, services, and more.

Learn more »

Policy and Guidance

Connect to various Federal Reserve resources, including SR and CA Letters, regulations, request for comment on rulemaking proposals, the latest Federal Reserve System speeches, and more.

Learn more »


Community Banking Connections is a quarterly Federal Reserve System publication available electronically or in print.

Learn more »


We want to hear from you! Please share with us any comments, suggestions, or topics that you would like to see on our website or in our publications.

Learn more »