In the current macroeconomic environment, ongoing high inflation and elevated interest rates are putting pressures on businesses of all sectors and types – including financial institutions. Many community banks, in particular, may be struggling to find the path forward as the Federal Reserve has shown no sign of deviating from a tight monetary policy.

“There are some banks that are essentially waiting out this Fed cycle right now. With interest rates remaining high, many community banks have reached the point at which it’s difficult to achieve necessary margins. Additionally, with capital and liquidity tight, they are pausing on lending, which means they’re not growing, and in fact their earnings are shrinking a little more each quarter,” said Robert Pachence, head of PNC FIG Advisory at PNC Capital Markets. “On the flip side, there are also banks who are actively trying to stay out of that situation. They’re ready to adopt strategies and approaches that they might not have pursued before in order to get through their current challenges. This is where relying on consultative guidance from well-diversified institutions in the banking industry can offer real benefit.”

Many community banks are currently focused on finding solutions in three significant areas of concern:

  • Liquidity: One big current question for banks is how to retain deposits. As interest rates have risen, so has the cost of deposits for banks and the competition for depositors, many of whom may be looking to capitalize on higher rates by keeping their money in something other than a traditional bank checking account, certificate of deposit, or money market account. This leaves banks in a position of having to decide how to raise liquidity in the most economical way possible, which may involve taking a non-conventional approach, such as through selling loans or securities. This, in turn, leads to a decision on how best to manage the funds from those transactions, whether keeping them as on-hand liquidity or reinvesting to fund future loan activity. This creates a push and pull on balance sheets, as banks try to manage maintaining profitability, keeping liquidity robust, and funding future growth.
  • Interest Rate Risk: Managing interest rate risk is another critical concern. Banks may face interest rate exposure due to the inverted yield curve, with short-term floating rates exceeding long-term fixed rates as a result of the Fed’s series of interest rate hikes. Implementing a hedging program may be an effective approach to minimizing risk and helping to make sure a bank’s balance sheet performs well if rates rise or fall. But many community banks may lack the in-house resources to develop such strategies, in which case it can be important to turn to third-party advisors with demonstrated expertise
  • Raising Capital: As interest rates have risen, capital levels have dropped for many financial institutions, leaving them either looking for capital now or anticipating the need for it in the future. However, it may be difficult for banks to decide on the form that capital should take. Many community banks are not currently in a position to raise equity capital, and if they are interested in raising debt, they have to account for the rising cost of borrowing. When it comes to procuring capital, just as with hedging to protect against interest rate risk, adopting a proactive approach is important. But taking action may require having specialized knowledge about options that are available in the capital markets and the timing that may be most conducive for pursuing them, which may be an area of limitation for community banks with limited internal resources.

While banks may understand the importance of being proactive in order to grow and thrive in the current economic setting, many community banks may not have in-house capabilities to take action effectively. This is where turning to outside institutions with dedicated expertise can help fill the gaps.

“At PNC, we understand the needs that banks have, because we have the same needs. But as a large, diversified financial institution, we have teams of experts with broad industry knowledge. Through PNC FIG Advisory, banking clients can tap into that expertise,” said Pachence. “Our goal is to work strategically with banks to develop cohesive, bespoke plans to meet their needs. This might involve implementing a hedging program to manage interest rate risk through the PNC Derivative Products Group, leveraging solutions like PNC Asset Exchange to help manage balance sheets, developing strategies to raise capital, or even exploring possibilities in mergers and acquisitions. Whatever the needs are, our goal is to identify strategies and tactics and help banks execute on them.”

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