In probability theory, there’s a well-known puzzle called the Monty Hall Problem, named after the presenter of the game show “Let’s Make a Deal”. You start by choosing one of three doors, only one of which hides a prize. After you pick, the host — who knows what’s behind each door — opens another door to reveal a goat. At that point, you’re given a choice: stay with your original door or switch to the remaining unopened one. Most people assume it makes no difference, but the math tells a different story. Switching actually increases your chance of winning, doubling the odds from one in three to two in three. It’s a clever reminder that our instincts aren’t always the best guide when navigating uncertainty.In a year marked by uncertainty — with evolving tariffs reshaping trade and supply chains — we review the key challenges and opportunities faced by community financial institutions (CFIs) and the strategies they have pursued in response.
1. Interest Rates and Margin PressuresFor most of the year, the federal funds rate held between 4.5% and 4.25% before an October rate cut lowered it to 4%-4.25%, followed by two more cuts of 25bp. Just yesterday, the Federal Reserve lowered the rate to 3.25%-3.5%. Despite the downward trend, rates remain historically high, making borrowing comparatively expensive. In this climate, the Conference of State Bank Supervisors (CSBS) 2025 community bank survey found that net interest margins (NIM) and core deposit growth were viewed as the most important external risks by respondents. That said, in its Q3 report, the Federal Deposit Insurance Corporation (FDIC) reported that NIM increased to 3.73%, up 37bp YoY — driven by a rise in the yield on earning assets that outpaced funding cost increases.CFI Strategies:
1. Interest Rates and Margin PressuresFor most of the year, the federal funds rate held between 4.5% and 4.25% before an October rate cut lowered it to 4%-4.25%, followed by two more cuts of 25bp. Just yesterday, the Federal Reserve lowered the rate to 3.25%-3.5%. Despite the downward trend, rates remain historically high, making borrowing comparatively expensive. In this climate, the Conference of State Bank Supervisors (CSBS) 2025 community bank survey found that net interest margins (NIM) and core deposit growth were viewed as the most important external risks by respondents. That said, in its Q3 report, the Federal Deposit Insurance Corporation (FDIC) reported that NIM increased to 3.73%, up 37bp YoY — driven by a rise in the yield on earning assets that outpaced funding cost increases.CFI Strategies:
- Developing flexible pricing strategies. Institutions have been repricing loans faster than deposits, adopting hybrid or tiered pricing models, extending early-termination provisions to retain high-margin loans, and exploring subscription-based fee models for bundled services.
- Improving deposit mix. Strengthening relationships with core customers and offering bundled services that deepen engagement have been key. At the same time, CFIs have tried to maintain stable, low-cost transaction accounts and have used targeted rate increases to manage funding costs effectively.
- Boosting noninterest income streams. Many CFIs have been trying to diversify revenue away from interest-based income toward non-interest sources, including fees, services, and other value-added products. This is evidenced by an 8.8% YoY rise in noninterest income reported in Q3.
2. Positive Regulatory ShiftsIn line with the administration’s push for deregulation, the Office of the Comptroller of the Currency (OCC) recently eased the regulatory burden on CFIs, moving from a fixed examination schedule to a risk-based approach. This means that examiners will tailor the scope and frequency of inspections according to a bank’s size, complexity, and risk profile. What’s more, in November, the banking agencies proposed lowering the minimum threshold under the Community Bank Leverage Ratio (CBLR) framework from 9% to 8%. Combined, these measures substantially reduce regulatory and compliance overhead for many CFIs and lower the capital burden, meaning more capital can be deployed into lending or other services rather than held as a regulatory buffer.Despite the favorable regulatory shift, compliance demands continue to weigh heavily on CFIs. The cost and complexity of meeting these expectations often hit smaller institutions the hardest, prompting many to look for smarter ways to balance strong compliance with day-to-day operational efficiency.CFI Strategies:
- Strengthening compliance programs. Institutions have been investing in robust compliance frameworks by updating policies and procedures, conducting regular internal audits, and maintaining thorough documentation to demonstrate compliance during examinations.
- Adopting a risk-based approach. CFIs have been aligning resources to areas of highest risk — prioritizing high-risk lending activities, vendor oversight, and cybersecurity measures — rather than applying a one-size-fits-all approach. This strategy enables more effective and efficient use of resources.
- Leveraging technology. Recent innovations in regulatory technology (RegTech) have made it more cost-effective for CFIs to boost their compliance programs with systems that promise to improve outcomes, cut costs, and mitigate risk.
3. M&A and Strategic PartnershipsAmid a more favorable regulatory environment for M&A, it is no surprise that activity picked up in 2025. In the third quarter of 2025, 52 US bank deals were announced, representing the largest quarterly total since Q3 2021 and bringing the total deals in 2025 to 125. Moreover, 37% of institutions surveyed by Bank Director say they were approached by a potential acquirer in the past year, up from 19% in 2024. The main drivers appear to be geographic expansion, a desire to acquire low-cost deposits, and the rising costs of technology. Some institutions, instead of pursuing acquisitions, chose to partner with more technologically advanced organizations. CFIs have also decided to band together in a merger of equals, preserving the community-focused approach and a smaller asset size while still obtaining growth and shouldering the high costs of tech upgrades and regulations together.CFI Strategies:
- Reassessing strategic positioning. CFIs have been reviewing their market position and evaluating whether remaining independent, merging, or selling is the best option. Some have focused on niche markets, specialized lending, or community relationships as differentiators to maintain independence.
- Strengthening internal operations. Anticipating potential consolidation, CFIs have been investing in technology, streamlining operations, and boosting back-office capabilities. These efforts are helping position institutions to either become stronger partners in a merger or maintain their independence.
- Collaborating with advisors. Over two-thirds of respondents to the Bank Director survey said they had engaged an advisor in the previous 18 months. They did this for several reasons, ranging from finding potential partners and negotiating deal terms to seeking planning and general advice.
US financial institutions have shown real resilience in navigating a complex environment. With persistently high rates and ongoing margin pressure, many CFIs have sharpened their pricing strategies and refined their deposit mix to stay competitive. While recent regulatory shifts have been more favorable, the compliance burden remains significant, pushing institutions to strengthen their programs and invest in RegTech for added efficiency. At the same time, the growing need for scale — whether to expand geographically or to support rising technology costs — is fueling more M&A activity. This has led many CFIs to take a fresh look at their strategic direction and reinforce their internal operations to position themselves for the future.2025 has been a year of complex changes in the financial world, especially in regard to regulations, improving margins on deposits, growing, and finding unique ways to weather the cost burdens of new technology. While the challenge has been great, CFIs have persevered by adopting strategies that paid off. Don’t miss the next installment of our year-in-review series next week — all about trends in tech, cybersecurity, and digital payments.
