In this evolving financial landscape, community banks rely heavily on core service providers (CSPs) and third-party vendors to implement innovative solutions. With digital transformation accelerating at an unprecedented pace, the ability to innovate swiftly has become crucial for maintaining customer loyalty, enhancing operational efficiency, and staying ahead in a competitive market. However, as highlighted in the Office of the Comptroller of the Currency’s (OCC) recent Request for Information (RFI), these relationships often present significant hurdles. Let’s examine the innovation challenges, provider performance cases, and insights to keep community banks competitive. Over the next few weeks, I will be publishing a series of articles addressing CCG Catalyst’s view on the OCC’s request for information.

The OCC’s RFI underscores the critical role community banks play in the U.S. economy, emphasizing their outsized impact on lending and local communities. Yet, many banks are dependent on a concentrated market of CSPs, where consolidation has led to reduced competition and innovation. According to industry surveys cited in the RFI, the three largest CSPs serve over 70% of depository institutions, often resulting in high dissatisfaction levels. This market dynamic exacerbates challenges, as banks struggle with legacy systems that hinder adoption of cutting-edge technologies.

Key Challenges in Implementing Innovative Solutions

Community banks face a concentrated market dominated by a few major CSPs, leading to legacy system constraints and slow adaptation to new technologies. Based on our work with clients, the primary issues include:

• Limited Innovation Roadmaps: CSPs often prioritize larger clients, delaying features like real-time payments, AI-driven fraud detection, or advanced APIs for community banks. This rigidity stems from providers’ focus on scalable solutions for bigger institutions, leaving smaller banks waiting years for essential updates that could enhance digital offerings
• Integration Barriers: Legacy systems create data silos and incompatible APIs, increasing costs and cyber risks when integrating fintech solutions. For instance, attempting to incorporate cloud-based analytics often requires extensive custom coding, exposing banks to vulnerabilities and operational disruptions.
• Contractual and Cost Issues: Non-negotiable “take-it-or-leave-it” contracts impose high fees for customizations, straining resources. As one bank technology executive noted, billing isn’t seen as a profit center, yet unclear structures and escalators can balloon expenses unpredictably.
• Regulatory Burdens: Varying guidance on third-party risk management complicates due diligence, especially for emerging tech like digital assets. Banks must navigate inconsistent expectations around cybersecurity and compliance, adding layers of scrutiny that slow innovation.
• Vendor Dependency: High market concentration reduces bargaining power, widening gaps in services like tokenized assets. This dependency often leads to a sense of lock-in, where switching providers incur prohibitive capital costs, further entrenching outdated systems.
  
  

These challenges hinder community banks’ ability to compete with fintechs and larger institutions offering seamless digital experiences. As the RFI highlights, rapid technological advancements, such as AI and blockchain, amplify these issues, with many banks reporting that anti-competitive forces prevent them from fully capitalizing on fintech partnerships.

Examples of Provider Success and Failure

Real-world cases illustrate the spectrum of outcomes:

• Success Story: A community bank successfully integrated API-based digital account opening and remote deposit capture with its CSP. Using affiliated vendors, the rollout took 9 months at reasonable cost, improving customer onboarding. This underscores the value of modular, open architecture, but nine months is too long in a fast-moving market where competitors can deploy similar features in weeks.
• Failure Example: Another bank sought real-time data access and fraud tools but faced multi-year delays and inflated prices due to legacy constraints. Forced to use costly third-party workarounds, the bank lost market share. Such cases reveal how providers’ rigid cycles prioritize enterprise clients, sidelining community banks and eroding their competitive edge.
  
  

Lessons Learned

From these experiences, community banks can adopt proactive strategies:

• Elevate vendor management to a strategic level with internal tech roadmaps and exit strategies.
• Push for open architectures from providers to reduce integration timelines.
• Collaborate on due diligence via consortia to share costs.
• Advocate for transparent billing and scalable pricing.
  
  

Regulators such as the OCC can encourage innovation by updating third-party risk guidance to emphasize data access and open standards. A collaborative ecosystem is essential for community banks to thrive amid technological advancements. For example, the OCC could facilitate industry dialogues, similar to pre-pandemic annual meetings with CSP executives, to address concerns like slow delivery timelines and foster better partnerships. Additionally, promoting safe harbors for data extraction and modernization could ease capital burdens, enabling banks to leverage their own data for AI-driven insights without fearing heightened scrutiny.

Innovation isn’t optional for community banks, it’s survival. By addressing these challenges head-on and leveraging regulatory support, banks can better partner with CSPs to deliver competitive services. As the financial sector continues to evolve, proactive adaptation will be key to long-term success and resilience. CCG Catalyst stands ready to assist in navigating these complexities, reach out to our team for tailored consulting support. Stay tuned for tomorrow’s content on stablecoins and crypto-asset challenges.