Tackling Risk Challenges in Community Banking

Rapid failures of regional banks in spring 2023 reverberated across the market. It prompted congressional and regulatory scrutiny, revealing risk mismanagement at banks holding tens of billions in deposits and assets as part of a relatively small but significant segment of the banking industry.

More recently, Philadelphia-based Republic First closed, following the prior-year meltdowns of the likes of Silicon Valley Bank, Signature Bank and First Republic Bank. A major, initial risk of contagion—or run on deposits—didn’t happen. However, high interest rates loom as a risk for community banks.

“Preparing for the risk of rising interest rates is a fundamental responsibility of both bank managers and regulators”, says Michael Padhi, senior finance lecturer for the University of Maryland’s Robert H. Smith School of Business. “The 2023 bank failures naturally raised the question of whether management at other regional and community banks also failed to manage their interest rate risk and therefore would suffer the same fate.”

Under his advising, Padhi’s students recently took the cue to answer these questions. The move involved a national case competition with a service-to-state component that has laid groundwork for potential collaboration with Maryland officials and industry leaders.

“If banks can be found that are prepared to navigate rising interest rates, then they can serve as case studies for how to avoid the same negligence and excessive risk-taking,” Padhi says. 

He established partnerships with two Maryland community banks—Middletown Valley Bank (MVB) and Farmers and Merchants Bank—and guided two teams of Smith undergraduate students to write case studies on their teams’ partner banks in the recent 2024 CSBS Community Bank Case Study Competition, hosted by the Conference of State Bank Supervisors. 

“Team 1”— Abdullah Hijazi, Austin Viti, and Evan Walton— studied Middletown Valley Bank (MVB). “Team 2”—Romir Chandra, Alexander Green, Zachary Leonard, Jared Richardson and Dimitri Sfakiyanudis—studied Farmers and Merchants Bank.

Both student teams initially examined the closures of Silicon Valley Bank, Signature Bank and First Republic Bank, Padhi says. “Participation itself was an achievement, involving interviews with the partner bank management, a 25-page written report, and 5-minute video summary. Their case studies responded to 26 questions covering the banks’ financials, customers, asset and liability management, response to regulatory changes, and use of social media.”

The students’ work left a positive impression. “At Middletown Valley Bank, we always enjoy working alongside local students and educators. These opportunities are invaluable, and they allow us to learn what is on the minds of today’s students,” says Cody Hill, MVB vice president - East Region retail services manager.

Regarding Smith’s Team 2, it advanced among 10 schools past the first round in the CSBS competition. And despite finishing outside the top three, the ‘Smith-Farmers and Merchants’ case “got the attention of Maryland's Office of Financial Regulation,” Padhi says, adding that discussions are underway for Smith-hosted speaking engagements involving that office’s leadership. He also is forging connections to the Maryland Bankers Association to include potential internships for Smith students.

MVB’s HIll further reflects the drive behind Padhi’s initiative: “This was the second opportunity we had to work with UMD students, and we continue to be thoroughly impressed by the thoughtfulness and curiosity of their questions. We look forward to continuing the relationship and supporting the development of the bankers of tomorrow.”

These efforts, along with the collective Smith student effort in the CSBS competition—and future case competitions, is especially critical, Padhi says—concurring with comments by his faculty colleague, Smith Enterprise Risk Consortium (SERC) director and leading risk management expert, Clifford Rossi.

Rossi recently told The National Desk: “There’s a higher probability that we will see more bank failures simply because banks are not used to being in this kind of an interest rate environment. Most of the management teams and boards that are out there have not lived through this, so they were caught off guard and all of their interest rate risk practices, and I think the same was true, quite honestly about the regulators, too.” (Go to SERC’s Resources-Articles section for more insights from Rossi on community banking risk and more.)

Read more about the Smith School’s Finance Department and about Michael Padhi, previously an economic analyst at the Federal Reserve Bank of Atlanta, where he primarily worked on banking antitrust cases and published numerous Fed articles on banking.