Community banks have been around for as long as there have been towns and villages. They are the lifeblood of small-town America, providing loans and support to local businesses and families. In today’s economy, community banks are more important than ever. But. as the Federal Reserve begins tightening monetary policy, interest rates are rising, making it difficult for these institutions to secure the loans they need to continue serving their communities.
However, there are strategies that community bank leaders can employ to future-proof their businesses and secure loans amidst increasing rates. In this article, we will explore three such methods.
Why Interest Rates Are Rising
The Federal Reserve has been gradually increasing rates since 2015, but the pace of increases in interest rates has picked up in recent months. The Fed wants to keep inflation in check as the economy strengthens.
If inflation gets too high, it can erode the purchasing power of consumers and businesses, which can lead to an economic slowdown. The Fed is trying to reduce inflation by raising rates before it becomes a problem.
Effect of Rising Interest Rates on Community Banks
The good news for community banks is that they rely less on short-term loans than larger banks. This means that they are less affected by increases in the federal funds rate, which is the rate banks charge each other for overnight loans.
Instead, community banks rely more on long-term loans, such as mortgages and small business loans. These loans are not as sensitive to changes in interest rates, so community banks can continue to offer them even as rates rise. It is still vital for community banks to manage their interest rate risk through the following strategies proactively.
Hedging Against Rising Rates
Interest rate swaps are one tool that community banks can use to hedge their risk. In a swap, two parties agree to exchange interest payments on a loan for a set time.
For example, if a community bank has a loan with a variable interest rate, they could enter a swap with another party, in which they agree to pay each other a fixed rate for the next five years. This would protect the community bank from any increases in the variable rate during that period.
Laddering the Loans
Laddering loans is another way for community banks to manage their interest rate risk. This means taking out a mix of loans with different maturity dates.
For example, a community bank might take out a three-year, five-year, and seven-year loan. This way, if rates rise, the community bank will still have loans coming due that were taken out at lower rates.
Maintain Strong Relationships with Their Borrowers
Lastly, community banks need to maintain strong relationships with their borrowers. In a rising rate environment, some borrowers may be tempted to refinance their loans with another lender however, if community banks have built strong relationships with their borrowers and can offer them competitive rates, they will be most likely to stick with the bank.
By following these strategies, community banks can secure the loans they need to continue serving their communities in a rising interest rate environment.
At Independent Community Bankers Bank (ICBB) in Frankfort, Kentucky, we offer a range of services to our community bank customers across Kentucky, Tennessee, West Virginia, Ohio, Indiana, and Illinois. We commit ourselves to help you cut costs and increase your earnings. Contact us today at email@example.com for more information about our services.