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As we head into 2024, it is important to note that a reduction in bank lending doesn’t necessarily mean that banks do not have an appetite to make loans. Even in a slowdown or mild recession, as experts predict, there should still be a lot of lending opportunities and plenty of strong, local, community banks ready to make those loans.

A decline in new loan activity can be driven by factors other than a bank’s appetite to lend, such as reduced demand for refinancing and new projects, as well as lower deposit balances. Banking is like any business: without raw materials, you can’t produce output. It’s a scenario that’s affecting several other banking trends heading into the new year.

Borrower behaviors

Public sentiment is that inflation is shifting toward stabilization after being significantly higher a few months back. During this time, the Federal Reserve’s short-term interest rate hikes led customers to prefer high-yield options like bond funds, reducing deposit flows.

Borrowers remain cautious today, using cash reserves for debt repayment or investments rather than taking out loans at higher rates. While this dynamic reduces the demand for new loans, this prudent approach does not signify a decline in economic activity. Instead, it reflects a strategic realignment where more businesses use their available resources instead of incurring additional debt.

Banks remain ready, willing and able to help customers, but sometimes the right solution does not involve taking on additional debt.

Commercial lending

The commercial lending business will likely slow down in 2024, with business owners and developers delaying projects and taking a cautious approach until there’s more clarity in the economy. However, this likelihood does not necessarily equate to reduced loan growth. Banks today can achieve growth with fewer new loans, even as refinancing decreases and borrowers keep their low-rate mortgages.

For example, three years ago, if a bank aimed to increase its loan portfolio by $200 million, it typically required issuing $500 million in new loans to counterbalance the $300 million in payoffs and paydowns. Today, banks might only need to make $300 million in new loans to achieve the same growth. Nevertheless, overall commercial lending could be constrained if banks do not record an increase in deposit growth.

Risk management

Given market fluctuations and the recent headlines, risk management remains a priority for community banks. Liquidity and deposit diversification represent key focus areas. Both are essential for lending activities.

One factor worth noting is the resiliency of the community banking model. Community banks experienced more stable deposit levels during the recent financial tumult than their mid-sized counterparts. This outcome wasn’t luck. It validated community banking‘s inherent strength: deep relationships with customers and their communities, which helps mitigate risk and stabilize deposits.

Regulatory changes

The regulatory landscape is constantly evolving, especially during an election year. While introducing new regulations can be lengthy, the immediate response to banking stresses and failures like those we saw in early 2023 often involves stricter enforcement of existing rules.

This increased regulatory scrutiny typically starts with larger banks and gradually trickles down to smaller community banks. Preparing for these changes is crucial for community banks facing uncertain regulatory adjustments in the new year.

Digital transformation

The push toward digitalization in community banking will continue to gain momentum. Customer-facing initiatives like digital loan origination and online account openings for small businesses will become even more common, as will other online tools that offer aid in areas such as cash flow analysis, payment processing and invoicing.

Despite the digital influx, community banks will continue to leverage a “high tech, high touch” strategy that blends the convenience of online platforms with the personalized service only relationship bankers can provide.

Financial prudence

Because of the increased cost of capital, banks will advise small business owners to adopt a careful investment strategy in 2024. This strategy will require a comprehensive analysis of potential gains against increased borrowing expenses.

Community banks are guiding businesses to be strategically active in this area, emphasizing meticulous planning and evaluating risks for new ventures. The goal is to support sustainable growth and prudent decision-making, ensuring businesses remain resilient and adaptive in a year that will bring both unforeseen challenges and new opportunities for community banks and small businesses.

Patrick L. Ryan is the president and CEO at Hamilton-based First Bank.