Regulatory Shifts and Risk Realities: Navigating the New Landscape for Community Banks

The U.S. banking sector is undergoing a seismic shift in regulatory priorities, with community banks at the center of a complex balancing act between deregulatory relief and emerging risks. As policymakers recalibrate oversight frameworks, investors must assess how these changes reshape credit, operational, and liquidity risk profiles for smaller institutions.

Deregulation and the Double-Edged Sword of Flexibility

The Trump administration's 2025 deregulatory agenda has significantly reduced compliance burdens for community banks. By revoking Biden-era merger restrictions and dismantling advisory councils like the Community Bank and Credit Union Advisory Councils, the administration has streamlined deal approvals and cut red tape, according to a CSH&Co analysis. The Office of the Comptroller of the Currency (OCC) has further lightened the load by shifting to risk-based supervision, eliminating fixed examination schedules, and simplifying model validation requirements, as outlined in an OCC release. These reforms aim to free community banks to focus on local lending while maintaining safety and soundness.

However, deregulation comes with caveats. The proposed cuts to the Community Development Financial Institutions (CDFI) Fund-a bipartisan program that has injected $187.9 million into rural and minority communities since its inception-threaten to erode financial lifelines for underserved areas, per a Politico report. America's Credit Unions warns that reduced CDFI funding could "dramatically narrow" access to affordable capital, particularly during economic downturns. For community banks reliant on CDFI partnerships, this creates a credit risk multiplier: weaker local economies may strain loan portfolios and increase delinquency rates.

Liquidity Risks in a Post-2023 Environment

Community banks have increasingly leaned on non-core funding sources to fuel loan growth, a trend amplified by the 2023–2025 regulatory reforms noted in the FDIC liquidity report. While this strategy has boosted profitability, it has also exposed institutions to liquidity vulnerabilities. The Federal Deposit Insurance Corporation (FDIC) has observed a decline in unencumbered liquid assets, with many banks opting for less-liquid municipal bonds over U.S. government-backed securities, as the FDIC liquidity report also shows.

The OCC's 2025 guidance on liquidity risk management offers a partial solution. By clarifying that community banks are not required to perform annual model validations, the agency has reduced operational overhead (see the OCC release). Yet, the same reforms have not fully addressed the structural risks of relying on volatile funding sources. As interest rates remain unpredictable, community banks must strengthen contingency funding plans to avoid repeating the failures of Silicon Valley Bank and Signature Bank, where poor liquidity management proved fatal, as noted in Debevoise's key takeaways.

Operational Risks in a Digital Age

The FDIC's 2023–2025 reforms have also expanded operational risk horizons. A new framework allowing FDIC-supervised institutions to engage in crypto-related activities without prior approval introduces both opportunities and challenges, highlighted in Debevoise's key takeaways. While this flexibility could drive innovation, it also demands robust cybersecurity protocols and risk management strategies to mitigate volatility and fraud.

To address these concerns, the FDIC, OCC, and Federal Reserve jointly released a Third-Party Risk Management Guide for Community Banks in 2025 (summarized in the OCC release). The guide outlines a lifecycle approach to managing vendor risks, emphasizing governance, contract oversight, and incident response. For community banks with limited resources, adopting these frameworks will be critical to avoiding breaches that could erode customer trust and regulatory goodwill.

Credit Risk and the Reimagined CAMELS Framework

Regulators are redefining how credit risk is assessed, with potential changes to the CAMELS rating system-a longstanding tool for evaluating bank health. The removal of the "management" component from CAMELS could shift focus toward material financial risks like market and capital-related exposures, according to a KPMG alert. While this streamlines evaluations, it may also obscure governance weaknesses that contribute to credit risk.

The FDIC's proposed "three-lines-of-defense" model-comprising front-line units, independent risk management, and internal audit-aims to close this gap, as detailed in Debevoise's key takeaways. By codifying board accountability for risk appetite statements and compensation programs, the model seeks to align strategic decisions with credit risk mitigation. For community banks, this means boards must become more actively involved in oversight, a shift that could either strengthen resilience or expose gaps in leadership.

Conclusion: A Delicate Equilibrium

The 2023–2025 regulatory landscape presents a paradox for community banks: reduced compliance costs coexist with heightened exposure to liquidity, credit, and operational risks. While deregulation offers short-term relief, the erosion of CDFI funding and the complexities of digital transformation demand proactive risk management. Investors should monitor how banks adapt to these dual pressures, particularly their ability to balance growth with prudence in an environment where regulatory expectations are still evolving.

For now, the path forward hinges on a delicate equilibrium-one where community banks leverage regulatory flexibility without sacrificing the safeguards that underpin their role as pillars of local economies.