Credit Risk Trends and Challenges for Community Banks

Chief credit officers at small, locally owned and operated banks are contending with a myriad of issues, ranging from the rise of fraud and the pros and cons of AI to fluctuating tariffs, commercial real estate obstacles, and emerging risks like private credit.

Sophisticated fraudsters, aided and abetted by artificial intelligence, are among the top threats facing community banks—which typically have under $10 billion in assets. David M. Chajkowski, the EVP and chief credit officer (CCO) at Harrisburg, Pennsylvania-based Orrstown Bank, said that perpetrators are now using AI to try to get around protections banks have in place. “The ability of the fraudsters to figure out ways to use the new technology is a constant battle,” he said. “We're seeing heightened levels of wire fraud attempts and other types of customer account takeover attempts.” While Orrstown’s fraud department has been effective in thwarting schemes and reducing losses”you always have to be very vigilant” in an environment teeming with phishing, ransomware, and other exploits. That includes customers, who he urged to exercise vigilance as well.

Chajkowski was among three CCOs who discussed credit risk challenges and trends for community banks at the recent ProSight Annual Risk, Compliance and Fraud Virtual Conference. He was joined by Misako Stewart, CCO at California-based Bank of Marin, and Linda Sternfelt, CCO of Taunton, Massachusetts-based Bristol County Savings Bank.

Benefits and Risks of AI

While criminals are now leveraging AI for nefarious activities, it also has been deployed by banks for years to combat fraud and money laundering. At community banks like Bank of Marin, moreover, AI is being employed for internal policy reviews.

Stewart said her bank is now using Copilot, Microsoft’s generative AI system, to provide employees with a research tool and working to create easy access to its credit policies and underwriting guidelines. This will save valuable time. If, say, a lender needs clarity on a specific policy, they could open Copilot, ask a question about the policy, and receive an answer immediately.

Despite the benefits it offers, there are still questions about the reliability of generative AI (which has been prone to so-called hallucinations). Some community banks are therefore taking more of a gradual approach toward adoption. Chajkowski said that while Orrstown is interested in expanding AI use, it would like to see the technology mature before making a larger commitment. “We’re trying to educate ourselves as much as we can, because we don’t want to make the mistake of jumping in feet first and falling into potentially a trap of becoming too reliant on a technology that we don't fully understand yet,” he explained.

The expansion of technology at community banks, of course, is not just confined to AI. For example, to identify early warning signs for potential delinquent and non-performing assets and to ensure that the bank maintains its lending and risk management standards, Bristol County Savings Bank is now using advanced data analytics.

These help the bank decide whether to renew relationships with borrowers. Sternfelt said Bristol County Savings recently “evaluated 74 relationships in about 50 minutes.” This greatly eased the burden on the bank’s portfolio managers, she said, as those evaluations would have taken much longer with manual reviews. 

Tariffs and Commercial Real Estate

Fluctuating tariffs are an additional area of worry for community banks. The full effects of shifting tariff policies under the Trump administration have yet to be determined, but Stewart said that the Bank of Marin’s construction company and contractor borrowers are starting to see their impact.

Indeed, she said, distributors that carry inventory and manufacturers that rely on parts from overseas (or sell to overseas counterparts) are already feeling the heat. “We have a fair amount of contractors in our portfolio. Some material prices are going up or their customers are either delaying or putting projects on hold,” Stewart said.

Chajkowski noted that a lot of uncertainty remains about the consequences of tariffs, and that community banks will therefore need to keep a close eye on this evolving issue. “We’ve still seen very little impact in the financial statements to date,” he said, but the bank was anticipating pressure on margins in fourth-quarter 2025 and first-quarter 2026.

Like tariffs, CRE represents an area of some concern for community banks. The real estate market, of course, took a big hit during the pandemic and in the aftermath of that crisis, as more firms adopted hybrid policies that allow employees to work from home two or three days per week.

Stewart said that while worries about CRE in the San Francisco Bay area have eased up,  Bank of Marin still has a “fair amount of CRE concentration” and plans to continue to stress test and closely monitor its CRE portfolio over the next year.

Part of the issue, she said, is that the bank made a lot of fixed-rate loans during the peak of the real estate market when interest rates were low. Now, higher rates and lower lease rates have changed the calculus facing some borrowers who need to renew their loans. “We’re not out of the woods yet,” Stewart said. “We are still making real estate loans and we’re still looking at office properties. But we’re being much more selective about it, and we’re probably asking more questions than we used to in the past.”

Emerging Risks

Competition from private credit firms and financial technology (fintech) companies is among the trends community banks will be keeping an eye on in 2026.

Sternfelt said that while the competitive landscape is evolving, and could potentially open up more banking opportunities for fintechs, it’s important that community banks not veer from their credit policies and underwriting standards.

Chajkowski concurred that it’s vital for community banks to not give in to “the temptation to stretch” from established policies in the face of competition, including less-regulated private credit firms, which continue to grow at a rapid pace.

The ability to adapt, said Stewart, will be key for community banks going forward. “Our competitors are not going to be the traditional banks, so a certain amount of open mindedness is going to be really important,” she said.