By Shashank Pattekar, International Banker
Smaller than the global investment-banking giants, such as JPMorgan Chase and Citigroup, but decidedly larger and more diversified than community banks, US regional and mid-sized banks have typically occupied a stable niche within the domestic banking ecosystem. But with changing depositor behaviour, onerous regulatory expectations, technological disruption and interest-rate volatility forcing many financial institutions to reconsider how they generate revenue and manage risk, banks in this bracket are increasingly undergoing dramatic transformations to remain competitive.
The characteristically diversified funding sources of larger global banks mean they are better equipped to absorb the significant changes currently impacting the financial-services industry. Smaller banks have fewer options to withstand such headwinds and are typically much more reliant on deposits for their revenue. Given that deposit flows are becoming less predictable, moreover, those banks are also having to deal with higher liquidity risks.
Among the most significant changes confronting regional banks at present is the increasingly active behaviour of depositors. Although customers historically tended to keep funds in accounts for long periods—regardless of changes in external factors, such as interest rates—that passivity is no longer the case. With depositors able to shift funds almost instantly through online banking platforms, the deposit dynamic has changed dramatically for banks of all sizes, with high-yield savings accounts, money market funds (MMFs) and digital financial services making it much easier for customers to chase better returns.
An August 2025 working paper by the National Bureau of Economic Research (NBER) studied how US county-level aggregate deposit outflows were affected by the diffusion of digital banks, measured as the proportion of digital banks operating in a county. “We find that counties with greater digital bank presence experience larger deposit outflows, supporting the view that digitalization increases depositor sensitivity rather than merely re-sorting them, in line with our model mechanism,” the research concluded.
Rising interest rates in recent years have only compounded matters, with many depositors moving money out of traditional bank accounts into higher-yielding alternatives. Regional and community banks, in particular, saw their “deposit betas”—the speed at which they must raise their own deposit rates to match the Federal Reserve’s (the Fed’s) benchmark rate hikes—climb prodigiously. Nomis Solutions, which provides loan- and deposit-pricing software to banks, estimated that while deposit betas were in the modest 15-percent-to-19-percent range at the largest US banks by the end of the third quarter (Q3) 2023, they had alarmingly exceeded 60 percent at regional and community banks.
The downward rate trajectory since then, however, has somewhat alleviated the pressure on regional banks to “pay up” to retain their depositors. Nonetheless, with rates still relatively high, banks will need to entice customers through more attractive deposit rates for the time being, which, in turn, translates into higher funding costs.
Regional banks could also suffer more than other segments of the US banking system from developments in stablecoin adoption. According to Standard Chartered, with regional banks’ net interest margins (NIMs)—the difference between lending rates and deposit costs—under threat of their shrinking deposits being enticed away by digital assets and due to their typically heavy dependence on net interest margins to generate revenue, the balance sheets of these regional lenders will be particularly under pressure.
“We find that regional US banks are more exposed on this measure than diversified banks and investment banks, which are least exposed,” the bank’s head of digital assets research, Geoff Kendrick, warned in late January. Kendrick added that determining the total amount of deposits at risk from stablecoin adoption depends on whether stablecoin issuers keep a large share of their reserves in US banks. If so, it would reduce the potential for a deposit flight. That said, the two largest stablecoin issuers—Tether and Circle—hold most of their reserves in US Treasuries, “so very little re-depositing is happening”, he also noted.
Such trends underscore the sheer disruptive power of digitalisation. Technology companies and fintech (financial technology) firms have introduced new competitors into financial services, with digital lenders, payment platforms and online savings providers jostling for market share across many of the businesses that regional banks traditionally dominated, including small-business lending, payments processing and consumer savings products.
“Small business banking is the next frontier of competition. Mercury, Brex, and Relay have attracted hundreds of thousands of small business customers with streamlined account opening, integrated expense management, and API-based financial tools,” market analyst Reeves Birner recently explained in an article for TechBullion. “Traditional banks require weeks to open a business account and months to approve a business loan. Fintech competitors complete both processes in days.”
By operating with lower cost structures and fewer physical branches, many are succeeding in offering consistently more attractive terms. According to TransUnion’s consumer credit report, the US alone saw digital platforms originate $47 billion in personal loans in 2025—23 percent more than in 2024—often using artificial intelligence (AI)-driven underwriting to approve borrowers at lower rates than many regional banks can offer. As such, traditional lenders are having to adopt new technologies themselves or partner with fintech companies to maintain their competitive positioning.
The regulatory onslaught that banks faced post-2008, particularly the imposition of much stricter capital and liquidity requirements, has also played a significant role in prompting recent changes in the business models of smaller regional banks. Although many of the rules introduced during this time initially targeted the largest institutions, regulatory expectations have gradually expanded such that mid-sized banks now face greater scrutiny regarding capital buffers, liquidity management, risk monitoring and stress testing.
Compliance with these requirements—especially via fixed costs—can be more expensive for banks that lack the scale of larger institutions. Maintaining profitability has thus become more difficult for regional banks with limited resources, which must manage complex regulations and liquidity requirements. The increased stress from tighter lending standards has thus accelerated industry consolidation, with regional banks increasingly realising that scale is necessary to remain competitive.
Outside of consolidation, some lenders are focusing on ramping up lending in the specialised areas in which they possess suitable expertise. Commercial real estate (CRE) financing, agricultural lending, equipment leasing and healthcare lending are just some of the niches in which regional banks not only differentiate themselves from competitors, but also develop stronger relationships with specific types of borrowers.
Another increasingly common response from regional and mid-sized banks is to simplify their balance sheets. Although traditional-banking profits depend heavily on NIMs, regional-banking profitability has suffered in recent years due to the need to pay higher rates to retain depositors, while borrower demand has remained subdued. Although regional banks previously achieved growth by increasing lending volumes, the lack of low-cost deposits and/or benign credit conditions makes such a model increasingly unviable today.
With higher funding costs and tighter regulatory expectations making balance-sheet growth more expensive, regional banks are increasingly moving away from assets that may expose them to significant interest-rate risk and towards capital-efficient solutions that generate returns without significantly increasing assets. As a result, non-interest income appears to be increasingly targeted by regional banks, with many expanding their fee-based services such as wealth management, advisory services, payments processing and treasury services for businesses—all of which generate revenue less sensitive to interest-rate movements.
In January, for example, Regions Financial Corporation—which serves customers across the South, Midwest and Texas—reported record growth in wealth-management and treasury-management income. And Fifth Third Bank, which operates across 12 US states, has expanded its payment and treasury-management services, targeting corporate clients with products that generate recurring fee income.
Regional banks are also investing heavily in digital infrastructure, including mobile-banking platforms, data analytics, fraud-detection systems and automated loan processing. Some banks are partnering with fintech companies to accelerate innovation, while others are developing internal technology teams, as they strive to bolster their competitiveness versus both large financial institutions and fintech rivals.
For example, the largest regional lenders, such as KeyBank, PNC Financial Services and Citizens Bank, are now actively seeking to transform their digital strategies to incorporate agentic AI, which can perform multi-step back-office tasks, including mortgage processing and fraud vetting, independently. Citizens Bank stated that it expected its automation overhaul to enable AI to handle 25 percent of customer call-centre volume by the end of 2026, en route to its long-term target of 50 percent.