To compete effectively, a community bank must identify an audience that it can serve uniquely well. Before digital banking, that was its local market defined by its branch footprint. But with digital services at play, community banks compete with bigger banks and fintechs that don’t have geographic bounds. This makes it harder to differentiate. A possible solution to this conundrum is to specialize in a customer segment that needs tailored services, not based on location. This is generally referred to as niche banking.

Such an approach shouldn’t be only a deposit-gathering exercise, like some banks have tried. A niche brand with a meaningful impact is most likely a significant business risk and may require an investment in supporting infrastructure. Any prospect of success with a niche brand requires working backward from specific, measurable business objectives.

The experience of fintechs and megabanks tells cautionary tales:

• A diverse slate of neobanks drove the market for niche banking services, but growth alone did not sustain them. Many showed promise with in-house development teams, features that financial institutions didn’t offer, sizeable target markets, and for a handful, massive scale. But a high cost base and limited sources of banking revenue, particularly when target markets were too narrow or too high risk, hampered the business case. Splashy marketing, generous incentives, and interest-free short-term lending drove user growth. Platform fees and revenue-sharing with bank and third-party partners squeezed margins.
• Megabanks experimented in niche banking with formats that were closer to what other banks might attempt. Chase’s Finn brand and mobile app were designed to attract younger customers with new features and a different interface, but Chase shut it down in 2019. Wells Fargo developed Greenhouse as a test case for budgeting tools, but it never reached a mass market audience as a fully featured banking app and was sunset in 2020.

Given these failures, why would a community bank experiment with digital-only niche banking? The answer likely lies in their history — a community bank needs a community to serve, and they are getting squeezed on their traditional businesses.

To achieve the best chance at survival, a separate brand should satisfy one fundamental requirement: It should do something that the legacy bank can’t do well to generate a higher long-run profit for the bank, either as a standalone business unit or to contribute to the bank’s business in a way that increases overall profitability.

Factors may include:

• Lower operating costs associated with a digital-only operation.
• Lower cost of customer acquisition via a targeted digital channel.
• Balance sheet scale from deposits gathered and loans originated to a larger, more geographically dispersed customer base.
• Stickier customers the bank serves exceptionally well based on their needs.

A potential hurdle is startup cost. A digital-only bank with a good business case may need development and custom design work. Additionally, long-term investment in products, services, and experience will be important to scale.

Whether a community bank can build a niche brand better than anyone else remains to be seen. But given their long track record of serving geographic niches so well, these institutions might be well positioned to do so — as long as they are strategic.