Challenges for Small to Midsize Banks Amidst Heightened Regulatory Scrutiny 

A series of bank failures in 2023 prompted bank management teams, boards, and regulatory agencies to ramp up regulatory standards of treasury risk management practices within financial institutions. Traditionally, small to midsize banks operate under less regulatory scrutiny compared to their colossal counterparts. However, these recent seismic shifts in the industry have flipped the script.

Regulatory bodies are keeping a vigilant eye on financial institutions— even small to midsize banks. This includes conducting surprise reviews of confidential supervisory bank health ratings and, in some instances, issuing downgrades to ensure that banks address any lapses in risk management. In the face of this intensified scrutiny, institutions of all sizes must prepare for the challenges ahead.

Here, we’ll discuss four challenges small and midsize banks face in the era of heightened regulatory standards and share valuable insights on navigating their complexities.

Challenge #1: Interacting With Regulators

Navigating the complexities of regulatory interactions can be challenging, especially for small to midsize banks that lack the experience of larger financial institutions. When interacting with regulators, it’s not enough to have the right knowledge about regulations and compliance. Banks must effectively apply that knowledge when communicating with regulatory agencies.

Larger banks make this process seem effortless, thanks in many cases to dedicated departments with experts well-versed in regulatory matters. They are familiar with interacting with regulators, the media, and other stakeholders, which streamlines the communication process.

However, for smaller banks, this can be a daunting task. They may lack the resources and expertise to handle regulatory interactions as smoothly as their larger counterparts. The communication style, terminology, and expectations in regulatory discussions can differ significantly from day-to-day banking operations.

How Heitmeyer Consulting Can Prepare Your Institution to Interact With Regulators

To overcome this challenge, smaller banks should consider seeking external expertise from a consulting firm specializing in financial institutions like Heitmeyer Consulting, or staff training to bridge the gap. Developing the necessary skillset for effective regulatory interactions is crucial for maintaining compliance and navigating the evolving regulatory landscape.

At Heitmeyer, we understand the unique challenges that small to midsize banks face when it comes to regulatory interactions. Our team of experts specializes in financial institutions and can provide the guidance, support, and training needed to ensure regulatory compliance.

Challenge #2: Reporting and Data Integrity

Ensuring the accuracy and integrity of your reports is paramount in the world of heightened regulatory scrutiny. Small to midsize banks must have complete confidence that their reports accurately reflect the data they represent and label that data correctly.

Let’s dive into why this is crucial. Take liquidity reports, for instance. These reports provide insights on how much cash a bank can have on hand if every customer were to request a withdrawal. During the recent bank failures in 2023, some institutions found themselves in hot water because they didn’t possess accurate estimates of their actual liquidity or a well-defined playbook to manage such situations.

It’s not sufficient to just compile reports. Financial institutions also need to ensure that the data lineage behind these reports is sound and that they comply with regulatory standards. This is where compliance, often referred to as the Second Line of Defense (SLOD), comes into play. SLOD plays a crucial role in confirming the accuracy and compliance of these reports before they make their way to the board of directors.

It’s important to note that board members can be held liable for not taking appropriate action based on the information presented in these reports. With the increased number of mission-critical reports—sometimes numbering in the hundreds—small and midsize banks need a reliable process to thoroughly review each one.

How Heitmeyer Consulting Can Help With Compliant Reporting and Data Integrity

This is also where Heitmeyer Consulting can step in to assist. We have the expertise to review these reports, ensuring they are compliant, sound, and accurate. Our goal is to help you navigate the complex landscape of regulatory reporting and data integrity and provide you with confidence and peace of mind in an environment of heightened scrutiny.

Challenge #3: Control Coverage and Risk and Control Self-Assessment (RCSA) Thoroughness

Just like the Big 4, small to midsize banks are also required to demonstrate their commitment to control coverage and risk identification. While regulations mandate that banks perform these assessments, there is often variability in the depth and thoroughness of these processes.

During self-assessment, banks are expected to proactively identify issues and risks within their operations. Regulators emphasize the importance of banks taking the lead in identifying and addressing these issues rather than relying on regulators to uncover them. In fact, regulators can become displeased if banks expect regulators to identify problems for them. The responsibility for this falls on the three lines of defense within the bank, including the individuals performing the work, compliance personnel, and internal audit teams.

Controls that haven’t been properly tested by qualified resources, instances of control gaps where necessary measures are absent in critical areas, and controls that are not functioning effectively are red flags for regulators and can expose banks to heightened scrutiny and potential regulatory actions.

Regulators Have Raised the Bar on Regulatory Expectations

Regulators are raising their expectations for the level of scrutiny and thoroughness involved in these assessments. Banks are expected to conduct assessments and to ensure the right control function personnel are conducting them. Controls are often placed on a rotation schedule, typically every 24 months, to ensure they are consistently evaluated.

Furthermore, the nature of controls is evolving from detective measures that identify issues after they occur to preventive measures that stop issues from happening in the first place. This shift toward preventive controls is part of a broader trend in banking towards automation, reducing the potential for human error and ensuring that controls are consistently applied on a regular schedule.

How Heitmeyer Consulting Can Help With Self-Assessment and RCSA Thoroughness

Team Heitmeyer specializes in risk and compliance consulting for financial institutions of your size. We offer guidance and support in conducting thorough self-assessments and Risk and Control Self-Assessments (RCSA). Whether you need assistance with implementing preventive controls, improving the effectiveness of existing controls, or ensuring compliance with the evolving regulatory landscape, our consulting services can help you navigate these challenges and maintain regulatory compliance.

Challenge #4: Process Mapping as Part of the RCSA

When it comes to risk and control self-assessment (RCSA), small to midsize banks face a unique challenge in process mapping. The depth and detail of process maps can significantly impact a bank’s ability to identify potential control gaps and assess risks effectively.

But why is process mapping so important in this context? In essence, it demonstrates that your bank comprehensively understands where controls need to be in place and where risks may arise. Detailed process maps can be invaluable in pinpointing potential control gaps and vulnerabilities within your operations.

Moreover, process mapping can help your bank showcase an awareness of dependencies on third parties and vendors. In an era where many banks rely on outsourced services and third-party vendors, regulators still expect banks to maintain oversight and monitoring of tasks and activities conducted by these external partners, including adherence to regulatory policies and guidelines.

However, there’s a broader industry trend where banks, including small and midsize institutions, increasingly turn to fintech and “as-a-service” providers instead of building tech capabilities in-house. This is often a pragmatic choice, especially for smaller banks that may lack the resources of their larger counterparts. Yet, it’s essential not to view these vendor relationships to shift responsibility entirely. Banks must maintain vigilance and control to ensure that third-party services align with regulatory expectations.

Heitmeyer Consulting Is Your Strategic Partner in Process Mapping and RCSA

We offer tailored guidance and support in creating comprehensive process maps, addressing control gaps, and ensuring regulatory compliance. Our expertise extends to enhancing your understanding of third-party dependencies, allowing your bank to effectively manage vendor relationships and meet regulatory standards. With Heitmeyer by your side, you’ll have the strategic insights and practical solutions needed to navigate these challenges successfully.

Prepare for a Regulator-Ready Future with Heitmeyer Consulting

In the face of heightened regulatory scrutiny, small and midsize banks must confront numerous challenges, from effective regulatory interactions to data integrity, control coverage, and comprehensive process mapping.

Specifically, sweeping changes under policies like Basel III Endgame will permanently alter employee workflows for credit checks, loan approvals, project funding, and more.


This is where Heitmeyer Consulting steps in as your strategic partner. Our specialized expertise and proven methodologies can strengthen your approach to Risk and Control Self-Assessment (RCSA), process mapping, data lineage, report integrity, and more. We bring the resources and experience to help you meet regulatory expectations without reinventing the wheel. Our methodologies have stood the test of regulatory requirements and can accelerate your execution while maintaining an expense-friendly budget.

If you’re ready to tackle these challenges and ensure the future success of your institution, book a call with Caroline Willis, Director of Business Development & Strategic Solutions, to discuss how Heitmeyer Consulting’s expertise can help your banking institution thrive.