Third-Party Reliance: How Community Banks Digitize at Scale

Executive Summary

Community banks overwhelmingly rely on third parties, core providers, technology vendors, fintechs, and compliance solutions, to execute digitalization strategies. Respondents describe universal dependence, managed through third‑party risk management programs that emphasize due diligence, contracts, and ongoing monitoring. Key impediments include limited API access, vendor concentration, slow timelines, and constrained flexibility, which banks counter with stronger control environments and selective in‑house capabilities. Practices range from single‑core integrated stacks to multi‑vendor arrangements, with banks monitoring vendors to prevent unapproved technology changes (e.g., AI) that could exceed risk appetite.

Key takeaways:

• 100% of responses indicated reliance on third parties for digitalization.
• More than 70% of banks rely on one of the Big 3 core providers, highlighting concentration risk.
• Nearly 80% of community banks rarely or never use in-house technology for non-lending products.
• Core service providers remain the primary source of digital banking products and services.
• Impediments cited include limited API access, slow implementation timelines, limited flexibility, and limited bargaining power in an oligopoly market.
• Banks manage reliance via third-party risk management: due diligence, contract management, comprehensive policies, and ongoing monitoring.
• Some capabilities must be built in-house to meet enterprise-specific needs when third-party solutions fall short.
• A core’s preferred vendor lists can limit testing of innovative technologies, pushing banks toward selective multi-vendor partnerships.

Bottom line:

Reliance on third parties for digitalization is near-universal among community banks and is managed through formal third‑party risk programs. While third-party solutions cover much of the need, persistent gaps and vendor constraints drive a mix of integrated core solutions, selective multi‑vendor partnerships, and targeted in‑house builds.

The Question (Ref #5)

Use of Third Parties: To what extent are community banks reliant on third parties (e.g., core service providers, technology vendors, financial technology firms (fintechs), regulatory compliance solutions, etc.) for the implementation of digitalization strategies or initiatives? How is this reliance managed? Are there any impediments to community banks’ digitalization strategies with respect to core service providers or other third parties? Are community banks able to address these impediments, and if so, how do they enhance their control environments to best manage third-party relationships in light of these impediments? Are community banks finding third-party solutions meet their specific digitalization needs? If not, where are community banks facing the biggest gaps? What is the range of practice for community banks working with a single third-party provider for an integrated approach to digitalization versus engaging multiple third-party providers to address specific needs? What are the benefits and challenges of each approach? How are banks managing the risk  that a third party may introduce a new technology (e.g., artificial intelligence (AI)) or process without the bank’s prior knowledge, potentially increasing risk outside of the bank’s risk appetite?

Direct Response to the Catalog Question

Introduction

Question 5 asks to what extent community banks depend on third parties for digitalization, how they manage this reliance, where impediments and gaps exist, what the range of practice looks like between single‑provider and multi‑provider models, and how banks control risks when vendors introduce new technologies (e.g., AI) without prior notice.

Historic Lessons in the Evidence

Respondents note that community banks have long relied on trusted third parties for technology delivery, with expectations shifting toward deeper collaboration and agility. Over time, the build‑buy‑partner decision has become central, reflecting budget limits, skill gaps, and vendor concentration. Lessons emphasize that robust governance, enhanced TPRM, clear policies, and continuous monitoring, must evolve alongside partnerships to control risk as reliance grows.

Recent Developments

Not observed in the provided materials.

The Challenge

Practical hurdles include limited API access, slow vendor timelines, constrained flexibility, and preferred vendor lists that curb experimentation. Concentration among a handful of core providers reduces bargaining power and can misalign costs and benefits for community banks. These realities complicate digital roadmaps and elevate oversight needs, especially when vendors may introduce new tools or processes that could exceed banks’ risk appetites.

Evolving Metrics

Respondents referenced concrete indicators: more than 70% of banks concentrated with Big 3 cores; nearly 80% rarely or never using in-house technology for non‑lending products; and cores as the primary source of digital offerings. At the aggregate level, 100% of responses for this question indicated reliance on third parties, reinforcing the consensus on dependence and the importance of maturing TPRM controls.

A Framework Inspired by the Inputs

An implicit pattern emerges: decide where to build, buy, or partner; anchor on a core provider for foundational services; then augment selectively with fintechs to close capability gaps. Across this stack, banks apply a continuous TPRM lifecycle, due diligence, contracting, onboarding oversight, ongoing monitoring, and policy‑driven controls, to manage concentration, performance, and change risk.

Case Study

A typical community bank anchors on a Big 3 core for core and digital banking, then partners with fintechs for onboarding or analytics. It encounters limited APIs and slow integration windows from the core and constrains from preferred vendor lists. To proceed, it strengthens due diligence, tightens contract oversight, and enhances monitoring; where gaps persist, it builds targeted in-house reporting or workflows to meet specific enterprise needs.

Recommendations

1. Enhance third‑party risk management programs with comprehensive policies and procedures tailored to digital partnerships.
2. Formalize due diligence, contract controls, and ongoing monitoring to detect and govern vendor‑introduced changes (including AI) within risk appetite.
3. Negotiate for API access and integration flexibility; challenge restrictive preferred vendor constraints where feasible.
4. Balance an integrated core approach with selective multi‑vendor partnerships to mitigate concentration risk and fill capability gaps.
5. Build critical capabilities in‑house where enterprise‑specific needs are unmet by third parties.
6. Allocate budget and staffing for vendor oversight, recognizing oligopoly dynamics and limited bargaining power.
7. Track vendor concentration and performance metrics to inform renewal, diversification, or exit strategies.

Conclusion

Community banks’ digitalization strategies are deeply and broadly enabled by third‑party providers, and respondents uniformly affirm this reliance. Effective management centers on mature third‑party risk programs, due diligence, contract governance, and ongoing monitoring, paired with selective in‑house builds to address gaps. Banks balance integrated core stacks with multi‑vendor solutions while controlling the risk of unapproved technology changes (including AI). In practice, success depends on active oversight of concentrated vendors and flexible partnering to meet specific digital needs.

This analysis will continue in our next publication. Don’t miss the next installment.

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