Regulatory Expectations for Startup and Community Banks
Startup and community banks occupy a unique space in financial services. They are innovative, growth-focused, and often closer to their customers than large institutions. But when it comes to regulatory expectations, they face a difficult balancing act: meeting the same compliance standards as established banks while operating with far fewer resources.
The Technology Reality for Small Banks
Unlike large banks that maintain in-house data centers and specialized security teams, most startup and community banks rely heavily on external vendors. Common patterns include:
Hosted infrastructure - Critical banking applications and even core systems often run on vendor-managed platforms.
Cloud-first productivity tools - Microsoft 365 or Google Workspace provide email, collaboration, and identity management.
Small or overstretched teams - Technology staff may also handle vendor management, IT operations, and customer support. Dedicated security staff are rare.
This model makes sense financially, but it also introduces risk. With limited budgets, banks often prioritize pipeline, sales, and customer growth over proactive cybersecurity. That creates tension when regulators examine governance, risk management, and incident response capabilities.
Why the Stakes Are Higher for Small Banks
For community and startup banks, even minor disruptions can have outsized impacts:
Regulatory consequences - Privacy incidents, ransomware attacks, or data breaches must often be reported, potentially leading to fines or supervisory action.
Financial fragility - Unlike large institutions with deep reserves, small banks may not survive prolonged downtime or expensive remediation.
Reputational damage - Customers choose community banks for trust and relationship. A single incident can erode that trust permanently.
What Regulators Expect
Even though regulators recognize the constraints of smaller banks, they still expect baseline security and risk management practices, including:
Vendor oversight - Banks are responsible for the security of their outsourced services, not just their in-house systems.
Incident response - Plans for detecting, responding to, and reporting security incidents must be documented and tested.
Data protection - Customer information must be safeguarded regardless of whether it’s hosted internally or in the cloud.
Governance - Boards and executives must demonstrate oversight of technology and security risk.
These expectations do not scale down just because an institution is small.
Independent Testing: What Must Be Performed by a Third Party
Certain regulatory requirements cannot be fulfilled internally or by your IT team, they must be conducted by an independent third party to satisfy examiner expectations. For startup and community banks, this is an area where missteps are common. Examples include:
External penetration testing – Required under FFIEC based on capability of management, and FDIC guidance to ensure systems exposed to the internet are evaluated by an independent firm. Internal teams cannot be the only ones to test their own defenses. FFIEC CAT FFIEC IT Handbook IV.A.2(b) FDIC FHFA
Vulnerability management validation – Many regulators expect that vulnerability scans and patching effectiveness are independently verified or executed on a periodic basis.
Independent audit functions – Certain risk assessments, control reviews, and validation activities must be performed outside the bank’s daily IT operations to ensure objectivity. This may be performed by an auditor, but there is also value in considering it being done by an independent assessor.
Model and controls validation – For banks using fraud models, lending algorithms, or automated decisioning, regulators often require independent validation of those systems. This is distinguished from building and using GenAI models, however, it is anticipated that regulators will use similar expectations for GenAI.
FINRA-specific expectations (for broker-dealer arms) – Independent cybersecurity assessments to ensure compliance with Regulation S-P and safeguarding of customer information.
The reasoning is clear: independence reduces bias and ensures transparency. For a community bank, this means budgeting not just for internal IT operations, but for third-party validation of critical cybersecurity functions. Regulators will ask for evidence of these independent assessments during exams.
⚠️ A Warning for Banks Seeking Security Services
As community and startup banks look for cybersecurity partners, it is important to proceed with caution. Not all providers are equally equipped to deliver the depth of expertise regulators expect. Common red flags include:
IT providers suddenly “becoming” security vendors - Technical support and cybersecurity are not interchangeable. Be skeptical if your IT vendor rebrands overnight as a full-service security provider without proven expertise.
Unrealistic guarantees - No firm can credibly promise that you will “never get ransomware.” Effective security is about reducing risk, not eliminating it entirely.
Audit or CPA firms offering penetration testing - Financial audit skills do not translate to technical security testing. Using the wrong type of provider can lead to compliance checkboxes without real protection.
Overreliance on automation or AI - Tools are valuable, but if your vendor is leaving your security to software alone—or to underqualified analysts interpreting those alerts—you may not be getting the protection you think you are.
There are cost-effective ways to obtain enterprise-level security expertise, but the key is partnering with specialized vendors who understand banking regulations and can right-size solutions for your institution. Checking a box will not withstand regulator scrutiny, or more importantly will not stop an attack.
Questions to Ask Before Signing With a Security Vendor
To avoid costly mistakes, here are practical questions every community or startup bank should ask a potential security partner:
Banking Experience - Have you worked with financial institutions subject to OCC, FDIC, or state banking oversight? Have you had relationships with the regulators to understand how they operate?
Regulatory Alignment - How do your services map to FFIEC or NIST requirements?
Incident Response Readiness - Do you provide guidance and testing for incident response plans specific to banks?
Staff Expertise - Who will actually perform the work? Seasoned security professionals, or junior analysts/automated tools?
Right-Sizing - How do you tailor your recommendations for small institutions instead of applying “big bank” solutions?
Transparency - What metrics, reports, or evidence will you provide to demonstrate effectiveness?
Cost Balance - Can you deliver enterprise-level capabilities without forcing us into unnecessary, high-cost tools? This can’t always be helped, technology is required, but which technologies and to what extent can be adjusted.
Asking these questions upfront helps ensure your bank is investing wisely and meeting both security and compliance needs.
How CipherNorth Helps
At CipherNorth, we check every one of those boxes. Our team has deep experience with banking regulators, financial technology, and incident response. We specialize in right-sizing security for startup and community banks—delivering enterprise-level expertise at a cost that aligns with your scale and resources.
Whether you need help validating your regulatory posture, conducting a penetration test, or building a roadmap for sustainable cybersecurity maturity, CipherNorth can help you get there.
👉 If you’re a community or startup bank looking to strengthen your defenses and satisfy regulatory expectations without overspending, let’s start a conversation.