WASHINGTON — Community banks and credit unions are well behind the innovation curve, enough to draw alarms from one of the segment's most ardent advocates.

"What is amazing about our industry is your customers and members use Amazon and Hulu and Square and we think it's OK that when those customers and members walk into our branches they are going back 30 years," said Louis Hernandez, chairman and CEO of Open Solutions. Open Solutions operates the DNAappstore in which smaller banks and credit unions can be certified to develop and share tech products, which are called DNAapps.

Hernandez frequently advocates for community banks and credit unions, and has written books about financial services and small businesses such as "Too Small to Fail" and "Saving the American Dream: Main Street's Last Street's Last Stand." At this week's BAI Retail Delivery Conference, Hernandez challenged community-based institutions to get more creative about mixing internal and shared development to reach consumers with innovation that's on par with popular digital payments startups such as Square. There's some incentive for Hernandez here, since Open Solutions gets a cut of DNAapps that are sold.

While not knocking Square, which allows mobile phones to be used to accept card payments, Hernandez bemoaned the fact that a startup beat traditional financial institutions to the punch. "Square is a great company, but [community banks and credit unions] must get in position to do this sort of thing," Hernandez said.

He also said the task isn't easy, since community banks and credit unions must keep up with not only larger banks and startups, but also arduous regulatory environment. While the Dodd-Frank law is generally aimed at larger banks, the law is still evolving and smaller institutions are also planning to comply-which requires major IT changes to risk and reporting systems. This compliance burden has left fewer resources available for product development for institutions that traditionally don't carry large tech budgets. "For community-based institutions, the regulatory framework has made it hard to capitalize on what should be a good time for us. Surveys say people would rather do business with [community-based institutions] but it's tough today to keep up. As consumers see our products as a commodity, we have to work harder price and package our products in a way that demonstrates value," Hernandez said.

Hernandez suggests community banks and credit unions take a close look individually at how to best compete against other financial institutions and non-bank startups and focus on developing tech for that differentiating factor, then be willing to cooperate with other institutions and share tech expenses for development that drives non-proprietary activities. "You want to spend less on the things that don't make you different… There's a moment of clarity [that's necessary], you need to be able to answer 'why am I here?'" Hernandez said.

For Harry Gunsallus, senior vice president of technology for Redstone Federal Credit Union, a $3.5 billion-asset credit union based in Huntsville, Al, part of the new competitive strategy is to actually sell its own technology expertise. The credit union, which has developed two dozen DNAapps in the Open Solutions DNAappsstore, has formed Redstone Consulting Group LLC, which markets the credit union's DNAapps to other banks and credit unions. Among the DNAapps the credit union has developed so far are tools that streamlined overdraft query and compliance with loan modification regulations. Gunsallus said the credit union's vigorous development of DNAapps was a matter of necessity.

"What a lot of folks don't know about Huntsville is that is has a large research park, so it has a very tech-savvy population. Redstone has 90 percent penetration of that market. That penetration is being disintermediated- not by Bank of America (BAC), but by Google (GOOG) and its Google Wallet. When we think about Google and market penetration, we jumped on the DNAappstore pretty quickly," he said.

Gunsallus didn't disclose how much money Redstone Consulting Group was earning but said the business was successfully generating non-interest income. "We turned the IT department from an expense line into a revenue source," he said.