Fintech
The collapse of financial technology is also affecting a small corner of the banking world
The collapse of fintech startup Synapse is rippling through a small corner of the banking world, leaving thousands of customers without access to their money and a mystery surrounding millions of dollars that went missing.
Four small American banks have some of the money. No one knows for sure where the rest went.
The saga surrounding the collapse of Synapse, a 10-year-old fintech company, highlights how networks of partnerships between venture-backed startups and FDIC-backed financiers can go so wrong.
Regulators are looking more closely at these reports and are warning banks to tighten controls when working with fintech firms.
Earlier this month, the Federal Reserve took enforcement action against one of Synapse’s partner banks, citing risk management weaknesses associated with those partnerships.
“The Bank as a Service”
Synapse was part of a wave of new fintech companies that emerged in the aftermath of the 2008 financial crisis, when Silicon Valley-style digital banking startups promised to revolutionize the world of traditional finance.
In just a decade, it has become a major intermediary between dozens of fintech companies and community banks, offering what it calls “banking as a service.”
Provided digital banking services such as Mercury, Dave (Dave), and Juno with access to checking accounts and debit cards that they could offer to their customers. They were able to do this through partnerships with FDIC-backed banks that in return gained a new source of deposits and fee revenue.
Traditional lenders that partnered with Synapse included Evolve Bank & Trust, American Bank, AMG National Trust, and Lineage Bank, all small banks compared to giants like JPMorgan Chase (JPM) or Bank of America (BAC).
The largest was Evolve, which had about $1.5 billion in assets at the end of the first quarter.
According to Jason Mikula, an independent fintech consultant who publishes a weekly newsletter and has followed Synapse, the message Synapse actually sent to these smaller banks was: “We’ll bring the deposits; you don’t have to do much.”
“This turned out to be inaccurate, in my opinion,” Mikula added.
Jelena McWilliams, former chair of the FDIC, is the trustee of the Synapse bankruptcy. (PATRICK T. FALLON/AFP via Getty Images) (PATRICK T. FALLON via Getty Images)
The problems emerged shortly after Synapse filed for bankruptcy in April, when it failed to reach an agreement with Evolve on how to distribute funds.
Three weeks into the bankruptcy proceedings, Synapse cut off Evolve’s access to its technology system. This, in turn, forced Evolve and its other partner banks to freeze customer accounts.
Both sides placed the blame on each other.
“Synapse’s sudden shutdown of critical systems without notice and failure to provide necessary records unnecessarily jeopardized end users, hindering our ability to verify transactions, confirm end user balances, and comply with applicable laws ” Evolve said in a statement.
The story continues
Synapse CEO Sankaet Pathak rebuked the claim, accusing Evolve of having the means to pay off a deficit but delaying the return of customer funds.
“The debtor was forced to play a perverse game of ‘whack-a-mole’ with unreasonable demands by Evolve as conditions for the unfreezing of depositors’ accounts, all while the depositors have no access to their funds,” Pathak said in court documents last month.
The end result is that thousands of fintech customers have lost access to their money.
“Synapse’s failure has left tens of thousands of end users of financial technology platforms who were Synapse customers stranded without access to their funds,” Jelena McWilliams, Synapse’s court-appointed trustee and former president of Synapse, wrote in a letter last year. FDIC. week to the heads of five federal banking regulators.
There was another problem: No one seemed to know where all the money was.
In early June, McWilliams said there was an $85 million deficit, with the four banks accounting for just $180 million of the $265 million owed to end users.
More recently he said the deficit range was between $65 million and $96 million.
Some of the money has been returned to customers. McWilliams said June 21 that more than $100 million “has been distributed by some of the partner banks.”
Blind spots
Banking regulators have long been concerned about partnerships between Silicon Valley-style digital startups and FDIC-backed banks.
Acting Comptroller General of the Currency Michael Hsu used a September 2023 speech to discuss potential blind spots for regulators as these relationships become increasingly confusing.
“Banks and technology companies, in an effort to provide a ‘seamless’ customer experience, are collaborating in ways that make it harder for customers, regulators and the industry to distinguish where the bank ends and the technology company begins,” Hsu said in the speech.
Last June, regulators issued a definitive settlement guide on how creditors should manage these relationships.
These partnerships are not yet widespread across the entire banking industry, although the use of this model is accelerating as banks of all sizes look for ways to attract deposits and earn more revenue.
Acting Comptroller of the Currency Michael Hsu has raised concerns about links between banks and fintech firms. (REUTERS/Evelyn Hockstein) (REUTERS / Reuters)
According to S&P Global Market Intelligence, less than 2% of U.S. banks were using the banking-as-a-service model in 2023.
But regulators are nevertheless becoming more aggressive in reporting such relationships. According to S&P, the banking-as-a-service model accounted for 13.5% of public enforcement actions by regulators in 2023.
In January, the FDIC issued a consent order to Lineage, one of Synapse’s partner banks, based in Franklin, Tenn., that identified weaknesses in its banking-as-a-service program and ordered the bank to develop a plan for how to achieve an “orderly termination” with major fintech partners.
The following month, New York-based Piermont Bank; Sutton Bank, based in Attica, Ohio; and Blue Ridge Bank, based in Martinsville, Virginia, received consent orders from regulators related to alleged deficiencies in their banking-as-a-service business.
Then, earlier this month, the Fed issued an enforcement action against Evolve, saying that examinations conducted in 2023 “found that Evolve engaged in unsafe and unsound banking practices by failing to implement an effective risk management framework” for its partnerships with fintech companies.
Regulators have asked Evolve to improve its risk management policies and practices by “implementing appropriate oversight and monitoring of such relationships.” They also noted that the action was “independent of the bankruptcy proceedings involving Synapse.”
An Evolve spokesperson said the recent order was “similar to orders received by others in the industry” and “does not impact our current business, our customers or our warehouses.”
The bank counts Affirm (AFRCM), Mastercard (BUT) and Stripe as notable fintech partnerships on its website.
It has also partnered in the past with two cryptocurrency firms that went bust, FTX and BlockFi, as well as Bytechip, a financial services company that saw its accounts with Evolve frozen late last year. accusation violated federal law by laundering money for scammers.
Adding to its recent challenges, Evolve said on Wednesday that some customer data had been illegally leaked to the dark web following “a cybersecurity incident involving a known cybercriminal organization.”
“Evolve has engaged relevant law enforcement authorities to assist us in our investigation and response efforts,” the bank said. “This incident has been contained and there is no ongoing threat.”
David Hollerith is a senior reporter at Yahoo Finance covering banking, cryptocurrency, and other areas of finance.
Read the latest financial and business news from Yahoo Finance