Finance
A fintech collapse is rippling through a small corner of the banking world
The unraveling of fintech upstart Synapse is rippling through a small corner of the banking world, leaving thousands of customers without access to their money and creating a mystery over the millions of dollars that have disappeared.
Four small American banks have some of the money. No one knows for sure where the rest went.
The saga surrounding the bankruptcy of Synapse, a decade-old fintech company, puts a new spotlight on how loose networks of partnerships between venture-backed startups and FDIC-backed lenders can go so wrong.
Regulators are closely monitoring these relationships and are warning several banks to tighten their controls when working with fintech companies.
Earlier this month, the Federal Reserve slapped one of Synapse’s partner banks with an enforcement action that exposed weaknesses in risk management around such partnerships.
‘Banking as a service’
Synapse was part of a wave of new fintech companies that emerged in the wake of the 2008 financial crisis, when Silicon Valley-style digital bankers promised to shake up the world of traditional finance.
In just a decade, it became a key intermediary between dozens of fintech companies and community banks by offering what it called “banking as a service.”
It provided digital bankers like Mercury, Dave (DAVE) and Juno with access to checking accounts and debit cards that they could offer to their customers. It was able to do this by partnering with FDIC-backed banks, which in return received a new source of deposits and fee income.
Traditional lenders that worked 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.
The pitch Synapse effectively gave to these smaller banks was: “We bring in the deposits; you don’t have to do much,” said Jason Mikula, an independent fintech consultant who publishes a weekly newsletter and has been following Synapse.
“This turned out to be incorrect in my opinion,” Mikula added.
The problems came to light shortly after Synapse filed for bankruptcy in April, when it was unable to reach an agreement with Evolve on a settlement of the funds.
Three weeks into the bankruptcy proceedings, Synapse shut down Evolve’s access to its technology system. That in turn forced Evolve and the other partner banks to freeze customer accounts.
Both sides blamed each other.
“Synapse’s abrupt shutdown of critical systems without notice and inability to provide necessary data needlessly placed end users at risk by hindering our ability to verify transactions, confirm end user balances, and comply with applicable laws ,” Evolve said in a statement.
Synapse CEO Sankaet Pathak rebuked this claim, accusing Evolve of lacking the means to settle a deficit while delaying the return of customer funds.
“The debtor has been forced to play a perverse game of ‘whack-a-mole’ with unreasonable demands from Evolve as a condition for releasing the freeze on the depositors’ accounts, while the depositors have no access to their funds,” said Pathak in court documents. last month.
The end result is that thousands of fintech customers lost access to their money.
“Synapse’s bankruptcy 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 chair of the FDIC, wrote in a final letter. week to the heads of five federal banking regulators.
There was another problem: no one seemed to know where all the money was.
McWilliams said in early June that there was a shortfall of $85 million, with the four banks accounting for just $180 million of the $265 million belonging to end users.
More recently, she said the deficit was between $65 million and $96 million.
Some of the money has been refunded to customers. McWilliams said on June 21 that more than $100 million “has been distributed by certain partner banks.”
Blind spots
Bank regulators have been concerned for some time about the partnerships between Silicon Valley-style digital startups and FDIC-backed banks.
Acting Comptroller of the Currency Michael Hsu used a speech in September 2023 to discuss the potential blind spots for regulators as these relationships become more tenuous.
“Banks and technology companies, in an effort to provide a ‘seamless’ customer experience, are working together in ways that make it harder for customers, regulators and the industry to distinguish between where the bank stops and where the technology company begins. Hsu said in the speech.
Last June, regulators issued a final joint accompaniment about how lenders should handle these relationships.
These partnerships are not yet widespread across the banking industry, even as the use of this model is increasing as banks of all sizes look for ways to attract deposits and generate more revenue.
Less than 2% of U.S. banks were using the banking-as-a-service model in 2023, according to S&P Global Market Intelligence.
But regulators are nevertheless becoming more aggressive in addressing such relationships. According to S&P, the banking-as-a-service model was responsible for 13.5% of regulators’ public enforcement actions in 2023.
In January, the FDIC issued a consent order to one of Synapse’s partner banks, Franklin, Tennessee-based Lineage, identifying weaknesses associated with its banking-as-a-service program and ordering the bank to plan for how to achieve an “orderly termination” with key fintech partners.
The following month, New York City-based Piermont Bank; Sutton Bank, based in Attica, Ohio; and Martinsville, Virginia-based Blue Ridge Bank received consent orders from regulators regarding alleged deficiencies in their banking-as-a-service operations.
Then, earlier this month, the Fed issued an enforcement action against Evolve, saying investigations conducted in 2023 “found that Evolve engaged in unsafe and unsound banking practices by failing to have an effective risk management framework” for its partnerships with fintech companies. .
Regulators asked Evolve to improve its policies and risk management practices “by implementing appropriate oversight and monitoring of those relationships.” They also noted that the action was “independent of the bankruptcy proceedings relating to Synapse.”
An Evolve spokesperson said the recent order was “similar to orders received by others in the industry” and “does not impact our existing business, customers or deposits.”
The bank lists Affirm (AFRM), Mastercard (MA) and Stripe as notable fintech partnerships on its website.
It has also worked in the past with two crypto companies that have gone bankrupt, FTX and BlockFi, and with Bytechip, a financial services company whose accounts at Evolve were frozen on the exchange late last year. statement it violated federal law by laundering money for fraudsters.
Adding to the recent challenges, Evolve said last Wednesday that some customer data was illegally distributed on the dark web due to “a cybersecurity incident involving a known cybercriminal organization.”
“Evolve has engaged the appropriate law enforcement authorities to assist us in our investigation and response efforts,” the bank said. “This incident has been brought under control and there is no ongoing threat.”
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto and other financial areas.
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