London July 18 2024: Over the past decade, dozens of financial-technology companies have linked up with small and midsize banks across the country. The idea: The fintechs would create slick smartphone apps and offer useful new services to lure customers, and banks would hold on to the deposits, generating lucrative fees from transactions. Importantly, the arrangement allowed the fintechs to tout protection from the Federal Deposit Insurance Corp.
But now, as millions of dollars’ worth of deposits remain frozen months after the collapse of a company called Synapse Financial Technologies, that supposed FDIC protection has come into clearer focus. And those partnerships are facing tough questions.
The reason customer deposits are in limbo is because Synapse was bad at recordkeeping. The firm acted as an intermediary between fintech apps including Yotta and Juno and their banking partners. When Synapse went bankrupt in April, it left behind a tangled mess: The trustee put in charge of Synapse said it was difficult to make sense of its ledgers, as the trustee was trying to resolve a shortfall of as much as $96 million in its accounts.
The banks that were supposed to hold the deposits, however, didn’t fail—so the FDIC’s insurance doesn’t kick in. That’s raised concern for consumers who do their banking via fintechs. How should a depositor using third-party apps determine whether their money is safe? “The short answer is: It depends,” the agency said in a bulletin published in May. Its insurance covers the bank but not the insolvency of a fintech.
Even so, banking regulators are taking notice of what happened—and they’ve focused their ire on the banks. “To the extent banks are working with fintech partners, banks have a responsibility to manage the risks,” Michael Barr, the US Federal Reserve’s vice chair for supervision, said in a July 9 speech in Washington. “We have, unfortunately, seen examples of failures of banks to effectively manage the risks of partnerships with other companies that support services to their end customers, and these failures have resulted in customer harm.”
In a Senate hearing the same day, Fed Chair Jerome Powell told Sherrod Brown, the Ohio Democrat, that it supervises banks but not Synapse. The conversation focused on Arkansas-based Evolve Bank & Trust, which had been one of the banks Synapse worked with. “We’re strongly encouraging Evolve to do whatever it can to help make money available to those depositors,” Powell said. He noted that the Fed has hit Evolve with an enforcement action related to its risk management.
Evolve says that in late 2023 it began winding down its business with Synapse, and that some fintech end users’ balances had been migrated from Evolve to a different program managed by Synapse. Evolve says it was still temporarily involved in payment processing and held some end users’ funds as a result. It also says only a small number of fintechs it works with were affected the Synapse bankruptcy, and that it’s working with the trustee, other banks and the fintechs to resolve the issue.
Juno and Yotta aren’t much like traditional banks. Juno is aimed at crypto traders. Yotta, co-founded by Adam Moelis, the son of billionaire investment banker Ken Moelis, makes a game out of saving by entering depositors into a lottery. But the trouble the fintechs have had has shaken a basic assumption about any banking product: that once customers see the “FDIC” label, they can stop thinking about the safety of their money. And it’s exposed a weakness in the broader fintech banking model, industry watchers say. “You realize it’s something that’s actually much more fragile than it appears to be and based on an area that very few people are really paying attention to,” says Hans Morris, a managing partner of Nyca Partners, a fintech venture capital firm.
Fintechs flush with venture capital money piled into banking services with a promise to revolutionize savings, with low or zero fees and easy access. Big banks often have high fees and minimum balances that disproportionately affect younger and less affluent people, and historically they’ve underserved segments of the population. But the fintech entrepreneurs could also leverage a regulatory loophole: Smaller banks are allowed to charge merchants higher fees than big banks for processing debit card transactions. This allowed fintech companies to work with those smaller banks to make money splitting the card fees. “It makes sense for small businesses and consumers to rely on fintechs—it helps improve the banking experience—when it works,” says Todd Phillips, a professor of financial regulation at Georgia State University. “And when it fails, it fails catastrophically.”
Until Synapse there wasn’t much attention on how to clean things up when a fintech company folds. Lawyers who advise fintech companies say that should change. “Banks need to be thinking not just about the marriage, but about the divorce,” says John Geiringer, a partner with Barack Ferrazzano Kirschbaum & Nagelberg.
The Synapse collapse affects just one corner of a much wider industry. Among the more successful fintechs is Chime, which is preparing for an initial public offering and was valued at $25 billion in 2021, the fintech frenzy’s peak. Chime keeps its customers’ deposits at the Bancorp Bank, based in South Dakota, and Oklahoma-based Stride Bank. Unlike the companies that worked with Synapse, Chime says it has a direct relationship with its banks. “Chime’s model is the standard in digital banking: customer funds held in FDIC-insured accounts at OCC-regulated banks with no middleware provider separating people from their money,” says Mark Troughton, Chime’s chief operating officer. The OCC, or Office of the Comptroller of the Currency, is another US banking regulator.
Current, a mobile banking fintech that caters to users who want to boost their credit, changed its homepage fine print in May to more clearly remind consumers that they’re not dealing directly with a bank, though their cash is sent to FDIC-backed Cross River Bank and Choice Financial Group. Current says it has a direct relationship to those banks. Current changed the language ahead of an FDIC regulation requiring fintechs to be more transparent. That regulation doesn’t kick in until January.
Some fintechs have chosen to become banks with full FDIC coverage. LendingClub Corp. and SoFi Technologies Inc. got into banking by acquiring existing institutions. But being a bank also comes with more rules and supervision, and the Biden administration has been seen as taking a tougher regulatory approach. Applications for new charters have languished. “This town’s inconsistency has led to the growth in this ecosystem and the problems that come from it,” says Isaac Boltansky, the Washington-based director of policy research at the trading firm and investment bank BTIG LLC.
For now, much of the onus of assessing the risk of fintech-bank partnerships is falling on consumers’ shoulders. “It’s a real public policy failure that we are expecting consumers to understand the nuances of FDIC insurance,” says GSU’s Phillips.
