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A fintech meltdown is reverberating in a small corner of the banking world
The collapse of the new fintech Synapse is having repercussions in a small corner of the banking world, leaving thousands of customers without access to their money and a mystery about millions of dollars that have disappeared.
Four small US banks hold some of the money. No one knows for sure where the rest went.
The saga surrounding the bankruptcy of Synapse, a 10-year-old fintech company, puts new focus on how the loose webs of partnerships between venture-backed startups and FDIC-backed lenders can go so wrong.
Regulators are taking a closer look at these relationships and warning several banks to tighten their controls when working with fintech companies.
Earlier this month, the Federal Reserve hit one of Synapse’s partner banks with an enforcement action that identified weaknesses in the risk management around such partnerships.
‘Banking 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 bank startups promised to shake up the world of traditional finance.
In just a decade, it has become a key intermediary between dozens of fintech companies and community banks, offering what it calls “banking as a service.”
Provided digital banking equipment such as 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 through partnerships with FDIC-backed banks that, in return, gained a new source of deposits and fee income.
Traditional lenders that partnered with Synapse included Evolve Bank & Trust, American Bank, AMG National Trust, and Lineage Bank, all small banks when compared to giants like JPMorgan Chase (JPM) or Bank of America (TAS).
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’ll bring the deposits; you don’t have to do much,” according to Jason Mikula, an independent fintech consultant who publishes a weekly newsletter and follows Synapse.
“That turned out to be inaccurate, in my opinion,” Mikula added.
Jelena McWilliams, former chairman of the FDIC, is Synapse’s bankruptcy trustee. (PATRICK T. FALLON/AFP via Getty Images) (PATRICK T. FALLON via Getty Images)
The problems arose shortly after Synapse filed for bankruptcy in April after it failed to reach an agreement with Evolve over the liquidation of the 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 parties blamed each other as the culprits.
“Synapse’s abrupt shutdown of critical systems without prior notice and failure to provide required records placed end users at unnecessary risk by impairing our ability to verify transactions, confirm end user balances, and comply with applicable law,” it said. Evolve in a statement.
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Synapse CEO Sankaet Pathak dismissed that claim, accusing Evolve of having the means to close a deficit but delaying the return of customer funds.
“The debtor has been forced to play a vicious game of ‘whack-a-mole’ with Evolve’s unreasonable demands as conditions for unfreezing depositors’ accounts, while depositors suffer from lack of 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.
“The Synapse bankruptcy left tens of thousands of end users of financial technology platforms who were Synapse customers without access to their funds,” Jelena McWilliams, Synapse’s court-appointed trustee and a former FDIC chairwoman, wrote in a letter last 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 shortfall, with the four banks accounting for just $180 million of the $265 million owed by end users.
More recently, she said the deficit range was $65 million to $96 million.
Some money was returned to customers. McWilliams said on June 21 that more than $100 million “has been distributed by some partner banks.”
Blind spots
Banking regulators have been concerned for some time about partnerships between Silicon Valley-style digital startups and FDIC-backed banks.
Acting Comptroller of the Currency Michael Hsu used a September 2023 speech to discuss potential blind spots for regulators as these relationships become more confusing.
“Banks and technology companies, in an effort to provide a ‘seamless’ customer experience, are coming together in ways that make it more difficult 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 statement guidance about how creditors should handle these relationships.
These partnerships are not yet widespread across the banking sector, 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 raised concerns about ties between banks and financial technology companies. (REUTERS/Evelyn Hockstein) (REUTERS/Reuters)
Less than 2% of U.S. banks will use the banking-as-a-service model in 2023, according to S&P Global Market Intelligence.
But regulators are nonetheless becoming more aggressive in calling out such relationships. The banking-as-a-service model accounted for 13.5% of regulators’ public enforcement actions in 2023, according to S&P.
In January, the FDIC issued a consent order to one of Synapse’s partner banks, Franklin, Tennessee-based Lineage, which identified weaknesses related to its banking-as-a-service program and ordered the bank to submit a plan to how to achieve an “orderly termination” with significant fintech partners.
The following month, New York-based Piermont Bank; Attica, Ohio-based Sutton Bank; and Blue Ridge Bank, based in Martinsville, Virginia, received consent orders from regulators related to alleged deficiencies in their banking businesses.
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 harmful banking practices by failing to implement an effective risk management framework” for its partnerships with fintech companies.
Regulators asked Evolve to improve its risk management policies and practices by “implementing appropriate oversight and monitoring of these relationships.” They also noted that the action was “independent of the bankruptcy proceedings regarding 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 warehouses.”
The bank account Affirm (AFRM), Mastercard (BAD) and Stripe as notable fintech partnerships on their website.
In the past, it has also partnered with two now-bankrupt crypto companies, FTX and BlockFi, as well as Bytechip, a financial services company that had its Evolve accounts frozen late last year. allegation violated federal law by laundering money for fraudsters.
Adding to its recent challenges, Evolve said Wednesday that some customer data had been illegally spread on the dark web as a result of “a cybersecurity incident involving a known cybercriminal organization.”
“Evolve has engaged the appropriate law enforcement authorities to assist 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, cryptocurrencies and other areas of finance.
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