The collapse of fintech startup Synapse is roiling a small corner of the banking world, leaving thousands of customers without access to their money and a mystery surrounding the millions of dollars that went missing.
Four small US banks have some of the money. No one is sure where the rest went.
The saga surrounding the bankruptcy of Synapse, a 10-year-old fintech firm, shines a spotlight on how loose networks of partnerships between venture-backed startups and FDIC-backed lenders can go so wrong.
Regulators are scrutinizing these relationships more closely and warning various banks to strengthen their controls when working with fintech firms.
Earlier this month, the Federal Reserve hit one of Synapse’s partner banks with an enforcement action that identified the risk management weaknesses surrounding such partnerships.
“Banking as a Service”
Synapse was part of a wave of new fintech firms that emerged in the wake of the 2008 financial crisis, as the Silicon Valley-style digital banking startup promised to shake up the world of traditional finance.
In just a decade, it became a major intermediary between dozens of fintech companies and community banks offering what it called “banking as a service.”
It gave digital banking outfits like Mercury, Dave ( DAVE ) and Juno access to the checking accounts and debit cards they could offer their customers. It was able to do this by partnering with FDIC-backed banks, which in return received a new source of deposit 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 ( BAC ).
The largest was Evolve, which had roughly $1.5 billion in assets at the end of the first quarter.
The pitch that Synapse effectively gave 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 has followed Synapse.
“This, in my opinion, was not correct,” added Mikula.
Problems surfaced shortly after Synapse filed for bankruptcy in April, when it was unable to reach an agreement with Evolve to resolve funds.
Three weeks into the bankruptcy proceeding, Synapse cut off Evolve’s access to its technology system. This, in turn, forced Evolve and other partner banks to freeze customer accounts.
Both sides blamed each other as the culprit.
“Synapse’s sudden shutdown of critical systems without warning and failure to secure necessary data unnecessarily put end users at risk by impeding our ability to verify transactions, confirm end user balances, and comply with the law in power,” Evolve said in a statement.
Synapse CEO Sankaet Pathak rebuked the claim, accusing Evolve of having the means to resolve a deficit but delaying the return of customer funds.
“The debtor has been forced to play a perverse game of ‘fist-a-mole’ with unreasonable demands from Evolve as conditions for merging depositors’ accounts, all while depositors suffer lack of access to their funds,” Pathak said 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 a former -chairman of the FDIC. week for the heads of the five federal banking regulators.
There was another problem: No one seemed to know where all the money was.
McWilliams in early June said there was an $85 million shortfall, with the four banks accounting for only $180 million of the $265 million owed to end users.
She recently said the range of the shortfall was $65 million to $96 million.
Some money has been returned to customers. McWilliams said on June 21 that more than $100 million “has been distributed by some of the partner banks.”
Blind spots
Bank 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 ambiguous.
“Banks and technology firms, in an effort to provide a ‘seamless’ customer experience, are merging in ways that make it harder for customers, regulators and the industry to tell the difference between where the bank stops and the firm begins of technology. Hsu said in the speech.
Last June, regulators issued final joint guidance on how lenders should handle these relationships.
These partnerships are not yet widespread across the banking industry, although use of the model is accelerating as banks of all sizes look for ways to attract deposits and earn more revenue.
Less than 2% of US banks used the banking-as-a-service model in 2023, according to S&P Global Market Intelligence.
But regulators are nonetheless becoming more aggressive about calling out such relationships. The banking-as-a-service model accounts for 13.5% of public enforcement actions by regulators in 2023, according to S&P.
In January, the FDIC issued a consent order to one of Synapse’s partner banks, Franklin, Tenn.-based Lineage, that identified weaknesses in its banking-as-a-service program and ordered the bank to develop a plan for how to reached an “orderly conclusion” with important fintech partners.
Next month, New York-based Piermont Bank; Attica, Ohio-based Sutton Bank; and Martinsville, Va.-based Blue Ridge Bank. received consent orders from regulators regarding 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 “revealed that Evolve engaged in unsafe and unsafe banking practices by failing to establish an effective framework of risk management” 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 related to Synapse.”
A spokesperson for Evolve said the latest order was “similar to orders received by others in the industry” and “does not affect 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 partnered in the past with two bankrupt crypto firms, FTX and BlockFi, as well as Bytechip, a financial services firm that froze its accounts with Evolve late last year alleging it violated federal law by laundering money for scammers.
To add to its latest challenges, Evolve said last Wednesday that some customer data was 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 controlled and there is no ongoing threat.”
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto and other areas in finance.
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