The collapse of Synapse, a new fintech company, is rippling through a small corner of the banking world, leaving thousands of customers without access to their money and a mystery about millions of dollars missing.
Four small American banks own some of this money. No one really knows where the rest went.
The saga surrounding the collapse of Synapse, a 10-year-old financial technology company, highlights how networks of partnerships between venture-capital-backed newcomers and FDIC-backed lenders can go awry.
Regulators are taking a closer look at these relationships and warning individual banks to strengthen their controls when working with fintech companies.
Earlier this month, the Federal Reserve initiated enforcement action against one of Synapse’s partner banks, which identified weaknesses in risk management surrounding 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, as Silicon Valley-style digital banking upstarts promised to upend the world of traditional finance.
In just a decade, it has become a major intermediary between dozens of fintech companies and community banks by offering what it calls “banking as a service.”
It gave digital banking companies like Mercury, Dave (DAVE) and Juno 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, obtained 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 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 that Synapse actually gave to these small banks was “we will bring the deposits; you don’t need to do much,” according to Jason Mikula, an independent financial technology consultant who publishes a weekly newsletter and has followed Synapse.
“That turned out to be inaccurate, in my opinion,” Mikula added.
The problems emerged shortly after Synapse filed for bankruptcy in April, when it was unable to reach an agreement with Evolve on a fund settlement.
Three weeks after the bankruptcy proceedings began, Synapse cut off Evolve’s access to its technology system. This measure forced Evolve and other partner banks to freeze their customers’ accounts.
Both sides blamed each other for responsibility.
“Synapse’s abrupt shutdown of critical systems without notice and failure to provide necessary records needlessly put end users at risk by hindering our ability to verify transactions, confirm end user balances, and comply with applicable law,” Evolve said in a statement.
Synapse CEO Sankaet Pathak refuted the claim, accusing Evolve of having 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 conditions to unfreezing depositors’ accounts, all while depositors suffer from a 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.
“Synapse’s failure 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 FDIC chairwoman, wrote in a final letter this 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 an $85 million deficit, with the four banks accounting for only $180 million of the $265 million owned by end users.
More recently, she said the deficit was between $65 million and $96 million.
Part of the money was returned to customers. McWilliams said June 21 that more than $100 million “has been distributed by certain 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 speech in September 2023 to discuss potential blind spots for regulators as those relationships become more blurred.
“Banks and technology companies, in an effort to provide a “seamless” customer experience, are partnering in ways that make it harder for customers, regulators and the industry to distinguish between where banking stops and technology business begins,” Hsu said in the speech.
Last June, regulators issued final joint guidance on how lenders should manage such relationships.
Such partnerships are not yet widespread across the banking industry, although the use of this model is accelerating as banks of all sizes look for ways to attract deposits and generate more revenue.
Less than 2% of U.S. banks used the banking-as-a-service model in 2023, according to S&P Global Market Intelligence.
But regulators are becoming increasingly aggressive in exposing these relationships. The banking-as-a-service model accounted 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, Tennessee-based Lineage, that identified weaknesses in its banking-as-a-service program and ordered the bank to develop a plan to achieve an “orderly termination” with key fintech partners.
The following month, New York-based Piermont Bank; Attica, Ohio-based Sutton Bank; and Martinsville, Virginia-based Blue Ridge Bank received consent orders from regulators over alleged deficiencies in their banking-as-a-service business.
Then, earlier this month, the Fed launched enforcement action against Evolve, saying reviews conducted in 2023 “found that Evolve engaged in unsafe and unsound banking practices by failing to implement a effective risk management framework” for its partnerships with financial technology companies. .
Regulators required Evolve to improve its risk management policies and practices “by implementing appropriate monitoring and control of these relationships.” They also noted that this 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 affect our existing operations, customers or deposits.”
The bank counts Affirm (AFRM), Mastercard (MA), and Stripe as notable fintech partnerships on its website.
He has also partnered in the past with two crypto companies that went bankrupt, FTX and BlockFi, as well as Bytechip, a financial services company whose accounts with Evolve were frozen late last year , accused of violating federal law by laundering money for fraudsters.
Adding to its recent challenges, Evolve said last Wednesday that some customer data had been illegally released onto the dark web following a “cybersecurity incident involving a known cybercriminal organization.”
“Evolve has engaged relevant authorities to assist us with our investigation and response efforts,” the bank said. “This incident has been contained and there is no longer any ongoing threat. »
David Hollerith is a senior journalist for Yahoo Finance covering banking, crypto and other areas of finance.
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