The collapse of fintech startup Synapse is sending ripples through a small corner of the banking industry, leaving thousands of customers unable to access their money and leaving millions of dollars mysteriously missing.
Some of the funds are being held in four small U.S. banks. No one knows where the rest of the money went.
The furor surrounding the bankruptcy of Synapse, a 10-year-old fintech company, is shedding new light on how the loose web of partnerships between venture-capital-backed startups and FDIC-backed lenders can go so wrong.
Regulators are scrutinizing these relationships more closely and have warned various banks to tighten controls when working with fintech companies.
Earlier this month, the Federal Reserve imposed enforcement actions against one of Synapse’s bank partners, identifying weaknesses in the risk management associated with those 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 startups were expected to shake up the world of traditional finance.
In just a decade, the company has become a major intermediary between dozens of fintech companies and community banks by offering what it calls “banking as a service.”
The company gave digital banking companies like Mercury, DAVE and Juno access to checking accounts and debit cards that they could offer to their customers by partnering with FDIC-backed banks, which in return got new sources of deposit and fee revenue.
Traditional lenders that have partnered with Synapse include Evolve Bank & Trust, American Bank, AMG National Trust, and Lineage Bank, all of which are smaller banks compared to larger banks like JPMorgan Chase (JPM) and Bank of America (BAC).
The largest was Evolve, with about $1.5 billion in assets at the end of the first quarter.
Jason Mikula, an independent fintech consultant who publishes a weekly newsletter and follows Synapse, said Synapse’s actual pitch to these small banks was, “We’ll collect the deposits, so the banks don’t have to do anything.”
“In my opinion, this turned out to be inaccurate,” Mikula added.
The problems came to light shortly after Synapse filed for bankruptcy in April after being unable to reach a financing agreement with Evolve.
Three weeks after the bankruptcy proceedings began, Synapse cut off access to Evolve’s technology systems, forcing Evolve and other partner banks to freeze customer accounts.
Both sides accused each other of being the culprits.
“Synapse’s abrupt shutdown of critical systems without prior notice and failure to provide required records hindered our ability to verify transactions, verify end user balances and comply with applicable laws, putting end users at unnecessary risk,” Evolve said in a statement.
Synapse CEO Sankaet Pathak denounced the allegations, accusing Evolve of delaying returning customer funds despite having the means to eliminate its losses.
“Debtors have been forced to play a perverse game of ‘whack-a-mole’ due to Evolve’s unreasonable demands as a condition for unfreezing their deposit accounts, while depositors suffer without access to their funds,” Pathak said in court documents last month.
The end result was that thousands of fintech customers were left without access to their money.
“Synapse’s bankruptcy has left tens of thousands of end-users of its financial technology platform who were Synapse’s clients unable to access their funds,” Synapse’s court-appointed trustee and former FDIC chair Jelena McWilliams said in a letter to the heads of five federal banking regulators last week.
There was another problem: No one seemed to know where the money was.
McWilliams said in early June there was an $85 million shortfall, with the four banks only covering $180 million of the $265 million due to end users.
She recently said the shortfall ranges from $65 million to $96 million.
Some of the money has been returned to customers, and McWilliams said on June 21 that more than $100 million has been “distributed by some of our partner banks.”
Blind Spot
Banking regulators have long had concerns about partnerships between Silicon Valley-style digital startups and FDIC-backed banks.
In a September 2023 speech, Acting Comptroller of the Currency Michael Schuh discussed the blind spots regulators may face as these relationships become increasingly blurred.
“As part of an effort to provide ‘seamless’ customer experiences, banks and tech companies are partnering in ways that make it harder for customers, regulators and the industry to distinguish between the limits of banks and the limits of tech companies,” Su said in his speech.
Last June, regulators issued final joint guidelines on how lenders should handle such relationships.
Use of this model is accelerating as banks of all sizes look for ways to attract deposits and increase revenue, but these partnerships are not yet widespread across the banking industry.
Fewer than 2% of U.S. banks will have adopted a banking-as-a-service model in 2023, according to S&P Global Market Intelligence.
But regulators have become increasingly aggressive in criticizing such relationships: Bank-as-a-service models accounted for 13.5% of public enforcement actions by regulators in 2023, according to S&P.
The FDIC in January issued a consent order ordering Franklin, Tennessee-based Lineage, one of Synapse’s partner banks, to identify weaknesses related to the bank’s banking-as-a-service program and develop a plan to achieve an “orderly exit” with its key fintech partner.
The following month, New York City-based Piermont Bank, Attica, Ohio-based Sutton Bank and Martinsville, Virginia-based Blue Ridge Bank received consent orders from regulators related to alleged deficiencies in their banking-as-a-service services.
And earlier this month, the Fed filed enforcement actions against Evolve, saying a 2023 investigation “found that Evolve did not have an effective risk management framework in place in its partnerships with fintech companies and engaged in unsafe and unsound banking practices.”
Regulators called on Evolve to improve its policies and risk management practices “through appropriate oversight and monitoring of its relationships,” and noted that the action was “unrelated to the insolvency proceedings regarding Synapse.”
An Evolve spokesman said the order was “similar to those received by other companies in the industry” and would “not impact our existing business, customers or deposits.”
The bank’s website lists Affirm (AFRM), Mastercard (MA) and Stripe as notable fintech partners.
The firm has previously worked with two bankrupt crypto companies, FTX and BlockFi, as well as financial services firm Bytechip, which had its Evolve account frozen late last year on suspicion of violating federal law for laundering fraudsters’ funds.
Adding to its recent challenges, Evolve announced last Wednesday that some of its customer data had been illegally distributed on the dark web as a result of a “cybersecurity incident involving a known cybercrime organisation.”
“Evolve is working with relevant law enforcement agencies to assist in the investigation and response,” 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, cryptocurrency and other areas of finance.
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