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 hold some of the money. No one knows exactly where the rest went.
The saga surrounding the bankruptcy of Synapse, a 10-year-old fintech company, highlights how networks of partnerships between venture capital-backed upstarts and FDIC-backed lenders can go wrong.
Regulators are taking a closer look at these relationships and warning various banks to strengthen their controls when working with fintech companies.
Earlier this month, the Federal Reserve slapped one of Synapse’s partner banks with an enforcement action that 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 startups promised to disrupt 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 did this by partnering with FDIC-backed banks that, in return, gained a new source of deposit and fee revenue.
Traditional lenders that partnered with Synapse included Evolve Bank & Trust, American Bank, AMG National Trust and Lineage Bank, all smaller 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.
According to Jason Mikula, an independent fintech consultant who publishes a weekly newsletter and follows Synapse, Synapse’s pitch to these smaller banks was “we’re going to attract deposits; You don’t have much to do.”
“In my opinion, this turned out to be inaccurate,” Mikula added.
The problems emerged shortly after Synapse filed for bankruptcy in April, when it failed to reach an agreement with Evolve on a settlement of funds.
Three weeks after the bankruptcy proceedings began, Synapse cut off Evolve’s access to its technology system. This forced Evolve and other partner banks to freeze customer accounts.
Both sides accused each other of responsibility.
“Synapse’s abrupt shutdown of critical systems without notice and failure to provide necessary records unnecessarily endangered end users by impeding 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 was forced to play a perverse game of ‘whack-a-mole’ with unreasonable demands from Evolve 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.
“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.
Some of the money has been refunded 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 speech in September 2023 to discuss potential blind spots for regulators as those relationships become more blurred.
“Banks and tech companies, in an effort to deliver a ‘seamless’ customer experience, are teaming up in ways that make it harder for customers, regulators and the industry to distinguish where the bank stops and where the tech company 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 use of the 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 will use 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, Tenn.-based Lineage, that identified weaknesses in its banking-as-a-service program and ordered the bank to develop a plan for how to achieve an “orderly termination” with major 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 an enforcement action against Evolve, saying that reviews conducted in 2023 “revealed that Evolve engaged in unsafe and unsound banking practices by failing to implement an effective risk management framework” for its partnerships with fintech companies.
Regulators required Evolve to improve its risk management policies and practices “by implementing appropriate oversight and monitoring of these relationships.” They also emphasized 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 affect our existing operations, customers or deposits.”
The bank counts Affirm (AFRM), Mastercard (MA), and Stripe as notable fintech partnerships on its website.
It has also partnered in the past with two failed crypto companies, FTX and BlockFi, as well as Bytechip, a financial services company whose accounts with Evolve were frozen late last year on charges it violated federal law by laundering money for fraudsters.
Adding to its recent challenges, Evolve said last Wednesday that some customer data had been illegally distributed on the dark web following a “cybersecurity incident involving a known cybercriminal organization.”
“Evolve has engaged the appropriate authorities to assist us in our investigation and response efforts,” the bank said. “This incident has been contained and there is no longer an ongoing threat.”
David Hollerith is a senior reporter for Yahoo Finance covering banking, crypto and other areas of finance.
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