The recent 'collapse' of Synapse, a key player in the banking-as-a-service (BaaS) sector, has directed increasing controversy toward the fintech industry. This headlining event has left over 100,000 Americans unable to access approximately $265 million in deposits, raising urgent questions about fintech regulation and customer fund protection with regulators and the public.
Synapse, founded in 2014, acted as an intermediary between customer-facing fintech startups and partner banks, serving 100 fintech companies and impacting around 10 million end users. Its bankruptcy and subsequent shutdown of critical systems have particularly affected users of apps like Yotta, a savings app that gamifies personal finance.
At the heart of the Synapse fintech collapse are two critical issues:
FBO Accounts in Fintech: Synapse used "for benefit of" (FBO) accounts to pool users' money across multiple banks. While common in traditional finance, this practice has proven problematic in the fintech context.
Fintech Ledger Issues: Court filings reveal significant problems with Synapse's ledgers, making it nearly impossible to accurately track customer funds. This has resulted in a potential shortfall of up to $96 million.
The Synapse situation differs from traditional bank failures, like the recent Silicon Valley Bank collapse, as it stems from accounting and fund management practices within the BaaS model rather than a bank run.
Key Implications of the Synapse Fintech Collapse:
FDIC Insurance Confusion: Many customers believed their funds were fully protected by FDIC insurance through partner banks like Evolve Bank & Trust. However, this situation has exposed complexities in how FDIC insurance applies to fintech arrangements.
Fintech Regulation Gaps: The collapse has highlighted potential blind spots in the oversight of fintech-bank partnerships, particularly regarding the use of FBO accounts and ledger practices.
Customer Fund Protection: Questions have arisen about the adequacy of current practices for protecting customer funds in fintech ecosystems.
The Financial Technology Association (FTA), representing major fintech players like Block, PayPal, and Chime, asserts that established companies in the sector are well-regulated and prioritize consumer fund protection. They argue that fintech companies provide valuable, accessible services to consumers and small businesses.
However, critics, including industry insiders like LendingClub CEO Scott Sanborn, suggest that dealing directly with banks may be safer for consumers, especially for primary accounts. Sanborn, whose company transitioned from a fintech lender to a fully regulated bank, has expressed concerns about the ability of small partner banks to properly monitor risks in BaaS arrangements.
Former FDIC chairman Jelena McWilliams, now overseeing the Synapse bankruptcy, has stated that fully reconciling customer funds may be impossible due to the complex nature of the FBO accounts and inconsistent ledgers.
This Synapse fintech collapse raises critical questions for the industry and regulators:
How can the use of FBO accounts in fintech be better regulated to ensure proper fund segregation and accounting?
What improvements are needed in fintech ledger practices and oversight to prevent similar situations?
How might this impact the broader adoption of BaaS models in fintech?
What steps will regulators take to address gaps in fintech regulation, particularly regarding fund management practices?
As the fallout from the Synapse collapse continues, the fintech industry faces a pivotal moment. The FDIC has clarified that the failure of non-banks like Synapse doesn't automatically trigger FDIC insurance, even when fintechs partner with insured banks. Regulatory responses and industry adaptations in the coming months will likely shape the future of fintech operations, with a particular focus on enhancing customer fund protection and improving transparency in BaaS arrangements.