The recent abrupt bankruptcy filing of financial technology company Synapse has sent shaken the banking industry. Synapse Financial Technologies, which acted as a middleman between fintech firms and banks, has frozen the accounts of tens of thousands of businesses and consumers as a result of its Chapter 11 bankruptcy protection filing in April.
This debacle has put the spotlight on the risks inherent in the banking-as-a-service (BaaS) model that has become increasingly popular in recent years. BaaS allows fintech companies to offer banking services like checking accounts and debit cards to their customers by partnering with licensed banks, without having to obtain a bank charter themselves.
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How Synapse’s Collapse Unfolded
Synapse provided the behind-the-scenes plumbing that connected over 100 fintech platforms, including savings app Yotta and business banking provider Mercury, to FDIC-insured partner banks like Tennessee-based Evolve Bank & Trust.
When Synapse abruptly shut down in April, it left banking partners unable to process transactions or verify customer balances.
Bankruptcy court filings paint a picture of missing customer funds and unreliable record-keeping by Synapse. The court-appointed bankruptcy trustee has reported an $85 million shortfall between the cash held in Synapse-linked bank accounts and what customers are owed according to Synapse’s ledgers.
Getting customers access to their frozen funds will likely take weeks if not months as the trustee and partner banks attempt to reconcile the accounts.
Increased Regulatory Scrutiny of BaaS Partnerships
Synapse’s meltdown has attracted the attention of banking regulators and is expected to lead to tighter oversight of bank-fintech partnerships. The Federal Reserve has already penalized Synapse partner Evolve Bank & Trust for “unsafe and unsound practices” in its fintech oversight.
Regulators are concerned that some BaaS arrangements have allowed fintech companies to evade the strict capital and liquidity requirements, consumer protection laws, and anti-money laundering rules that apply to traditional banks. The Office of the Comptroller of the Currency, Federal Reserve, and FDIC have all set up task forces to more closely monitor fintechs that partner with banks.
“Examiners are people,” said Todd Baker, a senior fellow at Columbia University. “It’s going to reinforce whatever concerns they have about the space in general. So, there’re going to be tough examinations, there’s no doubt about it.”
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The Future of BaaS
The increased regulatory scrutiny sparked by the Synapse bankruptcy is likely to make banks more cautious about entering into BaaS partnerships and could slow the growth of the BaaS industry. Fintechs may find it harder to convince banks to work with them and give them access to the payment rails and FDIC insurance that make many fintech business models possible.
Some BaaS providers are already pivoting in anticipation of the changing regulatory winds. Treasury Prime, a BaaS platform that connects banks and fintechs, laid off much of its staff earlier this year and announced it would start selling its software directly to banks rather than acting as a middleman.
This “bank-direct” model may become more common as regulators push for simpler, more transparent partnerships.
However, most experts believe BaaS is here to stay in some form given the strong demand from both consumers and financial institutions for more innovative, tech-driven financial services. Banks benefit from BaaS by being able to grow deposits and generate fee income without building consumer-facing brands or technology themselves.
A 2023 PYMNTS survey found that 76% of banks view fintech partnerships as necessary to meet customer expectations.
Protecting Consumers in an Embedded Finance World
The Synapse situation has exposed the risks to consumers when financial services are provided by loosely regulated fintechs rather than directly by banks. Customers of Yotta, Mercury and other Synapse-linked fintechs have been locked out of their accounts and face uncertainty about when they’ll be able to access their money again.
Regulators and lawmakers will likely look to strengthen disclosure requirements and restrictions around how fintechs can describe their financial products to ensure consumers understand whether they are dealing with a bank or a fintech, and what protections they are entitled to. The Consumer Financial Protection Bureau is expected to take a leading role given its power to police fintechs for unfair, deceptive or abusive practices.
“The disorderly failure of Synapse and the impact on end users is likely to confirm policymakers’ and regulators’ worst fears about the operating model and fintech in general,” wrote fintech advisor Jason Mikula.
What’s Next?
Synapse’s filing for Chapter 11 has exposed the risks lurking within the booming BaaS industry and is a harbinger of stricter oversight to come for bank-fintech partnerships.
While demand for BaaS is likely to remain strong, the industry’s growth could slow as regulators push for simpler arrangements and more of the compliance burden shifts to fintechs. Consumers should be aware of the differences between fintechs and fully regulated banks, and what protections they are giving up for the sake of convenience or higher yields.
The Synapse saga won’t be the last failure in this space, but it will hopefully spur changes to make BaaS partnerships more stable and transparent.