The unraveling of fintech upstart Synapse is rippling through a small corner of the banking world, leaving thousands of customers without access to their money and creating a mystery over the millions of dollars that have disappeared.
Four small American banks have some of the money. No one knows for sure where the rest went.
The saga surrounding the bankruptcy of Synapse, a 10-year-old fintech company, is a further illustration of how loose networks of partnerships between venture-backed start-ups and FDIC-backed lenders can go so wrong.
Regulators are closely monitoring these relationships and are warning several banks to tighten 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 exposed weaknesses in risk management around such partnerships.
‘Banking as a service’
Synapse was part of a wave of new fintech companies that emerged in the wake of the 2008 financial crisis, when Silicon Valley-style digital bankers promised to shake up the world of traditional finance.
In just a decade, it became a key intermediary between dozens of fintech companies and community banks by offering what it called “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 that in return received a new source of deposits and fees.
Traditional lenders working 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 idea that Synapse gave these smaller banks was basically, “We take care of the deposits; you don’t have to do much,” said Jason Mikula, an independent fintech consultant who publishes a weekly newsletter and follows Synapse.
“That turned out to be wrong in my opinion,” Mikula added.
The problems came to light shortly after Synapse filed for bankruptcy in April and was unable to reach an agreement with Evolve on a financial settlement.
Three weeks after the bankruptcy, Synapse cut off Evolve’s access to its technology system, forcing Evolve and its other partner banks to freeze their customer accounts.
Both sides blamed each other.
“By suddenly shutting down critical systems without notice and failing to provide required data, Synapse needlessly put end users at risk, preventing us from verifying transactions, confirming end user balances, and complying with applicable laws,” Evolve said in a statement.
Synapse CEO Sankaet Pathak rejected the claim, accusing Evolve of having the resources to make up a shortfall but delaying refunds of customer funds.
“The Debtor has been forced to play a perverse game of whack-a-mole with unreasonable demands from Evolve as a condition for releasing the freeze on depositors’ accounts, while depositors are unable to access their funds,” Pathak said in court documents last month.
The end result is that thousands of fintech customers lost access to their money.
“Synapse’s bankruptcy has left tens of thousands of end users of financial technology platforms who were Synapse customers without access to their funds,” Jelena McWilliams, Synapse’s court-appointed administrator and former chair of the FDIC, wrote in a letter 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 there was a shortfall of $85 million, with the four banks accounting for only $180 million of the $265 million that belonged to end users.
More recently, she said the deficit was between $65 million and $96 million.
Some of the money has been returned to customers. McWilliams said on 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 the potential blind spots for regulators as these relationships become more tenuous.
“Banks and technology companies, in an effort to provide a ‘seamless’ customer experience, are working together in ways that make it harder for customers, regulators and the industry to distinguish between where the bank stops and where the technology company begins. Hsu said in the speech.
Last June, regulators issued final joint guidance on how lenders should handle these relationships.
These partnerships are not yet widespread across the banking industry, even as the use of this model is increasing as banks of all sizes look for ways to attract deposits and generate more revenue.
Less than 2% of U.S. banks were using the banking-as-a-service model in 2023, according to S&P Global Market Intelligence.
But regulators are becoming more aggressive in addressing such relationships. According to S&P, the banking-as-a-service model will account for 13.5% of public enforcement actions by regulators in 2023.
In January, the FDIC issued a consent order to one of Synapse’s partner banks, Lineage of Franklin, Tennessee. It identified weaknesses in the bank’s banking-as-a-service program and ordered the bank to create a plan to achieve an “orderly termination” of collaboration with key fintech partners.
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 regarding alleged deficiencies in their banking-as-a-service operations.
The Fed then issued an enforcement action against Evolve earlier this month, saying investigations conducted in 2023 “found that Evolve engaged in unsafe and unsound banking practices by failing to have an effective risk management framework” for its partnerships with fintech companies.
Regulators asked Evolve to improve its policies and risk management practices “by implementing appropriate oversight and monitoring of those relationships.” They also noted that the action was “independent of the bankruptcy proceedings involving Synapse.”
An Evolve spokesperson said the recent order was “similar to orders received by others in the industry” and “does not impact our existing business, customers or deposits.”
On its website, the bank lists Affirm (AFRM), Mastercard (MA) and Stripe as notable fintech partnerships.
It has also worked in the past with two crypto companies that have gone bankrupt, FTX and BlockFi, and with Bytechip, a financial services company whose accounts at Evolve were frozen late last year on allegations that it violated federal law by transferring money to launder for fraudsters.
Evolve reported last Wednesday that, in addition to recent challenges, customer data has been illegally distributed on the dark web due to “a cybersecurity incident involving a known cybercriminal organization.”
“Evolve has engaged the appropriate law enforcement agencies to assist with our investigation and response efforts,” the bank said. “This incident has been contained and there is no ongoing threat.”
David Hollerith is a senior reporter for Yahoo Finance, covering banking, cryptocurrencies, and other areas of finance.
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