In April of 2024, the middleware company Synapse Financial Technologies filed for Chapter 11 Bankruptcy protection. Synapse, which provided Banking-as-a-Service (Baas) solutions for various fintech firms, operated as a middleman and bookkeeper between its fintech clients and traditional banks. Backed by VC firm Andreessen Horowitz (a16z), Synapse had struggled with layoffs in 2023 and failed to sell off its assets for $9.7 million to another fintech, TabaPay.
While Synapse touted its relationships with FDIC-insured banks, the company itself was not insured by the FDIC, nor were funds stuck in the transfer process. As a result, when Synapse collapsed, hundreds of millions of dollars in customer deposits were frozen while the banks tried to figure out who owned what.
The collapse of Synapse also left many of its fintech clients in precarious positions. Based on Synapse’s filings, it is estimated that as many as 100 fintechs were impacted. Mainvest, one such client that operated as a fintech lender to restaurant businesses, was forced to shutter its business permanently.
Regulatory Response
In July of 2024, the federal bank regulatory agencies (the Fed, the FDIC, the OCC) released a joint statement on banks’ arrangements with fintechs, outlining the potential risks of certain arrangements and reminding banks of their obligations to obey all applicable laws and regulations.
Concurrent with the statement, the regulatory agencies also requested “additional information on a broad range of bank-fintech arrangements, including with respect to deposit, payments, and lending products and services.”
Then, in September of 2024, the FDIC released a notice of proposed new regulations, colloquially known as the Synapse Rule, which, among other features, would require banks to verify on a daily basis the accuracy of their custodial accounts. Consistent with the joint statement in July, the Synapse Rule addresses concerns that bank compliance is in some cases being solely performed by fintech partners.
Additionally, the Synapse Rule reinforced a July push by the FDIC to establish a broader definition of a Deposit Broker, which means more fintech firms could fall under that classification, allowing more oversight by the FDIC.
Meanwhile, back in June of 2024, the Federal Reserve Board issued a cease-and-desist order to Arkansas-based Evolve Bank & Trust, one of the main banks with which Synapse did business.
After first examining the bank in 2023, the Federal Reserve Board found that Evolve Bank & Trust:
“engaged in unsafe and unsound banking practices by failing to have in place an effective risk management framework for those partnerships.”
Until such risks were mitigated, The Federal Reserve ordered that Evolve Bancorp be forbidden to establish any new fintech partnerships or issue new products with existing partnerships.
A spokesperson for Evolve brushed off the cease-and-desist order, stating that it was “similar to orders received by others in the industry.”
New Chair of the FDIC
While the collapse of Synapse sent a shockwave through the fintech sector, how much the industry will change due to this regulation remains to be seen. The Synapse Rule was left open to comments and suggestions into December 2024.
Since then, FDIC Chairman Martin Gruenberg has stepped down and President Trump has named Travis Hill Acting Chairman. While the issuance of the Synapse Rule could be imminent, it comes at the beginning of a new administration that is vociferously pushing for loosened regulations.
Included in a statement listing priorities for the FDIC in the coming months, Hill stated that he wants the FDIC to:
“Adopt a more open-minded approach to innovation and technology adoption, including (1) a more transparent approach to fintech partnerships and to digital assets and tokenization, and (2) engagement to address growing technology costs for community banks.”
–and–
“Withdraw problematic proposals from the past three years, such as proposals on brokered deposits and corporate governance.”
The mention of brokered deposits is notable. When the Synapse Bill was released in September, Hill had specifically criticized the proposed changes regarding brokered deposits, calling the new regulations a “poor use of time and resources.”
It seems likely that the Synapse Rule, if and when presented to the public, will omit previously proposed regulations regarding an expanded legal classification of what qualifies as a brokered deposit. If so, this will be a significant win for fintechs and partner banks.
The Other Hill
In addition to Travis Hill’s ascension to Acting Chairman of the FDIC, Representative French Hill (R-AR) has become the new Chair of the Financial Services Committee. The former founder and CEO of a community bank in Arkansas, Hill advocates for less regulation of crypto, AI, fintech, and certainly for community banks.
Given that many fintech firms partner with community banks, Rep. Hill’s placement at the head of the Financial Services Committee is another win for the fintech industry. While the Synapse Rule looks to increase the compliance burden of smaller banks, Rep. Hill seeks to do the opposite.
He said, “They have to partner with fintech firms, and that’s been very challenging in recent years. That’s an area that we should focus on to make it easier and more effective for smaller banks to partner with and add fintech and AI innovations into their companies.”
Looking Forward
Venture Capitalist money flowing into the fintech space in 2024 was at a six-year low, $15 billion as compared to $53 billion in 2021. While potential regulation looms, a lack of capital from skittish investors is a perhaps bigger issue for the fintech sector. In 2023, less than half of the top 70 public fintech firms were profitable. This reality could be stymying new investments.
Meanwhile, smaller community banks, still reeling from high interest rates and a need for liquidity, will most likely continue to seek out partnerships with fintechs. However, in light of Synapse’s bankruptcy, we may see more direct partnerships between fintech and banks, without the middleware companies in between.
In the last few years, the near-constant critique of regulatory agencies has created a lack of clarity as to what the law is. Both Travis Hill of the FDIC and Rep. French Hill have noted this and pledged to provide clarification that encourages innovation and more business.
With these regulators in place, the collapse of Synapse could prove to be less a seismic shift in the fintech space and more of an aberration. While fintech firms have sometimes prioritized speed to market over risk management, a more balanced approach is likely to be voluntarily adopted because no one wants to be the next Synapse.
Author: Laird Dilorenzo
#Crypto #Blockchain #DigitalAssets #DeFi
Laird Dilorenzo is a hatchet thrower and wordsmith.
The editorial team at #DisruptionBanking has taken all precautions to ensure that no persons or organizations have been adversely affected or offered any sort of financial advice in this article. This article is most definitely not financial advice.
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