Fintech firm Synapse's bankruptcy exposes risks in partnerships with small banks

It was a decade of apparent success, but now Synapse, a fintech upstart, is at the center of a scandal that has left thousands of customers without access to their money and millions of dollars unaccounted for.

The bankruptcy of Synapse has put the spotlight on the risky partnerships between venture-backed fintech firms and FDIC-backed lenders. Loose webs of partnerships have led to significant problems, leading regulators to scrutinize these relationships more closely and urge banks to strengthen their controls when working with fintech firms.

Banking as a Service

Synapse was part of the wave of new fintech firms that emerged following the 2008 financial crisis, offering "banking as a service" to digital banking companies. It acted as a middleman between fintech companies and community banks, providing access to checking accounts and debit cards in exchange for deposits and fee revenue for the partner banks.

Partnerships and Fallout

The traditional lenders partnered with Synapse included Evolve Bank & Trust, American Bank, AMG National Trust, and Lineage Bank. However, the promise of bringing in deposits without much effort turned out to be inaccurate, leading to conflicts and ultimately the freezing of customer accounts.

Amid the bankruptcy proceedings, it became evident that millions of dollars were missing, with no clear explanation of their whereabouts. The trustee in the Synapse bankruptcy stated that there was a shortfall of $85 million, and while some money has been distributed to customers, the mystery of the missing funds remains.

Regulatory Concerns

Bank regulators have expressed concerns about the blurred lines between banks and tech firms in these partnerships, leading to potential blind spots and difficulties in distinguishing between the two entities. Regulators have become more aggressive in calling out such relationships, issuing consent orders and enforcement actions to address deficiencies related to the banking-as-a-service model.

Ongoing Challenges

In addition to the financial and regulatory challenges, one of Synapse's partner banks, Evolve, faced further issues related to a cybersecurity incident involving customer data being spread on the dark web. The incident has been contained, but it adds to the bank's recent challenges.