Introduction
The recent collapse of Synapse, a Banking-as-a-Service (BaaS) provider, and its fallout with its banking partner Evolve Bank, has sent shockwaves through the fintech community. This situation has raised significant questions about the viability and risk associated with the BaaS model, where fintech companies and traditional banks collaborate to provide banking services.
What is Banking-as-a-Service (BaaS)?
Banking-as-a-Service, or BaaS, is a model that allows fintech companies to offer banking-like services without needing to become banks themselves. This is achieved through partnerships with licensed banks that provide the regulatory and operational framework needed to deliver financial services. Here’s how it works:
- Integration with Licensed Banks: Fintech companies use APIs provided by BaaS platforms to integrate with banks. This enables fintechs to offer services such as deposit accounts, payment processing, and lending under the bank’s regulatory umbrella.
- Fast-Track to Market: BaaS significantly reduces the time and cost required for fintechs to enter the financial services market. Instead of going through the lengthy and expensive process of obtaining a bank license, fintechs can leverage the infrastructure and compliance systems of their partner banks.
- Enabling Fintech Growth: This model has enabled the rapid proliferation of fintech companies, each offering innovative financial products and services that might have taken years to launch under traditional banking models.
Motivations and Incentives
Banks: Expanding Revenue Streams
For small local banks, partnering with fintechs was an enticing opportunity to expand revenue beyond their traditional geographic scope. By leasing out their banking licenses, these banks could earn profits without the significant customer acquisition costs typically associated with growth. This arrangement allowed them to benefit from the booming fintech sector without having to directly compete in the tech-heavy market.
Local banks saw these partnerships as a way to boost their deposit base and increase fee income from fintech activities. This was particularly attractive as it provided a steady revenue stream with relatively low investment compared to traditional banking operations. Essentially, these banks were able to tap into the fintech market’s growth while offloading some of the operational and compliance burdens to their fintech partners.
Fintechs: Skirting Regulatory Hurdles
Fintech companies were motivated to partner with banks to avoid the extensive due diligence and regulatory hurdles associated with becoming a chartered bank. Obtaining a bank license is a costly and time-consuming process, often taking years to complete and requiring significant capital and compliance infrastructure. By partnering with banks like Evolve, fintechs could offer banking-like services under the umbrella of the bank’s license, thus skirting the stringent regulatory scrutiny usually imposed on financial institutions.
This arrangement allowed fintechs to quickly bring innovative financial products to market without the delays and costs of regulatory compliance. It also enabled them to operate under the radar of regulators like the Consumer Financial Protection Bureau (CFPB), which typically focuses on larger institutions and more traditional banking practices. This “under the radar” approach meant fintechs could focus on growth and innovation without being bogged down by the heavy regulatory burdens faced by traditional banks.
The Players and the Problem
Synapse: The Middleman
Synapse aimed to simplify partnerships between fintechs and banks, enabling fintechs to offer banking-like services without obtaining a bank license themselves. However, Synapse struggled to provide enough value, leading to its largest client, Mercury, moving directly to Evolve Bank.
Evolve Bank: The Partner
Evolve Bank partnered with Synapse to attract fintech clients. However, the relationship soured over discrepancies in account balances and compliance issues. Evolve accused Synapse of blocking access to necessary account data, resulting in a mismatch of $13 million and leading to frozen customer accounts.
A Farcical Situation
The collapse of Synapse and the ensuing dispute with Evolve Bank have been nothing short of farcical. Both parties have engaged in a blame game reminiscent of schoolchildren, each pointing fingers and saying, “No, he started it!” This childish behavior underscores their failure to perform the most fundamental duty of a bank: keeping track of customer money. Instead of acting responsibly and resolving the discrepancies, they have chosen to bicker over who is to blame, leaving their customers to bear the brunt of their incompetence.
Trust and Facade: The Reality Behind the Companies
As we delve deeper into the collapse of Synapse, it’s crucial to understand the role of trust — or rather, the facade of trust — that the people running these companies have constructed.
The Illusion of Competence and Trustworthiness
The leaders of these fintech and BaaS companies often project an image of competence and trustworthiness. They present themselves as savvy innovators, capable of revolutionizing the financial sector while ensuring the safety and security of their customers’ funds. This image is carefully crafted to gain the trust of both consumers and investors.
However, the reality is starkly different. The collapse of Synapse reveals that this image is often just a facade. The inability to manage complex financial systems, the failure to reconcile accounts, and the lack of proper oversight show that these leaders are not as competent or trustworthy as they appear. They have leveraged the complexity and opacity of their operations to mask their inadequacies and the inherent risks of their business models.
The Danger of Pedestals
In our society, there is a tendency to put successful business leaders on a pedestal. We view them as paragons of innovation and reliability, assuming that their success equates to expertise and integrity. This perception can be dangerous, as it leads us to overlook the potential flaws and risks in their operations.
The Synapse case serves as a sobering reminder that we should not blindly trust these individuals simply because they occupy positions of power and influence. Their primary goal is often to persuade ordinary people to trust them and their companies, not necessarily to ensure the best outcomes for those people. The trust placed in them can lead to significant financial harm when their systems fail or their true capabilities are revealed.
The Core Issues
Layers of Complexity and Compounding Risk
The BaaS model introduced multiple layers of complexity, significantly compounding the risk within the financial ecosystem. Here’s how this complexity played out:
- Pooling and Intermingling of Funds: Synapse managed FBO (For-Benefit-Of) accounts, which pooled funds from multiple fintech end-users. These accounts intermingled funds from various fintechs, creating a tangled web of financial flows that were difficult to track and reconcile.
- Distribution Across Multiple Banks: Instead of maintaining a clear and straightforward financial structure, Synapse split funds back out across several partner banks. This meant that a single end-user’s funds could be spread out over multiple institutions, each with its own systems and reconciliation processes.
- Reconciliation Challenges: This complex layering made it nearly impossible to accurately reconcile funds across all accounts. Each layer — fintech, BaaS provider, and bank — had its own systems and procedures, leading to discrepancies and untraceable financial flows. When discrepancies arose, such as the $13 million mismatch with Evolve, it became an enormous challenge to pinpoint the source of the problem and resolve it effectively.
- Unusual Practices and Lack of Transparency: Synapse engaged in practices that further complicated the financial landscape. For instance, it held funds from multiple fintechs in accounts at various banks and did not provide clear, consistent data on fund allocation and movement. This lack of transparency meant that no single entity had a complete picture of where funds were at any given time.
The additional layers and unusual practices meant that when issues arose, such as a system failure or a compliance question, resolving them required navigating a maze of financial and operational complexity that few understood. This not only increased the risk of financial loss but also undermined the trust of end-users and partners.
Reconciliation Failures
Synapse and Evolve were unable to reconcile accounts and transactions properly. This failure was compounded by Synapse holding funds from various fintechs across multiple banks, which made tracking the flow of money nearly impossible.
Regulatory Blindspots
Regulatory oversight lagged behind the rapid innovation in fintech. Small banks often lacked the infrastructure to manage the compliance and operational demands of fintech partnerships, leading to systemic risks.
Consequences for Customers
Frozen Accounts
Thousands of customers found their accounts frozen due to the dispute between Synapse and Evolve. This situation highlighted the vulnerability of relying on non-bank entities for banking services, as these entities are not subject to the same regulatory protections.
Disparity in Treatment: A Tale of Two Groups
While the collapse of Synapse has left many fintech customers without access to their funds, it stands in stark contrast to the treatment of customers from Silicon Valley Bank (SVB) and Signature Bank. In those cases, despite the banks’ failures, customers were bailed out in full, even beyond the typical regulatory protections provided by the FDIC.
This disparity highlights a significant inequality in how different groups of customers are treated. The customers of SVB and Signature Bank, who often include well-connected tech companies and affluent individuals, received immediate and full financial support from the government. Meanwhile, customers of Yotta and other fintechs — often representing some of the most vulnerable and underserved members of society — are left without access to their funds and with little recourse for recovery.
Erosion of Trust in the Financial System
The inability of Synapse to manage customer funds properly and the subsequent freezing of accounts has eroded trust not only in Synapse but also in the broader fintech and traditional banking sectors. Customers who placed their trust in these fintech services now face financial uncertainty, underscoring the risks associated with relying on non-bank entities for banking-like services.
Broader Implications
Systemic Risks
The collapse of Synapse has exposed systemic risks in the BaaS model. The lack of clear regulatory frameworks and the complex web of partnerships make it difficult to ensure proper oversight and accountability.
Future of Fintech Partnerships
Regulators are likely to increase scrutiny on fintech partnerships with banks to prevent similar situations in the future. The collapse has shown that while fintech can drive innovation, it also requires robust regulatory oversight to safeguard customers.
Conclusion
The Synapse collapse serves as a cautionary tale for the fintech industry. It underscores the need for better regulatory frameworks, clearer accountability, and more robust systems to manage the complex relationships between fintechs, BaaS providers, and traditional banks. As the industry moves forward, lessons from this debacle will be crucial in shaping a more secure and reliable financial ecosystem.
In the end, we must remember that behind the polished facades of these financial innovators are fallible people who may not always act in the best interests of their customers. Trust, once lost, is hard to regain, and it’s critical that we approach these industry players with a healthy dose of skepticism and demand transparency and accountability in all their dealings.
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