The Federal Deposit Insurance Corporation (FDIC) has proposed new regulations following the collapse of Synapse Financial Technologies, aimed at addressing the risks associated with bank-fintech partnerships.
The collapse of Synapse, which froze thousands of customer accounts earlier this year, highlighted critical weaknesses in the way these partnerships manage customer deposits.
FDIC’s response: tightening recordkeeping for fintech deposits
The proposed rule focuses on ensuring banks have clearer visibility of the actual owners of deposits held by third-party fintech companies. FDIC chairman Martin J. Gruenberg stressed the importance of this regulatory shift: “The proposed rule will strengthen the FDIC’s ability to promptly make deposit insurance determinations and, if necessary, pay deposit insurance promptly in the event of failure of the bank. Further, the proposed rule will strengthen compliance with anti-money laundering and countering the financing of terrorism law.”
The FDIC is keen to avoid a repeat of the Synapse fiasco, where poor recordkeeping delayed access to consumer funds.
Currently, fintech companies often pool customer deposits into a single custodial account at a bank rather than creating individual accounts. This setup makes it difficult for banks to track the actual owners of funds, particularly in cases of financial trouble. The new rule requires banks to reconcile these accounts daily, ensuring they maintain an accurate record of each customer’s funds.
Lessons from the Synapse collapse
Earlier this year, Synapse – a middleman between several fintech companies and banks – filed for bankruptcy, leaving many consumers without access to their money. Many account holders believed their deposits were FDIC-insured, unaware of how their funds were managed, and later found themselves caught in the crossfire of Synapse’s financial failure.
According to Gruenberg, the chaos caused by Synapse’s downfall stemmed largely from deficiencies in recordkeeping. “Knowing the identity of the actual owners of the deposits… is necessary in order for the deposit insurance to ‘pass through’ the third-party non-bank company,” he explained. This confusion highlights the FDIC’s concerns about how banks manage funds in pooled accounts and the risks these arrangements pose.
Risks highlighted by Synapse and Yotta lawsuit
The collapse of Synapse and a related lawsuit involving Yotta Technologies illustrate some of the potential risks in fintech-bank partnerships. In a lawsuit filed against Evolve Bancorp and Evolve Bank & Trust, Yotta Technologies claims that Evolve and Synapse misappropriated tens of millions of dollars in customer funds over their four-year partnership. Yotta alleges that the two companies concealed these actions, inflating account balances and withholding critical information.
According to Yotta, Evolve suspended access to customer funds in May 2024, leaving millions in deposits inaccessible. Similar to the aftermath of the Synapse collapse, Yotta’s lawsuit claims that transparency issues in fintech-bank partnerships can have significant consequences for consumers. The lawsuit stresses the need for clearer oversight to prevent similar situations from occurring in the future.
Mixed reactions from industry players
The FDIC’s proposal has prompted varied responses from industry experts, with some applauding the move as overdue, while others express concern over potential unintended consequences.
Ryan Richardson, partner at US business and litigation law firm Davis Wright Tremaine, voiced some scepticism about the FDIC’s decision to push ahead with regulation in response to a single event. “It’s a little unusual that the FDIC would so directly respond to a singular event with rulemaking,” Richardson noted, though he conceded that the issues exposed by Synapse’s collapse are not isolated. “This is a ubiquitous issue in the bank-fintech partnership market that arguably justified a market-wide response.”
Richardson also questioned the practicality of enforcing the proposed requirements. He pointed out that the FDIC’s mandate for access to customer records may be difficult to achieve in real-world scenarios.
“It’s not yet clear how the FDIC expects banks to demonstrate and test their ‘direct, continuous and unrestricted’ access to a ledger in an event like the Synapse bankruptcy, where the entity responsible for the ledger has dissolved, its people have packed up and gone home, and, as a result, there’s no one around to support the service provider’s side of the required access channel.”
Industry concerns about over-regulation
Not all voices in the fintech industry are convinced the rule is necessary. Ian P. Moloney, senior vice president of policy at the American Fintech Council (AFC), warned against over-regulation suggesting that existing practices already provide adequate safeguards.
“We appreciate the FDIC’s initiative, and while it may be well intentioned, the proposed rulemaking is not necessary, as financial institutions, including AFC members, have already established clear deposit account ledger processes for the funds they have custody of as part of a bank-fintech partnership that allows prompt payment of deposits.”
Practical questions about implementation
Casey Jennings, a partner at US law firm Seward & Kissel LLP, raised several practical concerns about how the new rule would interact with existing regulations. Specifically, he pointed to potential conflicts between the FDIC’s proposed rule and Part 370, which governs similar recordkeeping requirements.
“The proposal fails to address how the new recordkeeping requirements interplay with similar, existing requirements imposed under Part 370,” Jennings noted. He also questioned whether the new rule would treat beneficial owners of pooled deposits as direct customers of the bank under the Bank Secrecy Act, potentially leading to significant regulatory implications.
Jennings also suggested that the proposed rule may have been rushed to market in response to the Synapse collapse. “It’s pretty clear the proposal was rushed to market in a push to ‘do something’ about Synapse,” he remarked, adding that more time for industry feedback could help address these unresolved questions.
A balancing act: regulation and innovation
The FDIC’s proposed rule aims to balance consumer protection with the ongoing innovation in digital-first financial services. The collapse of Synapse highlighted the risks inherent in the fintech-bank relationship model, and the challenge lies in introducing regulations that address these risks without potentially slowing innovation in a sector that has significantly expanded access to financial services.
Gruenberg defended the rule as a necessary step to maintain public confidence in the banking system, particularly given the rapid growth of fintech partnerships. “These events also highlight substantial risks with respect to the FDIC fulfilling its statutory mandate to maintain public confidence in the banking system by ensuring the prompt and accurate payment of deposit insurance in the case of a bank’s failure,” Gruenberg said.
Looking ahead
As the FDIC opens the proposal for a 60-day public comment period, industry stakeholders will have the opportunity to weigh in on the rule’s potential impacts. The debate is likely to focus on whether the proposed regulations are a necessary response to safeguard consumers or whether they will place an undue burden on fintech-bank partnerships, slowing innovation in the sector.
The collapse of Synapse has left an indelible mark on the fintech landscape, prompting regulators and industry players to reassess how they manage customer funds, regardless of the outcome. As Richardson noted: ““Many of our bank and fintech clients are at least a little relieved to see the FDIC regulating proactively by rulemaking instead of reactively by enforcement.”
The proposed rule aims to address both depositor protection and the continuation of fintech innovations – though achieving this balance could present challenges.
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