Neobanks Compliance

Neobanks

What Synapse BaaS Bankruptcy Means for the Fintech Industry

Jun 28, 2024

·

InnReg

·

9 min read

Contents

The recent collapse of Synapse, a prominent fintech middleware provider, has sent shockwaves through the financial technology industry. As one of the key players in the banking-as-a-service (BaaS) sector, Synapse’s bankruptcy has raised significant concerns about the stability and reliability of BaaS models. The fallout from this event has left many questioning the future of fintech partnerships and the regulatory frameworks that govern them.

Many unanswered concerns remain over the future of Synapse's roughly 100 fintech clients and millions of end users with funds on the platform in the wake of its bankruptcy and subsequent wind-down. It has also highlighted the human cost of making a mistake and underscored the difficulties and dangers associated with the BaaS model. 

Drawing on the key lessons from this collapse, it's critical to recognize the specific challenges Synapse faced, such as regulatory compliance, bank partnership structure, and its apparent inability to keep an accurate ledger.

InnReg Logo

InnReg is a global regulatory compliance and operations consulting team serving financial services companies since 2013. If you need assistance with compliance or fintech regulations, click here.

InnReg Banner
InnReg Banner

What Happened to BaaS Fintech Synapse?

To understand the full impact of Synapse’s collapse, it’s crucial to examine the company’s background and the events that led to its bankruptcy.

Background of Synapse

Established in 2014 in San Francisco as a banking app for people without bank accounts, Synapse swiftly changed its focus to provide infrastructure for B2B banking by allowing fintechs to embed banking services into their offerings. 

By its peak in 2022, Synapse supported over 18 million end users, raised $50.7 million from investors (including a16z), and had $9 billion in assets, most of which were placed with Evolve Bank & Trust. However, internal strife surfaced when Forbes reported that staff members and clients were leaving the company due to technical product defects, a lack of experience in developing banking solutions, and accusations against the company's "verbally 'abusive'" CEO, Sankaet Pathak. 

Despite these challenges, Synapse established itself as a key player in the BaaS sector, enabling a wide range of fintech applications and services through its platform. Its technology allowed non-bank companies to offer financial products such as payments, savings accounts, and credit services by connecting them with licensed banks.

Key Events Leading to Synapse’s Bankruptcy

Despite its promising start, Synapse encountered several challenges that ultimately led to its bankruptcy:

  • Operational Struggles: In 2023, Synapse faced significant operational difficulties, including layoffs and internal restructuring.

  • Loss of Major Clients: The decision by Evolve Bank & Trust and business banking startup Mercury to bypass Synapse and work directly with each other significantly impacted Synapse's revenue and operational viability.

  • Regulatory and Compliance Issues: Synapse struggled with maintaining compliance with regulatory standards, which is critical in the highly regulated banking industry.

These events culminated in the company’s bankruptcy filing in April 2024, revealing an $85 million shortfall in customer funds. The company had hoped to sell its assets in a fire sale to another fintech, TabaPay, but the deal fell through. This left Synapse with no viable options but to liquidate under Chapter 7.

How Did the Synapse Bankruptcy Impact Customers and Fintech Platforms?

Synapse’s collapse significantly impacted both customers and fintech platforms. 

As one of the key intermediaries in the BaaS ecosystem, Synapse's downfall has disrupted financial operations, leaving many users and businesses in precarious situations. This section examines the real-world impact of Synapse's bankruptcy, highlighting the challenges faced by customers and the operational hurdles encountered by fintech platforms that relied on its services. 

The bankruptcy of Synapse has also created substantial challenges for fintech platforms that relied on its infrastructure and their customers. These platforms used Synapse to offer various financial services, and its collapse has forced them to find alternative solutions quickly. Thousands of customers have been affected in the process, and to this date, many are still struggling to retrieve their funds and prove their ownership without a clear and accessible ledger.

Some notable examples include:

  • Copper: Users of teen banking startup Copper had to discontinue its banking deposit accounts and debit cards, leaving its primarily family-based customer base without access to their funds. The company is now pivoting towards a new product and partnership with larger American banks to continue its operations.

  • Juno: The crypto app's users faced a similar predicament, with many unable to access their funds due to the halt in transaction processing caused by Synapse's issues.

  • Mainvest: This fintech lender to restaurant businesses announced its shutdown as a direct result of Synapse's bankruptcy, leading to job losses and service discontinuation.

These fintech platforms are now grappling with operational disruptions and an urgent need to establish new banking relationships or technological solutions to maintain their services. 

The abrupt loss of Synapse as an intermediary has exposed the vulnerabilities of relying on a single BaaS provider, underscoring the need for robust contingency plans and diversified partnerships in the fintech industry.

Regulatory Gaps and Limitations in the Synapse Bankruptcy

The Synapse bankruptcy has exposed significant regulatory gaps and limitations within the fintech industry. The absence of robust oversight and clear regulatory frameworks for fintech intermediaries played a crucial role in the crisis. 

This section highlights these regulatory shortcomings and the subsequent responses from federal authorities, emphasizing the need for enhanced regulatory oversight to prevent similar future incidents.

InnReg Banner
InnReg Banner

Limited Authority of Federal Regulators Over Fintech Intermediaries

One of the primary issues the Synapse bankruptcy revealed is the limited authority of federal regulators over fintech intermediaries. Unlike traditional banks, fintech companies operating as middleware providers like Synapse are not directly regulated by agencies like the FDIC or the Federal Reserve. This lack of direct oversight created a regulatory blind spot, allowing Synapse to operate without stringent compliance checks and balances.

This regulatory gap meant that crucial aspects of Synapse's operations, such as financial record-keeping and customer fund management, were not adequately monitored. 

Consequently, when Synapse's financial troubles surfaced, there was little regulatory intervention to mitigate the impact on its customers and partner platforms. The lack of comprehensive oversight contributed significantly to the magnitude of the crisis, leaving customers with limited recourse to recover their funds.

Regulatory Response to the Synapse Collapse

In the wake of Synapse's bankruptcy, federal regulators addressed the fallout to prevent future occurrences. 

The Federal Reserve issued a cease-and-desist order against Evolve Bank, one of Synapse's key partners, highlighting shortcomings in managing its third-party fintech relationships. This order, originating from a routine supervisory review, underscored the need for banks to exercise greater diligence in their partnerships with fintech companies.

Additionally, regulators are now scrutinizing the broader BaaS model and fintech-bank partnerships more closely. 

The Federal Reserve, FDIC, and OCC have all set up special groups to examine banks providing partner banking services to fintechs. These groups aim to ensure that banks implement robust risk management practices and maintain high compliance standards when working with fintech intermediaries.

Furthermore, there is a growing call for more specific guidance and regulations tailored to fintech partnerships. 

Industry experts expect regulators to develop specialized exam manuals and guidelines to provide clearer expectations of managing third-party risks in these partnerships. This includes ensuring that fintech companies operate at a compliance standard equivalent to traditional banks.

The regulatory response to the Synapse collapse signals a shift towards greater oversight and accountability in the fintech industry. By addressing the identified gaps and enforcing stricter compliance requirements, regulators aim to safeguard consumers and enhance the stability of the BaaS model. This increased scrutiny will likely have significant implications for fintech companies and their banking partners, potentially leading to more rigorous regulatory frameworks and heightened operational standards.

5 Key Lessons Learned from the Synapse Collapse

The collapse of Synapse offers several critical lessons for the fintech industry. These insights are essential for preventing similar incidents in the future and ensuring the stability and reliability of the banking-as-a-service model.

InnReg Logo

Need help with neobank compliance?

Fill out the form below and our experts will get back to you.

Lesson 1: Importance of Operational and Compliance Standards

One of the primary takeaways from the Synapse collapse is the need for high operational and compliance standards in fintech. 

The financial sector is highly regulated, and fintech companies must adhere to stringent operational protocols and compliance requirements to ensure the safety and security of customer funds. 

Lesson 2: Need for a Comprehensive Regulatory Framework

The Synapse collapse underscores the urgent need for a comprehensive and adaptable regulatory framework to govern the fintech industry.

Authorities will more closely examine the function third parties play in tying banks and fintechs together, as well as the final risk frameworks and obligations.

In this case, the Consumer Financial Protection Bureau (CFPB) will be prominent because certain consumers claim their accounts are blocked, making it impossible for them to access funds.

We believe that a paramount priority for regulators will be to instill regulatory clarity around consumer protection: in particular, the FDIC needs to adopt clear language about what is and is not covered with FDIC insurance in a neobank that uses a third-party bank.

The issue of who will ultimately oversee fintechs is also far from resolved; intermediaries and other participants may operate in a gray area outside the purview of the FDIC or the central bank.

Instances wherein customer accounts can be locked and unlocked raise the question of whether backstops will be required. This seems necessary if companies cannot identify the owners of different accounts and what belongs to them.

There is also a dispute with sponsor banks expected to be subject to increased regulation. These banks also question whether they will continue to "bank" fintechs in the face of the uncertainty.

InnReg Banner
InnReg Banner

Lesson 3: Risks of Relying on Intermediary Platforms

The risks associated with relying on intermediary platforms like Synapse have become evident. 

These platforms are crucial in facilitating financial services, but their collapse can have far-reaching consequences for all parties involved. Fintech companies must be aware of these risks and consider diversifying their partnerships to avoid over-reliance on a single intermediary.

By spreading their risk across multiple providers, fintechs can better protect themselves and their customers from disruptions caused by one platform’s failure.

Lesson 4: Future of Bank and Fintech Relationships

The future of bank and fintech relationships will likely involve more rigorous due diligence and selectivity in forming partnerships

Banks and fintechs must carefully evaluate potential partners, ensuring they have the operational strength, compliance capabilities, and financial stability to support long-term collaboration. Thorough due diligence will be essential in mitigating risks and building resilient partnerships that can withstand regulatory scrutiny and market fluctuations.

Lesson 5: Impact on Customer Trust and Security

Finally, the Synapse collapse has highlighted the significant impact such incidents can have on customer trust and the security of their funds. 

Customers who have lost access to their money or faced difficulties in proving ownership will likely be wary of fintech platforms in the future. To rebuild trust, fintech companies must prioritize transparency, communication, and robust security measures

Ensuring that customers feel confident in the safety of their funds is paramount to maintaining a loyal and satisfied customer base.

Future ramifications of Synapse's demise for the larger finance and fintech industries are expected to be substantial. It is possible that banks will exhibit greater prudence in their fintech partnerships, preferring those with solid risk management protocols. In parallel, fintech middleware providers must ensure accurate financial record-keeping and transparent operations.

In the short term, this increased scrutiny could potentially result in higher costs and possibly slower innovation

In the long run, though, these changes could contribute to a financial ecosystem that is more secure and stable

Therefore, the expenses and effort to achieve this are likely justified. It is evident that a more thorough and flexible regulatory framework is required as regulators struggle to keep up with the demands of the quickly changing fintech landscape. 

The advantages of innovation must be weighed against the requirements of sufficient consumer protection and financial stability in this framework. Ensuring compliance is not merely a cautionary measure; it is the fundamental safeguard against catastrophic failures like the Synapse collapse. Without increased scrutiny and robust regulatory oversight, the fintech industry risks facing similar disasters in the future. Compliance is the key to protecting consumers and maintaining the integrity of the financial system.

Businesses will have to adequately manage risk and compliance efforts to optimally engage in innovative solutions like regtech.

Navigating such a complex and ever-evolving regulatory environment is best performed by engaging experienced external advisors like InnReg. At InnReg, we resolve a myriad of complex fintech compliance issues for cutting-edge clients in highly regulated industries—reach out to our team to learn how our expert compliance services can help your business mitigate risks.

InnReg Banner
InnReg Banner
InnReg Banner
InnReg Banner
InnReg Banner
InnReg Banner

How Can InnReg Help?

InnReg is a global regulatory compliance and operations consulting team serving financial services companies since 2013.

We are especially effective at launching and scaling fintechs with innovative compliance strategies and delivering cost-effective managed services, assisted by proprietary regtech solutions.

If you need help with neobank compliance, reach out to our regulatory experts today:

Published on Jun 28, 2024

·

Last updated on Jun 28, 2024

Subscribe for Compliance Insights

Subscribe for Compliance Insights

Subscribe for Compliance Insights

Latest LinkedIn Posts