Synapse Bankruptcy Has Put the World Of Fintech on Edge

 

"Thousands of consumers for months have been unable to access money they thought was deposited at banks.

They are victims of the bankruptcy of a little-known venture-backed startup called Synapse Financial Technologies, whose shutdown is harming not only consumers but also fintech startups that worked with it, as well as the fintech sector. The situation, now in bankruptcy court, is bringing additional regulatory scrutiny to fintech, demonstrating risks for consumers who deposit money via nonbank financial-services providers, and creating uncertainty for fintech venture investors and entrepreneurs.

What is Synapse?

The San Francisco company served as a middleman between fintech startups and licensed banks. Its fintech clients marketed financial products and got consumers to sign up. Synapse sent consumer money to partner banks where it was deposited.

Since its founding in 2014, Synapse raised about $50 million from Andreessen Horowitz, Core Innovation Capital and Trinity Ventures for its banking-as-a-service business. The company was a pioneer of the banking-as-a-service model and helped make building fintech startups faster and easier. In part because of the rise of banking-as-a-service, venture investors put billions of dollars into consumer fintech startups in recent years.

Synapse serviced more than 100 fintech companies, including many of its current creditors, such as venture-backed companies Juno, Yotta Technologies, and Yieldstreet.

Synapse filed for chapter 11 bankruptcy in April.

Why are consumers upset?

Starting in May, banks including Evolve Bank & Trust and Lineage Bank froze access to accounts associated with Synapse, citing discrepancies in ledgers kept by Synapse.

Roughly 116,000 accounts are affected across all banks, according to estimates by Evolve Bank & Trust, said Thomas Holmes Jr., senior vice president and chief marketing and communications officer at the bank.

Accounting reconciliation is continuing in the Synapse case, a trustee managing the Synapse estate said. However, more than $100 million hasn't been distributed, as of early July, according to the trustee's reports. Most of that is in pooled accounts held by Evolve and Lineage, where figuring out how much capital is owed to whom appears to be especially difficult.

There is a shortfall of up to $96 million between cash held at partner bank accounts and Synapse's ledger balance, the trustee said.

Reconciliation is on track to be completed in a matter of weeks, Holmes said. Evolve "is eager to return the funds it has from that activity to the correct consumer accounts once the reconciliation has been completed," he said.

He added that Evolve is unable to confirm the amount of missing funds, if any, until the reconciliation is done.

Evolve had previously provided payment-processing services to the affected accounts, Holmes said. The accounts belonged to customers of Synapse Brokerage, a subsidiary of Synapse, he said.

Consumers signed up for fintech services on a promise that they would be able to pay off their debts faster, earn high interest, or get prizes. Startups offered easy-to-use mobile-banking apps. The apps claimed deposits were kept safe at banks insured by the Federal Deposit Insurance Corp.

How are fintech startups affected?

"We cannot serve our customers without the ability to transfer their funds, so our business has ground to a halt," said Nick Sky, chief executive of Changed, one of the Synapse creditors.

Changed helps people pay off debt and manage their savings. The company raised more than $3 million from investors and has more than 100,000 registered users, Sky said. Changed has worked with Synapse since 2017. The company was told its customer money is held at Evolve, Sky said.

He said Changed customers "have nearly $2 million caught up in this bankruptcy limbo and that's a small amount of the total, but it's real, and really important."

Numerous fintech startups that worked with Synapse are in similar straits. Yotta has been providing its customers near daily updates on its website but many remain unable to access their money. Yotta has an unsecured claim of $65.15 million in the Synapse bankruptcy case.

What do regulators say?

FDIC insurance kicks in when a bank fails. In the Synapse case, none of the banks have failed.

In a July 2 letter to the Synapse estate trustee, a representative of the FDIC said the agency is "strongly encouraging the banks involved in this matter" to address consumer harm caused by the Synapse bankruptcy. Federal Reserve Chair Jerome Powell said in Senate testimony that the Fed is strongly encouraging Evolve, which the Fed supervises, to make money available to customers.

In May, the FDIC issued an advisory to consumers about banking with what it calls "third-party apps." Opening accounts at mobile-banking apps that aren't themselves members of the FDIC has additional risks, the advisory said. "FDIC deposit insurance does not protect against the insolvency or bankruptcy of a nonbank company," it noted." [1]

1. Banking & Finance: Banking & Finance: Synapse Bankruptcy Has Put the World Of Fintech on Edge. Chernova, Yuliya.  Wall Street Journal, Eastern edition; New York, N.Y.. 16 July 2024: B.10.