The bankruptcy of bank-fintech partnership middleware provider
The way forward should include much more due diligence on banks' parts, according to Karen Petrou, co-founder and managing partner of Federal Financial Analytics, a Washington, D.C. firm that provides analytical and advisory services on legislative, regulatory and public-policy issues affecting financial services companies.
"I think they really need to kick the tires and not just look at the fee revenue, but at the resilience of their counterparty in these deals," Petrou said. "Clearly one of the issues with Synapse is at least a hundred million dollars of customer money is missing, and while [compared to] the scale of trillion dollar financial crises, that might not seem like a lot, it's a lot to the individual households," she said in a recent
Synapse, for example, could have triggered red flags for banks from the very beginning, she said.
"One of them was, apparently the Synapse founder had never had a job before," Petrou said. "A little bit of customer due diligence might have identified the fact that there were unlikely to be effective internal controls. I'm all for bright young things getting into new businesses, but that's not enough for a durable, viable business proposition."
Another question is whether Synapse had a general ledger that recorded all transactions.
"It doesn't appear to. That should have been a real red flag," Petrou said.
Shared ledgers that banks and their fintech partners can access at the same time could be part of the answer here.
In some cases, fintechs have one large, pooled "for benefit of" account at a bank, and only the fintech itself knows how much money belongs to each of its customers. Other times, as appears to be the case in the Synapse situation, there are individual insured accounts on behalf of each of Synapse's customers at its partner banks.
"But FDIC insurance promises them nothing if Synapse fails," Petrou noted. "This is misleading, false advertising. If you give your money to a Synapse or a similar entity and are told that it is safe and sound because it's in an FDIC-insured bank, that is only true if the insured bank fails. It is demonstrably not true if the fintech fails."
The FDIC recently issued a warning to customers that said FDIC deposit insurance does not protect against insolvency or bankruptcy of a nonbank company. "In such cases, the consumer may be able to recover some of their funds through an insolvency or bankruptcy proceeding. Such recovery may take some time," the agency stated.
But it's unlikely this message reached consumers, Petrou said.
"How many regular average consumers follow the FDIC and their social media feeds or read the FDIC's website to catch these things?" she said. "It's frankly an irrelevant form of consumer protection. There's something known as asymmetric disclosures, which means that people don't see, or sometimes if the disclosures are complex, don't understand the disclosures they're getting and that's exactly what this FDIC notice is all about."
Bank regulators need to set higher expectations for due diligence, controls and restrictions based on the nature of the relationship, including the promise of FDIC insurance, Petrou said.
"I would like to think banks will not enter into these arrangements without taking all those steps, but we sadly know that they do and they will," she said. "The regulators need to go beyond hoping that they can make the speculative fintechs behave, which is fruitless."
Once a bank is working with a fintech, it needs to have robust controls at the outset and extra controls based on what promises the fintech is making, Petrou said.
"Banks have a moral obligation to not put regular people's money at risk," she said. "They have FDIC insurance, and it's not good for the public when banks just sell it – a Faustian bargain. They need to not make promises their business counterparty can't keep."
Banks have to make sure their fintech partners comply with know-your-customer, Bank Secrecy Act and sanctions regulations.
But Petrou points out that such requirements, which are spelled out in recent consent orders, enforce pre-existing guidance.
"The obligation to take compliance responsibility for your counterparties is a longstanding one for banks, recently reinforced by guidance from the banking agencies, which say consent orders are being issued because banks did not adhere to prior standards," Petrou said. "The banking agencies do need to decide if enough consent orders concentrate the attention of banks contemplating high-risk relationships. If they deem that insufficient, it may be hard for some banks to resist temptation. Then it may be time for a more stringent rule."
Some in the fintech community would argue that bank-fintech partnerships have helped bring new customers affordable financial services, including small-dollar loans, early access to paychecks and loans that don't require a high FICO score.
Petrou agrees that in some cases, fintechs have made consumers' lives better.
"If banks deal with fintechs that are expanding financial access in a sound way, then none of the controls I'm suggesting will impede that," she said. "I do not understand why fintechs believe that tougher restrictions on with whom banks do business will hurt them unless they in fact do not think they can stand up to scrutiny."
Smaller banks tend to take on fintech partnerships because they are facing significant strategic challenges, she said.
"The basic business of banking has been under tremendous stress in recent years due to a combination of new rules, slow growth and now higher interest rates along with technological challenges," she said.
"They've got to come up with something else to survive and sometimes they essentially sell their soul, the whole purpose of a regulated bank charter, to a fintech company to try to get some fee income and make ends meet that way," Petrou said.
Good partnerships between community banks and sound counterparties could benefit small communities where access to financial services, particularly for lower income households, may not suffice, she said.
"But they can't be high risk, because particularly for these vulnerable populations, losing your money just makes it worse," Petrou said.
