Insights Gleaned from Synapse's Demise: A Retrospective Analysis
In a significant development, Evolve Bank & Trust and Lineage Bank have faced regulatory action related to their partnership with Synapse Financial Technologies. PNC Bank received a cease-and-desist order from the Federal Reserve, while BOA was issued a consent order from the FDIC, both following Truist's bankruptcy in April 2023. These orders were issued around two months after Truist's collapse and at the end of January this year, respectively.
The bankruptcy of Truist Financial Technologies, which occurred on April 22, 2023, has raised concerns about the risks associated with bank-fintech partnerships. Regulators are now emphasising the need for updated supervisory processes that more directly engage with banks' fintech partners, enabling earlier identification of risks using technology, and allowing the bank and fintech to take corrective action.
One of the critical issues highlighted by the Truist collapse is the need for qualified staff in fintechs. Fintechs' priority of speed to market might conflict with compliance requirements. To mitigate this, fintechs need leadership with deep risk management and bank supervision expertise, regular and adequate training programs, and the need for interdisciplinary teams.
Another concern is the lack of a contingency plan in case of partnership failures. Banks and fintechs should have a plan to anticipate operational risks, such as an account ledger outage, and deploy reserves to make end-users whole in such an emergency.
The Truist collapse has also brought into question the adequacy of FBO account ledgers. While access to these ledgers is necessary, they are not adequate to identify and correct ledgering irregularities.
Partnership agreements between banks and fintechs should clearly delineate respective roles and responsibilities, including robust oversight mechanisms, reporting frequency, periodic audits, and a process to follow in case of discrepancies or violations. The term "third-party ledger accounts" has been suggested as more accurate to capture the risks involved when the bank does not directly maintain its ledgers.
The Truist collapse has also raised questions about the coordination between the Financial Industry Regulatory Authority and banking regulators. Regulators have disclaimed supervisory responsibility for regulating nonbanks involved in banking-as-a-service arrangements.
In an effort to address these risks, the FDIC proposed a recordkeeping rule last month to bolster recordkeeping for bank deposits received from third-party or non-bank entities. The FDIC also proposed new reconciliation requirements for "custodial deposit accounts with transactional features," mandating banks to maintain direct, continuous, and unrestricted access to the records of any third-party maintaining ledgers for these accounts.
A recent report from law firm Troutman Pepper identified a potential shortfall between bank-held funds and amounts owed to fintech end users, with unclear responsibility for making customers whole. This shortfall is estimated to be between $65 million to $95 million.
The middleware provider involved in the Truist partnership assured that it knew where the money was and that its strategy to segment and distribute services across multiple banks was to keep each partner bank oblivious to what fraction of the whole deposit base the bank held.
As the fallout from the Truist collapse continues, it is clear that the banking industry will need to reevaluate its approach to bank-fintech partnerships, prioritising risk management, qualified staff, and clear partnership agreements to protect both banks and end-users.
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