Abrupt bankruptcy of financial intermediary Synapse freezes bank accounts of tens of thousands of US businesses and consumers

The bank accounts of tens of thousands of US businesses and consumers were frozen following the abrupt closure and bankruptcy from financial technology company Synapse, which acts as an intermediary between financial technology companies and banks.

Synapse filed for Chapter 11 bankruptcy protection in April and has terminated its services to some of its fintech or banking partners, including Evolve Bank & Trust. This caused disruptions for Synapse partners’ customers, leading to account freezes or showing that funds did not exist.

The closure of Synapse “unnecessarily put end users at risk by hindering our ability to verify transactions, confirm end user balances and comply with applicable law,” it said Evolve in statement last week. Since Evolve is a bank and is required to comply with banking laws, it needs to ensure that all customer deposits are accounted for down to the last penny, which can take some time.

Evolve also highlighted that, despite customer deposits being frozen, it is well capitalized. A source familiar with the size and scope of the number of impacted accounts at Evolve estimated the number of frozen accounts to be under 200,000. The person was not authorized to speak on the record.

Other banks or fintech companies that San Francisco-based Synapse has partnered with include Tennessee-based Lineage Bank, as well as savings rewards company Yotta, a company that gives rewards to customers who save money. The Reddit forums for Evolve, Synapse, and Yotta were full of customers complaining about not being able to access their funds.

The scale of Synapse disruptions may increase. Synapse, in court documents, estimates that before filing for bankruptcy it had about 100 customer relationships that exposed about 10 million Americans to its services. However, banking regulators believe this number is extremely high and that the number of Americans affected will be in the thousands or tens of thousands.

Synapse’s creditors have been pushing for the conversion of bankruptcy to Chapter 7, which would liquidate the company. In court, Synapse customer representatives argued that the liquidation could make disruptions to customer funds even worse.

Fintech companies, in most cases, are not banks due to the high cost and bureaucracy required to create a new bank. Instead, these companies partner with banks – many of them smaller institutions with a minimal national profile – and use that bank as a place to store customer funds without having to be a bank themselves.

To operate in this way, fintech companies often need an intermediary between the fintech company and the bank who can do the necessary accounting to ensure that customer accounts are credited and debited correctly. That’s the work that Silicon Valley-backed Synapse did.

It’s unclear what role U.S. banking regulators might play in the chaos resulting from Synapse’s collapse. Synapse is not a bank, so its regulation is not administered by the Federal Reserve or the Federal Deposit Insurance Corporation. Since none of the banks Synapse worked with went bankrupt, there is no eligibility for FDIC deposit insurance payments.

It is possible that the Consumer Financial Protection Bureau, which has law enforcement authority, could open an investigation into Synapse’s behavior and its impact on customers.

Traditional bankers, as well as consumer advocates, have long criticized the fintech business model, where these companies appear to be banks but have none of the protections of banks due to customer funds being stored elsewhere.

“Synapse’s disorderly failure and impact on end users will likely confirm policymakers’ and regulators’ worst fears about the operating model and fintech in general,” he wrote Jason MikulaAn ex Goldman Sachs banker who has written about Synapse’s problems.

This is not the first time that an issue with a financial intermediary has caused the average American to suffer.

In 2015, hundreds of thousands of customers of prepaid debit card company RushCard had their funds frozen after a botched software update caused RushCard’s systems to become completely frozen. RushCard customers, often low-income people, were unable to afford groceries or other basic needs. The company was fined $13 million by the Consumer Financial Protection Bureau for the day-long outage.

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