Sankaet Pathak, CEO of Synapse, by Tim Pannell for Forbes
Tim Panel
Nine-year-old Synapse Financial Technologies has long been a leader in banking as a service, a niche of software providers offering startups a streamlined way to use financial infrastructure like checking accounts or access to money from bank to bank. transfers.
In short, Synapse gives power to neobanks, fintechs offering banking services without having a banking charter. For 2022, the company announced an annual transaction volume of $76 billion from 18 million end users. At one point, Synapse counted notable fintechs among its clients, including neobank Dave, and business banking newcomers Rho and Mercury. As regulatory oversight of banking-as-a-service arrangements has increased, all of these customers have migrated to direct relationships with banks. In August of last year, FDIC-insured Evolve Bank and Trust, which was the company’s primary banking partner, informed Synapse of its intention to end their relationship, according to a letter seen by Forbes. The breakup became complicated after a $14 million hole was discovered in a Synapse account at Evolve holding customer funds. In response, Evolve is withholding a payment of approximately $17 million owed to Synapse to cover the difference.
“We strongly believe that this issue has not only impacted our partnership, but has also negatively impacted our valued fintech customers,” Sankaet Pathak, CEO of Synapse, wrote in a statement. Average post this month, in response to Fintech Business Weekly report on the relationship. Synapse refused Forbes’ requests for comments.
Synapse and its customers must completely exit West Memphis, AR-based Evolve by Dec. 31, according to a person with knowledge of the situation. In the meantime, Synapse must find one or more new FDIC-insured banks to support its Evolve customers and notify them of the change. The Synapse website names three other banks that hold funds on behalf of their clients: American Bank, AMG National Trust and Lineage Bank. It’s unclear whether any of them will take on the new business, especially as regulators take a closer look at banking-as-a-service partnerships.
“Over the past eighteen months, Evolve has implemented a strategy to prioritize direct fintech relationships, rather than relationships through third-party intermediaries,” an Evolve spokesperson said in a statement. . “Any suggestion, in the media or otherwise, that these intermediary clients have not had sufficient time to prepare for a transition of accounts receivable is inaccurate. »
A central issue concerns the fundamental structure of Synapse’s partnership with Evolve. Banking-as-a-Service providers operate by creating what are called FBO accounts for their customers. These “for the benefit of” accounts allow banking-as-a-service providers to manage funds on behalf of customers while protecting customers’ claims on assets. Today, many banking-as-a-service providers create separate FBO accounts for each customer, making it easier to track funds.
Instead, Synapse holds six FBO accounts at Evolve for about 40 customers, according to a person with knowledge of the situation. This structure is easier to set up and maintain, especially if a banking-as-a-service provider has many customers with small balances, but prevents a personalized approach to account management in the long run. Synapse distinguished between consumer-serving and enterprise-serving clients, but otherwise end-client funds were pooled. Synapse’s largest customer, Mercury, had its own FBO account. At peak activity, Synapse accounts at Evolve held $7 billion in customer deposits.
This questionable setup likely made it difficult to detect operational issues. For example, Synapse and Evolve are responsible for distributing a share of interchange fees (fees that merchants pay to cover the cost of processing payments) to card networks like Visa or Mastercard. Synapse accidentally overcharged its customers for each transaction by using FBO funds to cover both the purchase amount and interchange fees, according to a person with knowledge of the situation. Synapse is supposed to provide interchange payments using its own funds, which are typically rolled into its customers’ fees. This issue resulted in a $14 million overload on the FBO account holding the fintechs’ consumer-facing cash.
A month of September letter Synapse’s Pathak attributes the error to Evolve, but a company spokesperson says it followed Synapse’s instructions and is not responsible for the incorrect debits. When the issue was discovered by Kroll Consulting, Evolve increased the amount required in a Synapse reserve account to $50 million. After Synapse failed to meet the new minimum, Evolve took approximately $17 million in rebates owed to Synapse and directed it to the reserve fund.
The same day Evolve increased the reserve minimum, Synapse learned that Mercury would not renew its contract and would move to a direct relationship with Evolve. Shortly thereafter, Synapse laid off 40% of its staff without severance pay.
In addition to pointing the finger at Evolve regarding the issue of interchange fees, in a letter obtained by Fintech Business Weekly, Pathak also highlighted in a letter a number of “reconciliation issues” and underpayments that , according to him, caused losses to Synapse.
“We work closely and diligently with fintech platforms, who are required to perform reconciliations on a daily basis, and we proactively ensure that platforms have the appropriate data and tools to assist them in this process,” Evolve said in a statement.