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 make use of financial infrastructure like checking accounts or access to bank-to-bank money transfers.
In short, Synapse empowers neobanks, fintechs offering banking services without having a bank charter. For 2022, the company touted $76 billion in annual transaction volume across 18 million end users. At one point, Synapse counted notable fintechs including neobank Dave, and business banking upstarts Rho and Mercury among its clients. As regulatory scrutiny of banking-as-a-service arrangements has increased, all of these customers have migrated away in favor of direct relationships with banks. In August of last year, FDIC-insured Evolve Bank and Trust, which had been the company’s primary banking partner, notified Synapse that it planned to end their relationship, according to a letter seen by Forbes. The breakup has turned messy after the discovery of a $14 million hole in a Synapse account at Evolve holding client funds. In response, Evolve is withholding a roughly $17 million payment owed to Synapse to cover the difference.
“We firmly believe that this issue has not only impacted our partnership but has also had adverse effects on our valued fintech customers,” Synapse CEO Sankaet Pathak wrote in a Medium post this month responding to Fintech Business Weekly’s report on the relationship. Synapse declined Forbes’ requests for comment.
Synapse and its clients need to be completely off West Memphis, AR-based Evolve by December 31, according to a person with knowledge of the situation. In the meantime, Synapse must find one or more new FDIC-insured banks to take on its Evolve clients and notify them of the change. Synapse’s website names three other banks that hold funds on clients’ behalf: American Bank, AMG National Trust and Lineage Bank. It’s unclear whether any of these will accept the new business, especially as regulators are turning a more scrupulous eye on banking-as-a-service partnerships.
“Over the past eighteen months, Evolve has executed on a strategy to move toward prioritizing direct fintech relationships, rather than relationships through third-party intermediaries,” an Evolve spokesperson said in a statement. “ Any suggestion, in media reports or otherwise, that these intermediary clients did not have sufficient time to prepare for a transition of customer accounts is inaccurate.”
One core issue dates to the foundational structure of Synapse’s partnership with Evolve. Banking-as-a-service providers work by setting up what are known as FBO accounts for their clients. These “for benefit of” accounts allow banking-as-a-service providers to manage funds on behalf of clients while protecting the customers’ claims on the assets. Today, many banking-as-service-providers set up separate FBO accounts for each client, making it simpler to keep track of funds.
Instead, Synapse holds six FBO accounts at Evolve for roughly 40 clients, 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 clients with small balances, but in the long run prevents a customized approach to account management. Synapse distinguished between clients serving consumers versus businesses, but otherwise, end-client funds were pooled. Synapse’s largest customer, Mercury, had its own FBO account. At the height of the business, Synapse accounts at Evolve held $7 billion in client 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–charges merchants pay to cover the cost of payment processing–to card networks like Visa or Mastercard. Synapse accidentally overcharged clients for every transaction by using FBO funds to cover both the purchase amount and the interchange fees, according to a person with knowledge of the situation. Synapse is supposed to provide the interchange payments using its own funds, which are typically priced into its client fees. This issue resulted in a $14 million overcharge to the FBO account holding consumer-facing fintechs’ cash.
A September letter from Synapse’s Pathak places the blame for this error on Evolve, but a spokesperson for the company says it followed Synapse’s instructions and is not responsible for the incorrect debits. When the issue was uncovered by Kroll Consulting, Evolve increased the required amount in a Synapse reserve account to $50 million. After Synapse failed to meet the new minimum, Evolve took roughly $17 million worth of rebates owed to Synapse and directed them to the reserve fund.
On the same day that Evolve raised the reserve minimum, Synapse learned that Mercury would not be renewing its contract and would be moving to a direct relationship with Evolve. Shortly after, Synapse laid off 40% of its staff without severance pay.
In addition to pointing the finger at Evolve when it comes to the interchange-fee issue, in a letter obtained by Fintech Business Weekly Pathak also outlined in a letter a number of “reconciliation issues” and underpayments that he claims 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 right data and tools to assist with that process,” Evolve said in a statement.