Global: FDIC Warnings on Nonbanks Highlight Gaps in Deposit Insurance

They say there are no guarantees in life, and that sentiment applies to financial services, especially when dealing with nonbanks. While traditional financial institutions (FIs) offer some guarantees, such as up to $250,000 in deposit insurance, the same assurances may not apply to digital-only FinTechs, neobanks, and other nonbank entities.

The ongoing fallout from the Synapse Financial bankruptcy — which saw apps like Yotta, where savings accounts are tied to debit cards and other financial services, leaving depositors locked out of their accounts — underscores the need for a broader discussion about which depositors are protected by the government, where they’re protected, and under what conditions.

Last month, as Synapse filed for Chapter 11 bankruptcy and entered a dispute with Evolve Bank and Trust, 85,000 Yotta customers, holding a total of $112 million in savings, were locked out of their accounts. Similarly, FinTech Copper, which also used Synapse, announced in May that it would shut down some of its offerings, including bank deposit accounts and debit cards.

Consumers are often left in a gap between accounts that are backed by government insurance and those that are not. Legal battles over data and cease and desist orders have only further complicated the situation, making it unclear where the money is and how it can be returned to customers.

The issue arises because consumer funds often move through several intermediaries, such as Synapse, before reaching deposit accounts at regulated institutions like Evolve Bank and Trust. The “end” accounts held at these regulated FIs are the ones covered by deposit insurance.

In the FinTech-bank partnership model, questions remain about where deposits are held and whether they are insured. FinTechs, largely unregulated so far, act as middlemen, providing the infrastructure and software to offer banking services for companies that are not banks. Problems occur when these firms offer FDIC insurance while their partners do not, leaving consumers unsure of where their funds are held and whether they are insured.

Deposit insurance, established about 90 years ago, was set up by the government as an independent agency to help foster trust in the U.S. financial system and prevent bank runs. Evolve Bank, part of the Synapse drama, falls under FDIC purview, but deposit insurance only activates in the event of a bank failure. Since Evolve didn’t fail, insurance coverage was not triggered, leaving consumers in limbo.

In her initial status report, Synapse trustee Jelena McWilliams noted the complexity of Synapse’s model: “Synapse often used multiple Partner Banks to service different functions for the same Fintech Partner. In certain instances, end user deposits through a Fintech Partner were deposited in an account at one Partner Bank, while end user withdrawals through that same Fintech Partner were processed from a different account at a different Partner Bank. This business model makes it both essential and difficult to reconcile transactions and ensure end users receive access to the correct amount of funds due to each end user.”

McWilliams’ third status report mentioned that while end user funds were initially deposited through Synapse, which was not directly regulated by the Federal Reserve, FDIC, and OCC, these deposits now reside with the regulated Partner Banks.

Evolve, according to reports, is holding onto $46 million in deposits, citing “numerous significant discrepancies” in Synapse’s record-keeping. Some depositors, according to The New York Times, are selling assets or homes to pay bills. The judge overseeing the case has advised depositors to hire their own attorneys to lodge lawsuits against the companies involved in the Synapse proceedings.

In a June post, the FDIC stated, “The easiest way for most consumers to have confidence that their money is safe continues to be opening an account directly with insured depository institutions, like FDIC-insured banks and savings associations.” The FDIC also noted the rising trend of consumers opening accounts through nonbank companies, such as FinTech firms, which may or may not have business relationships with banks.

Issues with record-keeping and clear delineation of ownership have been problematic, as Synapse had reportedly been commingling funds. In response to these concerns, cease and desist letters have been issued to several companies for violations of the Federal Deposit Insurance Act, which prohibits misleading representations about deposit insurance.

The FDIC highlights the complexities of the FinTech-bank relationship, noting that “even if they claim to work with FDIC-insured banks, funds you send to a nonbank company are not eligible for FDIC insurance until the company deposits them in an FDIC-insured bank and after other conditions are met.” Once the nonbank deposits your funds at a bank, “records must be kept to identify who owns the money and the specific amount that each person owns.”

This situation underscores the need for consumers to exercise caution and fully understand where and how their funds are held and insured.