PYMNTS MonitorEdge May 2024

FDIC Warnings on Nonbanks Point to Gaps in Deposit Insurance

They say there are no guarantees in life.

That sentiment applies to financial services — at least depending on where you look, or what promises are made by nonbanks.

With traditional financial institutions (FIs), the banks that have been around for decades, even centuries, there are some guarantees. Up to $250,000.

For all other settings, and particularly with the digital-only FinTechs, neobanks, and generally speaking, the nonbanks … caveat emptor.

Consumers Frozen Out

The continued fallout from the Synapse Financial bankruptcy — as apps such as Yotta, where savings accounts are tied to debit cards and other financial offerings, saw depositors frozen out of accounts — will likely force a wider discussion about which depositors are protected by the government, where they’re protected, and even when.

Last month, as we wrote here, while Synapse filed for Chapter 11 bankruptcy and dueled with Evolve Bank and Trust, 85,000 of Yotta’s customers — holding a total of $112 million in savings — were locked out of their accounts. Copper, another FinTech that used Synapse, announced in May it will shutter at least some of its offerings, including bank deposit accounts and debit cards.

Consumers Caught in a Gap

The consumers are the ones who are, arguably, left in a gap between the accounts that are backstopped by the government and those that are not.

And in recent developments, legal wrangling over data and cease and desist orders have only muddied the waters of where the money’s gone and how it can be returned to customers.

The gap comes as the money has leapfrogged across several players, where consumer funds move through companies including Synapse, acting as intermediaries on their way, ultimately, to deposit accounts at regulated institutions — for example, Evolve Bank and Trust. The “end” accounts held at the FIs are the ones that are covered by deposit insurance.

In the partnership model that brings FinTechs together with banks, questions remain as to just where deposits are held and whether they might be insured or not. The FinTechs, largely unregulated to date, act as middlemen, providing infrastructure and software to help provide banking services for companies that are not banks.

The gaps come when some of these firms offer FDIC insurance, partners do not and consumers may not necessarily understand exactly where their funds are held.

Deposit insurance, tracing its roots back about 90 years, was set up by the government as an independent agency to help foster trust in the U.S. financial system — specifically, traditional FIs — and to help prevent bank runs that now seem to be shorthand for the Great Depression.

Evolve was the entity in the Synapse drama that, as a bank, falls under the purview of the FDIC. But deposit insurance is activated only in the event of a bank failure. Evolve didn’t fail, and so insurance coverage (which extends to $250,000 per account) was not triggered. And so, the consumers and depositors are left in limbo.

In Synapse trustee Jelena McWillams’s initial status report, she noted: “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.”

In her third status report, issued last month, McWilliams wrote that “while end user funds were initially deposited through Synapse, which was not directly regulated by the Federal Reserve, FDIC and OCC, the end users’ deposits now reside with the Partner Banks that they do regulate.”

Thus, we note, the gap that’s ensnared consumers.

Evolve has, according to reports, held onto $46 million in deposits, alleging that Synapse’s record keeping has shown “numerous significant discrepancies.”

The New York Times noted that some depositors have said they are selling assets, even their homes, to pay bills. The judge overseeing the case has said that depositors may need to hire their own attorneys to lodge lawsuits against the companies embroiled in the Synapse proceedings.

The FDIC’s Warnings

In a June post on its website, the FDIC said: “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.”

But the FDIC also noted that “increasingly, some consumers are choosing to open accounts through nonbank companies (typically online or through mobile apps), such as technology companies providing financial services (often referred to as fintech companies), that may or may not have business relationships with banks.”

At least some of that record keeping and clear delineation of ownership has been, well, a work in progress as Synapse had been reported to be commingling funds. And, in a nod to the “caveat emptor” exhortation above, PYMNTS reported last month that “cease and desist” letters had been issued to several companies for violations of the Federal Deposit Insurance Act.

The act prohibits individuals and entities from “making false or misleading representations about deposit insurance, using the FDIC’s name or logo in a manner that would imply that an uninsured financial product is insured or guaranteed by the FDIC, or knowingly misrepresenting the extent and manner of deposit insurance.”

Through the past few months, the letters have been issued to companies like Prizepool, AmeriStar and virtual wallet firm Organo Payments.

PYMNTS Intelligence has estimated that 10% of consumers surveyed said that their primary bank accounts are with digital banks and 25% had used neobanks or FinTechs to access at least some banking services.

The complexities of some of the FinTech/banking relationship — and the implied gaps — are detailed by the FDIC, as its post noted 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.” (emphasis from PYMNTS). After the nonbank places your funds on deposit at a bank, “records must be kept to identify who owns the money and the specific amount that each person owns.”