Thredd CEO Counts on Regulators to Address Vulnerabilities of Banking as a Service

The relationships between FinTechs, banks and neobanks has been placed under a harsh spotlight with the recent revelations around the Synapse bankruptcy.

The reaction from the industry so far has focused on the Synapse case as an isolated incident rather than a systemic issue, but it has also been the occasion for a reconsideration of the banking-as-a-service business (BaaS) model. As Jim McCarthy, CEO of Thredd, told PYMNTS’ Karen Webster recently, it’s time to get back to basics.

“Too many people are focused on the ‘as a service’ part — but have ‘minored’ in the banking part, if at all … if you’re going to play in that space, I’d argue that if you fail at the banking, the service piece doesn’t matter,” McCarthy said.

At this writing, there’s a $85 million “gap” between what of FinTech middleman Synapse’s partner banks are holding and what end customers are owed. More recently, Synapse’s former CEO has told the bankruptcy court that funds tied to Synapse, to the FinTechs and to the end customers were commingled in accounts, which means tracking down who owns what, and in which account, will take time and may never fully be answered.

Compliance and Regulation in the Spotlight

“The commingling of funds is just poor compliance,” McCarthy said.

With a nod to the current state of banking as a service, McCarthy said — in remarks made as part of the continuing “What’s Next in Payments” series focused on BaaS — some issues have come to light.

There’s a reason, after all, that banking remains among the most heavily regulated of all industries.

Many of the BaaS providers were simply renting the proverbial rails from third-party banks that were just getting into the space in the last few years. Collaboration and transparency are keys to success, McCarthy said — but in come cases, problems occur when the BaaS provider is not cognizant of its obligations to the bank, or the bank did not quite understand what needs to be examined from an audit and risk perspective.

“I’m sure that Synapse and [partner bank] Evolve spent a lot of time on the front end,” said McCarthy, “looking at what the Synapse model is, what they’re doing and how they’re setting up accounts … but my guess is that over time, Synapse made changes.”

The fallout has been immediate and widespread, and McCarthy said there are plenty of strong players in the field — and consumers are voting with their dollars to shift to digital-only providers.

“I want to make it clear that, when done well,” McCarthy said, “there’s a great opportunity here in terms of making it easier for third parties to connect to the larger financial services ecosystem.”

In the U.K., where McCarthy is based with Thredd, companies like Starling have done well with their efforts to grow a bank and to monetize investments they have made with their new, modernized banking cores. In other cases, companies “take” services from providers such as Thredd or other issuer processors, and “consume” banking licenses from sponsor banks.

No matter the model, there’s a truism across BaaS and for FinTechs:

“The regulators are now awake,” McCarthy said, to the vulnerabilities as well as the potential of BaaS. No matter their focus, companies are going to invest more in regulatory and compliance technologies and processes, and compliance will wind up being a key differentiator.

Who Comes Out Ahead?

“If the FinTechs were defined by ‘digital first,’” McCarthy said, “with a better user experience and user interface, the winners of the future will combine that with a focus on the back office, on compliance, settlement and reporting, and working closely with their bank partners to make sure they do not get into trouble.”

There’s a danger that there may be too much regulation in the mix, McCarthy said, who observed that in the U.K., new rules around authorized push payment fraud can make banks liable for hundreds of thousands of pounds per transaction … which is a liability that can quickly drive financial institutions out of business. Many banks, he said, will slow down those payments or put guardrails around them to the point where innovation and the customer experience are adversely affected.

Looking ahead, over the short term, banks may shy away a bit from embracing BaaS partners, McCarthy said. In the wake of the Synapse collapse, he said “banks may look at their portfolio and ask, ‘do we have anything that looks like this, smells like this or gets us into trouble … and if so, get us out of this.’”

The list of BaaS providers will be winnowed down through consolidation — and an ultimate flight to quality.

As he told PYMNTS, “At the end of the day, it’s the banks that sponsor these banking-as-a-service programs that will be the ones that are impacted … so they will take this all quite seriously.”