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Implications of the BaaS Synapse Collapse

BaaS | May 29, 2024

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The Synapse Collapse and What It Means for up to 10 Million Consumers and the Fintech Industry

Synapse's shutdown is sending ripples throughout the fintech space

The fintech sector has been rocked in recent weeks by the failure of Synapse Financial Technologies, which has surfaced huge issues within the fintech sector’s Banking-as-a-Service (BaaS) model of doing business. Synapse, a high profile BaaS player backed by Andreessen Horowitz (a16z) filed for Chapter 11 bankruptcy in late-April 2024, potentially affecting up to 10 million consumers per TechCrunch.  So lots of customers are unable to access their funds exposing vulnerabilities within the BaaS middleware model providing crucial lessons for the entire fintech ecosystem.

Banking-as-a-service (BaaS)

Banking-as-a-service (BaaS) is the delivery of banking services in partnership between a licensed bank and a fintech or nonbank entity. By and large, the services offered are a range of online banking, payment processing, money transfer, lending, and tools to help budget, save, and invest. BaaS allows fintech firms to innovate at speed and to provide financial services at a lower cost of entry. BaaS does have additional risks in the areas of compliance, security, and operational resilience.

What caused the collapse?

Synapse's failure can be attributed to a number of operational and partnership issues. Among these was a €13 million deficient reconciliation problem with its major banking partner, Evolve Bank & Trust, highlighting inherent risks where middleware can delay real-time financial reconciliation.  This was further complicated by Synapse using For Benefit Of Accounts (FBO),a common setup with BaaS firms where FBO accounts hold customer funds under a single account on behalf of multiple end-users, which made reconciliation and tracking of customer funds more difficult.

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To add fuel to the fire, there was a lack of proper management of such technological and operational bugs which eventually resulted in the freezing of the accounts of Synapse as well as the winding up of its operations. So millions of end customers across a variety of fintech applications like Juno, Yotta, and Copper woke up one day and were denied access to their accounts, with no apparent solution in the near term.  For customers, it is a cautionary tale of the risks involved when banking with fintech company relying on a BaaS model.

Industry Implications

The implications for the fintech industry and its investors are significant.

  • Greater regulatory scrutiny is also likely to follow, with regulators possibly seeking to impose greater constraints to hold fintech companies to account to high expectations of compliance and risk management.
  • Andreessen Horowitz, a leading investor in Synapse, and other investors are now cautious and applying more rigor to the commercial sustainability and risk mitigation systems of BaaS providers. There may be less money on offer for new fintech startups and a more risk-averse strategy towards investment.

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  • The failure has also sparked a debate as to whether such failures are the nature of the BaaS model or whether such shortcomings can be averted by more effective governance and operational controls.  Experts are of the opinion that while the BaaS model itself is not having any fundamental flaw, management of partnership workings, and particularly with banking institutions, has to be managed closely.
  • Fintech companies must work out sound reconciliation process, maintain frank communications with banking partners and ensure fulfillment of regulatory requirement.
  • Consolidations and M&A may increase across the market as smaller struggling companies are forced out of the market or into the arms of larger, stronger companies, leaving fewer but more robust providers of BaaS.

Insights for Fintech

To avoid running into the same problem that Synapse Inc. encountered, fintech companies are advised to undertake some proactive measures:

  • Provide clear and transparent as well as well-documented agreements with banking partners. Periodically review and update such agreements, so that new risks are addressed.  The goal is to foster positive, sustainable relationships.
  • Test and verify that middleware systems can effectively process complex financial transactions and reconciliation processes.

See:  How GenAI Is Transforming Risk and Compliance in Banking

  • Compliance. Compliance. Compliance. Adhere tightly to the specifications of the regulatory bodies to avoid major operational gotchas.
  • Establish and follow extensive risks management frameworks with contingency plans for operational breakdowns and partnership failures.

The Road Ahead

As the sector looks on amid the ruins of Synapse’s collapse, it is obvious that fintech firms and their financiers will need to re-establish trust and a high degree of operating resilience. The appointment of an unaffiliated Chapter 11 trustee will serve to manage the immediate crisis, but the fallout will be felt among BaaS participants for some time.

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