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The Crisis Unfolding in the World of Banking as a Service - Jason Mikula TFTC EP. 522

Jul 10, 2024

The Crisis Unfolding in the World of Banking as a Service - Jason Mikula TFTC EP. 522

The Crisis Unfolding in the World of Banking as a Service -  Jason Mikula TFTC EP. 522

Key Takeaways

In this episode of TFTC with Jason Mikula, we explore the banking sector's complexities, focusing on the legal battle between Evolve Bank and Synapse, a BaaS middleware company. The discussion delves into Synapse's history, its relationship with banks like Lineage and American Bank NA, and the fallout from Synapse's bankruptcy, including the misappropriation of funds and its impact on consumers. The conversation also clarifies misconceptions about FDIC insurance and examines the regulatory challenges small banks face amid increasing regulatory scrutiny.

Best Quotes

  1. "I can't understate how negatively this has impacted the people caught in the crossfire here."
  2. "A lot of these programs really heavily leaned on logos and language around FDIC, knowing that people interpret that to mean this is safe and my money is safe."
  3. "The problem is, what does FDIC insurance do? It protects you against the failure of an insured depository institution, the failure of a bank... there is no role for the FDIC to step in and make depositors make end users whole because a bank hasn't failed."
  4. "The number of banks has been declining at this point for decades... there are competing public policy priorities."
  5. "It is possible to do [FBO account structures] correctly and responsibly... but if something like this happens, you get to a pretty catastrophic situation.".



The episode underscores the interconnectedness of financial systems and the potential fallout from the failure of a single link, highlighting the roles and responsibilities of financial institutions, service providers, and the limitations of consumer protections like FDIC insurance. Jason Mikula's discussion provides a sobering view of the current state of banking and fintech, the challenges faced by smaller banks, and the impact of regulatory pressures and technological advancements. The Synapse and Evolve Bank case serves as a cautionary tale about the fragility of modern financial ecosystems.


0:00 - Intro
1:06 - Background on the Synapse case
11:43 - River & Unchained
12:58 - Who is at fault?
19:33 - FBO account structure
24:00 - Impact on end users
30:18 - Gradually, Then Suddenly & Zaprite
31:55 - Unclear resolution and stain on fintech
40:41 - Can small banks compete?
49:09 - SVB and the state of the banking system
56:23 - Are we seeing Chokepoint 2.0?
1:03:22 - Plugs


(00:00) there were stories of users who you know couldn't buy medicine for their kids couldn't buy food you know couldn't pay their mortgage couldn't pay rent I can't understate how negatively this has impacted the people um you know the people caught in the crossfire here a lot of these programs really heavily leaned on logos and language around FDIC you know knowing that people inter that to mean this is safe and my money is safe the problem is what does FDIC Insurance do it protects you against the
(00:39) failure of an insured depository institution the failure of a bank there's no rule for the FDIC to step in and you know make depositors make end users whole because a bank hasn't failed this rip of tftc was brought to you by river it's the best place to buy Bitcoin go to tftc and enjoy this episode Jason welcome to the show thank you for joining us yeah absolutely thank you for having me well like I was just telling you uh brought you on because it's not really well known in mainstream media at least or not talked
(01:20) about much but there seems to be something going on behind the scenes in the banking sector as it pertains to banks that service these banking as a service startups that have started throughout the last decade particularly evolve bank and the current uh lawsuit they're entangled in with synapse which was one of these bass companies and you've been covering it I think for the better part of a year now and I wanted to bring you on just to help understand what is actually going on what is the interaction between synaps evolve the
(01:58) funds that have been appropriated and who this is affecting at the end of the day so I think just starting off with a little background on the history of snaps and evolve specifically yeah for sure I mean it is um a rather convoluted situation which makes it difficult to explain succinctly but I will try excuse me um so they're actually Four Banks involved uh evolve being sort of the most prominent one um but the sort of ongoing situation also involves a bank called lineage as well as AMG National Trust and American Bank NA as well as you know
(02:42) dozens of non-bank fintech programs that relied on synapse to provide connectivity to the banking system so the court case currently unfolding is specifically synapses chapter 11 bankruptcy so to the extent that there are other parties involved you know in specifically evolve Bank and Trust right now that involvement is as it relates to this bankruptcy process um I'll give some brief background on sort of how we got here uh and then sort of explain sort of what might happen next so as you mentioned synapse is a
(03:23) middleware company some people use the term banking as a service provider some people might call that model the connector model uh it is a bit difficult because the language isn't sort of standardized um but synapse itself not a bank uh not even for most of its life a regulated entity although it did acquire a broker dealer around 2020 and that would be uh SEC and Fina regulated so synapse you know last raised Capital uh in 2019 you know we're recording this now in 2024 typical VC fundraise cycle might be
(03:59) something like every 12 to 18 months uh it was sort of well known at least within call IT fintech industry that you know the company was up for sale was being shot by investment bankers in 2023 you know couldn't find any takers um in early 20124 uh I reported out that there was a proposed deal for a thirdparty company called tabapay to acquire the assets of synapse uh about a month later in April control that was confirmed when tabapay announced that it would acquire synapsis assets as part of a chapter 11
(04:39) bankruptcy so the reason why it was structured that way was to allow tabapay to acquire synapses assets um without taking on some of the liabilities synapse had occurred uh including specifically a dispute with its largest program business banking startup Mercury if we want to go into that backstory we certainly can so this was sort of like a soft Landing right tabapay was going to acquire the assets of synapse you know fold it into its existing business which primarily focuses on Merchant acquiring and you know the lights would stay on
(05:15) things would keep running um needless to say that's not how this has turned out that TOA pay deal had three Key conditions one the chapter 11 filing that I mentioned uh two most importantly evolve bank and trust agreeing to fully fund any shortfalls in FBO accounts which is a type of custodial account uh and the court approving a settlement agreement between synapse and evolve which arose from disagreements about who was responsible for possible shortfalls in these FBO accounts which to be clear shortfalls of customer money end user
(05:57) money uh among other issues so ultimately evolve took some time to do an analysis and came back and determined there was no shortfall that evolve needed to fund that caused tabapay to walk away from the deal uh and at that point synapse basically collapsed into bankruptcy causing the unprecedented situation you know we find ourselves in today yeah from what I understand there's many layers to this because as you mentioned synapse was this Bast middleware connector type fintech company that was servicing many other fintech apps that
(06:37) were leveraging its backend so this resulted in not well the end users of synapse were other companies and then the other companies had end users which were were individual consumers who were affected by this could you explain the sort of layered nature of those relationships yeah absolutely so um I mean you described it exactly correctly right synapse is a is a service provider that basically sells services to primarily other fintech companies um although there there are other uh you know other kinds of maybe vertical SAS
(07:11) companies or like payroll processor type companies that you might not bucket under that label of fintech but basically companies that needed some type of access to the banking system whether that was to Pro you know receive payments process payments hold customer funds customer deposits in an insured depository institution uh and these you know over time included you know pretty well-known programs like Dave uh which is a publicly traded Neo Bank although Dave transitioned off of synapse some time ago uh Mercury which I mentioned
(07:46) which transitioned off of synapse in late 2023 you know at the time that user funds were frozen or at the time of the bankruptcy uh the largest programs were yada which is a Neo bank with these sort of priz Link savings or kind of like gambling like features uh a program called Juno which offered both uh crypto as well as like Fiat banking or traditional USB banking services uh and an investing an alternative investing platform called yield Street were some of the biggest programs but there were still maybe you know 30 40 50 programs
(08:26) live at the time that that this bankruptcy happened and then ultimately on May 11th when end user access to their funds were frozen so I mean you have basically evolve plus the other Banks I mentioned synapse is sitting on top of those then there's a customer facing program like Juno or yada which is the service that an end user ultimately signed up for download of the app for you know understands their relationship to be with and correct me if I'm wrong but the shortfall is somewhere in the range of
(09:03) quarter of a billion dollars uh it's not quite that big thankfully so at the time that uh the bankruptcy commenced and then funds were Frozen um which actually it's important to point out funds were not frozen because of the bankruptcy These funds that we're talking about in these FBO accounts unlike in some of the crypto bankruptcies like the IUS or blockfi or FTX the funds in these FBO accounts are not were not ever property of synapse and they are not part of the bankruptcy estate however on May 11th for reasons
(09:43) that are still not totally clear synapse cut off evolves access to its systems uh which I believe uh synaps is now former CEO said something along the lines of like it was for like maintenance or to investigate some things or something like that um when that access was cut off evolve responded in my opinion and based on my understanding of the situation not inappropriately by freezing funds that evolve held and freezing Payment Processing for funds held at other Banks the reason why I say not inappropriately is because without
(10:22) access to synapsis systems it was really impossible for evolve to to continue operating those programs in a safe sound and responsible manner uh as far as making sure that transactions were processed correctly you know proper fraud checks moneya laundering checks and whatnot um so again the the freeze of funds is you know related to but not really caused by the bankruptcy as far as the amount at the time that these programs were frozen the amount was something like 260 million since then approximately a 100 million of funds
(10:57) have been returned to end users of certain programs from certain Banks and the shortfall so the gap between what end users are owed and what the banks the collective four Banks actually hold is somewhere between 65 million and 96 million the reason why that is a range is because there's potentially as much as 31 million in funds that are actually funds that are owed to synapse uh as far as being revenue from deposit rebates interest payments or the like and so that there's a little bit of still now ambiguity as far as how big is that
(11:38) shortfall and certainly ambiguity about what caused that shortfall this episode was presented by river river is the best most secure place to buy Bitcoin in the United States go to tftc set up an account today you'll be able to DCA into Bitcoin without paying any fees you'll be able to give people Bitcoin via river links you'll be able to send and receive Bitcoin over the lightning Network and you'll be able to set limit orders if you want to buy Bitcoin at a particular price below or above where it
(12:06) is now you can set orders to buy Bitcoin when it hits that price go to tftc and set up your account today this rep was also brought to you by our good friends at Unchained Unchained is building a financial services platform for a Bitcoin standard they have over 7,000 clients that are securing over 990,000 Bitcoin with 12,000 keys on their platform their platform leverages bitcoin's native multisig properties their Cornerstone product is their volt product a two of three multisig volt which allows you to hold two of three
(12:37) keys and a multisig quorum that gives you full control over your Bitcoin they also have an IRA product a lending desk and they're rolling out a bunch of other products including inheritance protocol and sound advisory so go to unchain domcom set up a call with our concierge onboarding team today tell them that tftc sent you and use the promo code tftc at checkout unchain and so from your position based off all the research that you've done is this some sort of domino effect that was started by snaps not running their
(13:09) business correctly is it a miscommunication between the banks that they're they're leveraging on the back end and sort of it's still not it's still not clear to me like who's at fault here is it the banks that are at fault is it snaps is the combination of the two I mean it that's a it's a difficult question to answer not knowing all of the facts um that said I think it's pretty clear that you know sort of everyone holds some some level of responsibility here you know from Strictly speaking from a bank regulatory
(13:44) lens you know synapse generally speaking and these and these end programs yat and Juno and copper and all that you know they are not licensed regulated entities so the way that that most people would think about them is as service providers to the banks that they're working with now synapses model uh is again I'll use the word convoluted um is even quite different than other companies that operate these sort of middleware platforms you know synapse is not the only one you have companies like unit and treasury Prime um you know bond
(14:25) which was acquired by core banking provider FIS so synaps is certainly not the only one you know earlier I mentioned the four Banks and I also mentioned that synapse acquired a broker dealer what synapse chose to do uh and begin to transition towards is what they referred to as a modular banking model and instead of having uh a checking account or you might hear the phrase demand deposit account or DDA which was actually directly Affiliated one with one of these Banks synapse moved to a model where end users would have technically
(15:08) have brokerage accounts with a cash management feature and again that is not in and of itself crazy right like if you have an account at Fidelity or at Robin Hood you know this is a pretty standard structure the purpose of it well there's a couple of purposes one is if you're trading stocks you know you could have money sitting in that brokerage account at the end of the day that's not invested that money needs to go somewhere so you can have it swept into an Associated Bank account where they'll
(15:38) typically earn you know whatever a decent rate of interest and also BFD insured the other thing a cash management feature can let you do is use that brokerage account very similarly to to a bank account right you could get a debit card that's tied to your Fidelity account you can even sometimes write checks tied to account so legally speaking it'll be a brokerage account where cash is swept to one or or often multiple Banks through a sweep network but to an end user it'll often look and feel like a quote unquote bank account
(16:16) so the reason why I bring this up and and I'm aware that it's confusing um is because it does have some important impacts on sort of who who is responsible or frankly at this point introducing a lot of confusion about who is responsible so the four Banks I mentioned lineage AMG American and evolve provided different services to The Brokerage so those four Banks had relationships with synapse Andor with synapse brokerage to hold money as a custodian to act as an rdfi which is a receiving depository financial institution meaning if you
(17:02) wanted to get your paycheck put into this account you would see the name of all Bank and Trust and you would see the routing number because evolve acted as the rdfi to accept that incoming payment lineage acted as an odfi meaning origin originating depository financial institution to send out A's uh and at various times both American and evolve issued debit cards tied to these programs so you can imagine how complex this structure is where instead of having everything at One Bank you know if you walk into Chase
(17:38) and you have a bank account there you know your money's held at Chase Chase accepts incoming money sends outgoing money and issues the debit card it's all sort of in one place here you had you know functionally something that looks like a bank account but is legally not it's legally a brokerage account and then you have the pieces of it that make it run spread over four Banks stitched together by synapse which is operating the technology platform that sort of pulls all these pieces together and so
(18:11) to try to get back to your original question um you know there were rumors allegations reporting that I did uh about shortfalls in customer funds dating at least back to last October um and at that time you know the the sort of story was that it was due to a incorrect configuration about where um basically where bills synapse owed were being debited from and it is being debited from end user money customer money instead of being debited from synapses money you know you've also had allegations made by synapses co-founder
(18:53) and former CEO s ke pek saying that when Mercury moved off of synapses system and began working directly with evolve that it moved in total about $50 million that didn't belong to it now I don't know if that's true or not true at this point it's just an allegation but there are sort of open questions of you know was this just sort of like incompetent that snowballed um was there intentional wrongdoing you know at this point it it just it remains really unclear what caused this what caused the
(19:33) shortfall so it seems like in an attempt to level up their services synaps engage in some form of regulatory Arbitrage leveraging this broker dealer to have a quasi bank account for their end users and the confusion ensued from there because we see this a lot in the Bitcoin space um where companies will leverage a trust or something so that they can piggy back on their money transmitter licenses so that they can service and users um which puts them in a bit of a vulnerable position if the trust itself uh gets into some
(20:11) trouble which we've seen with prime trust specifically um so is it similar to that I mean I would say the outlines are broadly similar and again you know there are I think plenty of companies non-bank fintech companies that use somewhat similar models that that haven't had these kinds of problems right so um you know I mentioned that the FBO account structure and it may be helpful um to illustrate you know how and why that can become a problem so the F you know FBO legally what that stands for is for the
(20:48) benefit of and you can think about it as you know let's say there's a pool of a100 million in an FBO account at evolve the title like the literal legal title on that account might be something like you know synapse Financial Technologies uh for the benefit of end users of yada right evolve does not know who that money belongs to in that example all evolve knows is it's not synapse' money and it's not yada's money it's money that belongs to the end users of that program and you know the bank is relying on these
(21:32) external third parties to maintain the necessary books and Records to understand of that big bucket of hundred million you know how much belongs to Marty and how much belongs to Jason and how much belongs to everybody else and again I'm not saying that like this is not a common practice a lot of us fintech is built on this model for a whole bunch of reasons I mean the two main ones being the commercial terms that core banking providers typically charge where they actually charge on a per account basis which causes
(22:10) disincentives for banks to open up a ton of accounts on core inside their own system uh the money transmitter license thing that you mentioned you know there's also an issue around um you know Finch's not necessarily wanting to go through the hassle of getting mtls and using fpos as a mechanism uh to try to avoid that that regulatory burden um so yeah I mean there there's a number of reasons why the structur is in play and also you know it is possible to do it correctly and responsibly you know in
(22:42) this situation what we're seeing on part of what we're seeing unfold now is you know evolve and lineage um combined have you know something like 100ish million dollars and they either don't don't know who it belongs to and you know per the court filings don't believe that synapses records are accurate they're saying and this is per the court filings and statements their attorneys have made to the court they're saying what we see in synapses ledgers which is like the records synapse holds does not match the actual
(23:19) flow of funds in and out of these accounts like we can't trust them because what the you know the bits and pieces we can verify don't add up and so again if the bank doesn't actually hold the records it is Paramount that the third party or third parties in this case running the programs have accurate books and Records uh otherwise you know if something like this happens you get to a pretty catastrophic situation which you know we're we're chatting here in July you know those users haven't had access to their money
(23:56) since May 11th it's been you know two months plus yeah and to highlight what this means for this Zen user I mean you've reported on it I've seen people in Reddit threads I mean these were people who were dependent on these companies to be their quasi bank account so that they could pay their bills and go about their lives and a lot of people have had their lives put on pause for for many months now yeah I mean I you know I've heard plenty of um the impacted users who have actually called into the court
(24:31) proceedings and expressed to to the judge or to the court how it's impacted their lives you know certainly there's been reporting in American Banker in the in the New York Times in CNBC um and again I mean imagine you know a lot of these fintech Services cater to lower income users or lower income households you know Andor users that may have limited access to credit or Limited experience in the banking system and I mean can you imagine if you had your only bank account that had you know where your paycheck went into and
(25:08) you just sto being able to use it at all you know and you that would be bad for anybody but you start to Think Through the actual like practicality of like okay you know if I need to go and change my direct deposit at HR but like maybe that might take one or two pay Cycles maybe my last paycheck hit my my account and bounce back but then like they won't reissue it if you're living paycheck to paycheck you probably can't wait two to four to six weeks to work through you know some HR paperwork and uh you know
(25:42) the fun realities of how a as a payment rail Works in in the United States you know there were stories of users who you know couldn't buy medicine for their kids couldn't buy food you know couldn't pay their mortgage couldn't pay rent I mean one um you know one impacted user actually sent an email to the judge um saying that they were suicidal over the situation um so I mean I I really you know I can't understate how negatively this has impacted the people um you know the people caught in the crossfire here and
(26:20) I'll also sort of take a moment to reiterate a lot of these programs really heavily leaned on logos and language around FDIC you know knowing that people interpret that to mean this is safe and my money is safe you know I actually at some point uh used the internet archive the way back machine to look at some of the websites and it's just like plastered everywhere and you know on the one hand I mean they may not have like properly disclosed exactly how Deposit Insurance Works in this circumstance um but technically speaking that was TR
(26:59) that was true and remains true right um if you used a service like yat or Juno through synapse and your money was sitting at evolve or AMG those funds were and are FDIC insured the problem and and I'm not by no means am I you know blaming any uh average consumer for not understanding this the problem is what does FDIC Insurance do it protects you against the failure of an insured depository institution the failure of a bank a bank has not failed here and uh the the trustee for the synaps estate who actually is the former chairperson
(27:39) of the FDIC yena McWilliams sent letters to all of the key Regulatory Agencies implicated here uh all three major Bank Regulators the FDIC as well as the OCCC which oversees nationally chartered Banks uh and the Federal Reserve board which oversees State chartered banks that are members of the Federal Reserve System as well as the SEC and finra and basically said like you know can you make resources available like what can you do to help these end these end users these consumers and you know the feedback it varied a little bit regulator to
(28:18) regulator but it was basically you know we don't have legal authority to act and intervene in this situation you know what is fundamentally a business dispute between s and this bankruptcy process you know our job is to oversee the banks and you know to the extent that they're in in the case of evolve that would be that the Federal Reserve um to the extent that there there are actions you know supervisory actions enforcement actions that need to be taken there you know that's what Regulators will do but
(28:50) there is no there's no rule for the FDIC to step in and you know make depositors make end users whole because a bank has hasn't failed um and I mean I I really do see both sides of this in the sense that I you know I understand banking law I understand the role of the FDIC and that is legally speaking correct you know on the flip side you know I think you mentioned svb you know people look at the failure of svb in Spring of 2023 and you know a couple of angry tweets from the all-in crew and all of a
(29:24) sudden you know the sorry the the FDI is invoking the systemic risk exception and lo and behold every dollar of every depositor uninsured or not um you know is is being made whole and again those situ you know there's a lot of reasons why those situations are not exactly parallel or comparable but I do think at like a narrative level you know the Optics on it are really awful of oh Rich Silicon Valley VCS or You Know Rich companies that had hundreds of millions get bailed out and then the guy who you know can't pay his rent or whose car
(30:04) gets repossessed or who racks up a ton of uh credit card late fees you know they're just screwed because oops sorry we can't do anything so I do you know I see the the legal banking side but I also see the human side of this story quick break here freaks this rip is brought to you by gradually then suddenly a framework for understanding Bitcoin is money by Parker Lewis I wrote the forward to the book I'm honored to have done so because it's the that's 0 to1 primer if you're looking for a
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(31:56) com tftc $40 off two questions how do you see is coming to a resolution is is a resolution even clear is there a clear path to a resolution at this point in time and then to will this um synapse debacle really put a stain on the sector of of fintech Bing of service connectors because I know as a Mercury user myself I think the the ux the UI uh that mercury specifically is brought to the banking um sector or the Neo banking sector whatever we're defining Mercury as um is incredible like I love the product and I haven't used many of the others Mercury is
(32:36) probably the only one I've interacted with directly but compared to Bank of America Chase uh it is a way better user experience and I would love to see innovation in this area particularly around ux UI and value added Services um but does this create a stain that will make it harder for these type of services to proliferate moving forward forward I mean to answer your first question you know the the route forward here is really unclear right so as I mentioned you have had um AMG specifically return approximately a 100
(33:13) million in funds which it claims it was able to reconcile to the penny now I will say it's a little unclear exactly how it went about that reconciliation or what it was reconciling again when you know as I pointed out previously you have these two other Banks lineage and evolve that say we don't trust synapsis records you know it they don't make sense Visa V money Movement we actually saw in these accounts so you know it's unclear whether or not uh you know maybe AMG jumped the gun on returning some of
(33:50) those funds um so there's a little bit of ambiguity there but they did return about $100 million uh you know as far as the the remaining I mean you have the remaining money sitting at primarily at lineage and evolve and then you have this unknown shortfall between 65 and 96 million um you know this is not going to be you know welcome news for for any impacted end users who happen to listen to this I I I'm not particularly optimistic on a quick resolution here um I will say like the one recent piece of
(34:25) news that that I do think is promising is that the chapter 11 trustee did engage a financial advisory and forensic accounting firm uh B Riley to assist in basically parsing this data trying to figure out what happened um you know what the shortfall is what caused it um there is a I mean in my in my mind there's a quite big unknown which is let's say let's take the most optimistic case that the shortfall is 65 million who's who's on the hook for that 65 million you know particularly because
(35:04) you know the banks in question both lineage and evolve are not I mean in the scheme of the American banking system they're both very small Banks lineage in fact was the smallest bank in the state of Tennessee until it started engaging in these banking as a service programs uh with synaps and and with another similar company um you know evolve is somewhat bigger but you know it has about 1.
(35:32) 5 billion in assets on balance sheet and if memory serves Equity capital of like 150 million so bigger but still in the scheme of things quite small um so yeah I mean there there are definitely there's definitely still a lot of unknowns as far as how does this proceed when will users get money back will they get all of their money back um still a lot of unknowns there to answer your second question you know the the synapse situation is kind of the most extreme outcome um that I could imagine you know and and I have been following sort of
(36:11) this bass or partner banking space for probably two years in pretty close detail um you know it's not it's certainly not the only um program are the only bank to get in trouble I mean in the past two years you've seen a significant number of banks that operate these partner models get enforcement actions from their Regulators uh including lineage which I mentioned uh which was due to primarily due to its relationship with synapse um Metropolitan Commercial Bank uh which at some time had quite a number of crypto
(36:48) programs uh firstfed Choice bank which actually also partners with Mercury Blue Ridge Bank so you know there's been what I would call kind of a broad sweep of banks operating in this partner banking space or this bass space um I certainly do think the synapse situation and just how catastrophic it's been for end users makes this much more tangible and concrete right if you look at some of the consent orders for these other Banks there are broad themes Bank secrecy act and anti-money laundering being present
(37:29) in basically all of them except for Sutton uh third- party risk management board governance but those you know to to those are very abstract topics you know if you went and talked to an average person on the street they they probably have no idea maybe they have an idea of money laundering from watching TV um but generally speaking like these are kind of like abstract ideas the idea of your bank account being frozen and losing access to your money is something that is very concrete and very tangible I mean even earlier today uh you had the
(38:02) FED Vice chair of supervision Michael bar give a speech at uh an event I believe on financial inclusion and he wasn't he didn't specifically name synapse but the comments were quite clearly directed at the situation and talking about the need to have you know proper uh proper controls due diligence Etc in place uh and so you know like I said we've seen a significantly elevated level of scrutiny on this sort of banking as a service operating model you know at least since 2022 and I think synapse is only likely
(38:38) to escalate that given the level of customer harm that's taking place here and it's also worth mentioning you know apart from the customer harm evolve got a very wide reaching enforcement action from its regulator uh touching on you know some of the topics I mentioned as as well as uh its inadequate information security practices that consent order came out I think about 2 weeks before it was revealed that the bank had been hacked by a Russian ransomware group um so I mean there's a lot of moving pieces
(39:15) right now but they I think you know the broad picture is absolutely heightened you know heightened scrutiny heightened pressure on banks that are that are partnering to power these non-bank programs you know I do take your point that it's like you know often Innovation for a lot of reasons tends not to happen inside the banking regulatory perimeter and so you've seen it with companies like Mercury or or chime or Dave or whatever um you know there's a lot of reasons why both culturally speaking uh business
(39:51) cultur speaking and um you know regulatory speaking that Banks tend not to be very good good at doing Innovation uh but I do think this sort of wave of enforcement actions the synapse situation and now this you know Russian Hack debacle um it's certainly going to make Regulators take an even closer look at banks that are engaged in these business models um you know as well as potentially serve as as disincentives for some banks that may not have the right resources or expertise to operate these model model in a responsible
(40:30) way yeah I forgot to mention the double whammy with the uh the data leak mercury made me aware of that a couple of weeks ago which is uh never fun but beyond that point I it is it is interesting when you consider the landscape of the banking sector here in the United States particularly post 2008 all the consolidation that's happened into the big four um I think we've gone from thousands of banks to I believe under a thousand now at this point I could be wrong um the I'm wrong what is it like so I mean I think the the the trend
(41:09) you're highlighting is absolutely correct you know the number of banks has been steadily declining since like the late 1970s um currently there's a bit over 4,000 licensed commercial Banks and there's another like 44500 credit unions but I think the trend you're pointing out is absolutely correct that the number of banks has been declining you know at this point for decades and even the number of branches which feels like very old school every time I look up this number I it like I have to double check the
(41:43) number of branches continued increasing until 2008 2009 and then it that point it it starts coming down with a rise of Mobile Banking and all that but but the I think you are right to flag sort of the trend and ask the question you know why is this happening and what does it mean for access to Banking and Financial Services as well as like the health of a lot of the smaller communities that are served by you know small Banks and that you know that has been you know we've really been talking a lot on call it the demand
(42:25) side for you know f that need banking services but there's sort of another side of this equation which is why have Banks uh and again particularly smaller Banks sub 10 billion Durban exempt that that earn more interchange income why have they been relatively speaking eager to enter into these Partnerships and enter into these bass business models I mean there's a whole lot of factors that go into that I mean being being a small Bank especially being a small Bank post 2008 with increasing regulatory burden
(43:04) as well as being a small Bank just sort of in the modern technology era where you know JP Morgan Chase spends literally billions of dollars on Tech and R&D every year if you're you know the banks that we're talking about lineage and evolve you in no way can you possibly compete with the amount of of money larger banks are spending in in those areas and you know fintech uh as well as these banking as a service middleware platforms really offered a Lifeline as far as offering banks that historically have served a defined
(43:40) geographic area through their Branch footprint to sort of enter the 21st century and through you know through Partnerships through sort of different digital distribution channels Source deposits generate fee income you know the to not to go on like a how do banks work tangent but like you know to make it super simple Banks generate a spread uh interest net interest margin on lending or they generate fee income and so with the you know the declining importance of Branch Banking and Geographic footprint these fintech
(44:19) programs and bass models offered way for small Banks to play in that space that otherwise they really wouldn't be able to yeah it seems like the smaller Banks trying to figure out how to compete with the systemically important Banks as they're referred to today sort of stepped out on the risk curve of counterparty risk um with these startups just to try and compete which begs a question like is the regulatory environment too burdensome to enable competition that many people would like to see or is it is there something more
(45:03) systemic in the back like is it is the liquidity situation such that it may be impossible for these smaller Banks to compete and we just forced to consolidate into these much larger systemically important banks that will neverly get out I mean the the US banking system to put it bluntly is is bizarre I mean compared to any other country and I don't just mean any other like developed country I really mean like any other country right so you know I live in the Netherlands there's really like three Banks here Aban Amro ing Robo
(45:39) Bank Canada I think has five but even at a country like Mexico which people might put in like the developing bucket you know Mexico has four or five banks that control the majority of the market I mean this is true pretty much everywhere now I'm not necessarily saying that that is a good thing or a bad thing um rather that it tends to be the reality of most markets now the US has a very interesting history um and again I I will try not to be like boring history teacher here but the Dual state federal banking system means that both
(46:20) individual states Illinois Texas California could Charter Banks uh through their you know their local or EXC state level banking commission and the national government could Charter Banks through the OC you also until I'm going to forget this off the top of my head but like 70s 80s you had restrictions on Interstate Banking and branching and so this really was a regulatory either prohibition or disincentive on the sort of Mega Banks we see today I mean I can remember you know in the course of growing up and and
(47:00) I lived in the same suburban Chicago town you know my entire life until I went to University and seeing the same bank change hands from like American National to bank one to chase there's probably like five or six before that um and so there were real regulatory reasons why it was the way it was before and there are real regulatory reasons why you're seeing this trend towards consolidation now I mean I think something that you're hinting at is there are competing public policy priorities right you know we can talk about um
(47:42) systemic risk or safety and soundness we can also talk about competition uh you know Financial crime risk and money laundering and access and inclusion and the reality is these things are not all you know achievable to 100% at the same time you know if you want to sort of Tamp down on financial crime risk and money laundering like one of the ways that you're going to do that is by heightening kyc KYB requirements um increasing the thoroughness of transaction monitoring and that can actually have the impact you know
(48:19) intended or otherwise of causing Banks to drisk certain kinds of customers or certain kinds of transactions so I mean the point I'm trying to make is like well you know depending on what is a public policy priority at any given time sort of what is the top of the stack you know you may say you we don't want to see Chase get bigger it's already you know the biggest bank in the country but when First Republic blows up and you need to broker somebody buying that bank look who's here to save the day it's JP
(48:52) Morgan Chase right and so you know there's this constant give and take between these different policy priorities uh and regulations and you know it it's just not possible to achieve all of them simultaneously yeah yeah and you think about what's happening in Europe with UBS and credit s and so what are I mean with this in mind like what are your thoughts on the overall health of the banking system right now a year and a few months away from the svb blow up uh signature silvergate all those there was many
(49:31) people were worried at the time that that was going to lead to 2008 like systemic domino effect obviously the FED FDIC stepped in you had the btfp program which just then did um but it seems that uh a lot of and another interesting thing earlier this year which actually went under the radar as well is that they took treasuries out of the reserve ratio um for a lot of these Banks as well and so with all that in mind what your what's your take on the overall health of the banking sector not only the small Banks but the larger Banks as
(50:08) well yeah I mean I'm you know with a with a strong caveat that I'm not like a bank Equity Bank balance sheet analyst um you know sort of the big post svb thing that everyone was paying attention to was um Bank Securities portfolio and the level of interest rate risk they had taken um you know to try toce returns and then as rates went up uh putting those portfolios underwater so not necessarily at a true solvency risk assuming that they had the ability to hold those Securities uh to maturity uh but of course you know you get a
(50:50) situation where um there is a loss of confidence and I think one of the interesting things things about the svb story and this maybe speaks a little bit to a certain level of hubris at that organization was in part it was like a Communications uh you know unforced error of saying you know we're going to go out and raise capital and having that Capital raise fail um and sort of how the messaging around all of that was handled right um you know I think now uh certainly there's still you know some level of risk as far as uh elevated
(51:30) interest rates Visa where Banks Securities portfolios are I think the the bigger problem that people are paying attention to now is around commercial real estate in particularly like concentrations of commercial real estate lending in you know certain kinds of banks in certain Geographic areas uh again I don't actually spend a ton of my time looking at this at like a sort of sector wide or bank balance sheet level so i' I'd hesitate to offer too much more than that no that makes sense the uh you the
(52:09) commercial real estate market uh doesn't seem to be doing well right now and that's that's the thing with these banking crises is uh you don't know how weak these banks are until um they're put in a very stressed situation and they have to tap the FDIC on the shoulder of the fed and say hey we need your help or JP Morgan for that matter yeah I mean sorry now I'm just remembering the svb thing uh it happened while I was actually trying to take a real vacation in Mexico and then it it quickly became less of a vacation um but
(52:43) I mean even you know some of the some of the steps Regulators have taken since then and I forget if this was svb specifically or if it was first Republic or somebody else around having the right like literal operational procedures in place to tap the FED discount window should they need to um so some of these things which you know again if you're not like a hardcore Banker person you know you might not understand what they are or why they matter it's like you know ideally your bank doesn't ever need
(53:16) to pledge assets at the discount window but like there's a reason why it's called the lender of Last Resort right um uh and so yeah I mean I think we've seen a number of um you know guidance documents policy documents come out in the wake of you know svb First Republic signature uh and each of these are like a little bit idiosyncratic there're you know there's some similarities and some differences uh but to try to both raise awareness and then address you know some of the sort of solvable problems that that you
(53:53) know may have occurred and contributed to those failures um yeah no and you got to think both the banks and The Regulators I mean svb being the perfect example of how Bank runs can materialize in the digital age particularly social media of Peter teal sent an email out to founder fund companies and that leaks and within two days the bank is um essentially bankrupt uh it was as I mentioned before we hit record it was a stressful time for us as well but um yeah I think the the nature of how Bank runs can happen today is
(54:31) completely new monster even compared to 2008 with social media being as prolific as it is and well and it's it's interesting you know to think about the potential implications as the US finally slowly creeps towards faster payments right I mean you know clearing house RTP real-time payments has been around for a while it's not necessarily like widely available through your Banks like ux as far as like oh I want to send you a payment like instantly via RTP versus any other mechanism and now the you know it's
(55:08) approximately the one-year anniversary of the roll out of the fed's instant payment rail fed now um you know certainly there are you know mechanisms policies Etc that you can put in place to try to address potential liquidity risks from having those faster payment mechanisms but you know the I I forget the exact numbers at this point but I mean if you were withdrawing money from svb during that time you know typical a is I'm going to put in a request and it's going to process in a batch overnight right and so you could have
(55:42) whatever you know tens of billions of dollars that are basically queed up to go out the next day uh and of course this is Monday to Friday you know no bank holidays all that but imagine if you have a 247 real-time payment rail plus all the sort of you know social me media WhatsApp group you know uh group think contagion that was in play during svb you know you could certainly imagine a bank run like svb happening even more quickly um you know if real-time payments uh were widely available yeah it's Brave New World out there um
(56:24) and with that in mind like just to wrap up I know I mentioned in the email I sent with some questions like do you consider what's happening between snaps and now with the regulatory scrutiny uh on the banks and the bass industry more broadly could that be seen as an extension of choke point 2.0 and then um as it pertains to bitcoin companies trying to get Banks uh bank accounts that's been that's been hard and do you see this affecting the ability of of Bitcoin and broader crypto companies to get bank accounts because um they're
(57:03) seen as riskier than even these fintech bass players yeah so I mean I think there there are a couple of different strands here I I I will point out that um you know operation choke point sort of the original operation choke point um has almost taken on uh mythology that I think is causing a pretty severe amount of confusion about like what really happened um I will try to like resist the urge to go down that rabbit hole but you know there was uh there were several office of Inspector General reports about that uh it found little to no
(57:40) involvement at the FDIC uh to the extent that there was any focus it was not on any of these sort of disfavored Industries like uh gun manufacturers or ammunition or tobacco or whatever uh there was um some impact on payday Lending uh which is actually an industry I know a lot about because I worked in it for five years um as well as RS which is like a refund anticipation loan where the oig did find there was like a bit more you know potentially like inappropriate pressure coming from Bank Regulators um but really like the sort of narrative that
(58:15) that the whole thing took on about the original like Obama era choke point of like cutting off gun sellers from the banking system is just patently untrue uh on the other hand um and again I'll I'll cave out that I I know a bit less about um sort of policy and how the policy has impacted crypto or any sort of like crypto blockchain related companies so I'm going to speak here at like a very high level uh but it certainly is my impression from following policymaking out of OC FDIC and the FED that you know they can't
(58:56) licitly say don't do crypto stuff but they can create um you know oversite or regulation that is so burdensome that it basically says the same thing or functionally acts the same way so I think you know particularly post silvergate uh as well as signature uh and then along with you know FTX blockfi Celsius all of the cryp firms we saw which by the way like have links to evolve FTX did blockfi did um you know not to the same extent as like silvergate Etc um you know I do think that there's been a pretty clear
(59:41) telegraphing from Bank Regulators including with things like the fed's novel activities program um that you know if you do anything with crypto we're going to take a very very very close look at it um yeah so I mean to that extent does that serve as a major uh disincentive or does it adjust the cost benefit cost you know uh risk benefit calculus of a bank choosing to either you know partner with empow a crypto company or even to offer a bank account like a business bank account to a crypto firm you know I think it's fair
(1:00:17) to say the answer to that is probably yes um you know when it comes to like setting aside the crypto piece and talking about like bass and partner banking um I mean you've already seen this to a certain extent right where the the expectations for from a bank for onboarding a fintech program have gone up considerably I don't necessarily think that's the worst thing in the sense that you know particularly in the 2020 2021 period when you just had buckets of VC cash getting splashed around to anyone with a half-baked idea
(1:00:57) in a pitch deck you know if it was a fintech company you probably need needed a bank partnership to make that happen and you know as the slew of consent orders has made clear you know a lot of these Banks either weren't doing the necessary due diligence in thirdparty Risk Management you know didn't know how to do it didn't care um and so you know there has been the pendulum has swung right and so you know what is the result of this heightened level of scrutiny you know some people have complained oh you know they're changing
(1:01:31) the rules or they won't tell us the rules I don't think that's really the case I think it's more like you know collectively the three B major Bank Regulators Federal Bank Regulators weren't paying a lot of attention to to the sort of bass partner world and then it grew extremely quickly from about 2019 to 2022 uh during covid with all this VC money with these new midle platforms then they realize like oh hey like we have some problems here whether it's like BSA AML problems third party risk
(1:02:05) management consumer compliance you know there's this cycle of enforcement actions some banks will decide maybe this is not the right business for us you know we don't have the right expertise we don't we we can't afford to make the right Investments Blue Ridge sort of is doing this where they're saying we're going to go back to our community banking routs other banks will say Hey you know we took the wrap on the knuckles we're going to make the Investments we need to make and we're
(1:02:30) going to you know continue to serve this line of business it's you know in my mind it's not fundamentally different than what we saw in the early 2000s with banks like Bank Corp and then it was known as meta bank now it's known as paord with prepaid cards which were fundamentally quite similar as far as being a partnership model and so yeah there's some pain happening right now some banks will probably choose to exit the line of business other Banks won't we'll probably see fewer fexs which I
(1:03:02) think is appropriate because you know not all of these companies have a viable business model we'll probably see no we already have seen fewer middleware platforms um and you know I think to to a certain extent that's the market working yeah natural cleansing event is unfolding right now Jason thank you for your time this is uh been a of knowledge on this particular topic which I've been watching from afar uh with baited breath considering uh the the nature of Mercury's involvement with evolve can I
(1:03:38) get can I get my quick my quick plugin which is they can subscribe your listeners can subscribe to my newsletter at fintech buus or find me I'm still on Twitter for some reason and on LinkedIn yes you can plug you just did and uh uh we'll put all this um we'll put all this in the show notes as well how often are you put you're putting out the newsletter at least once a week now I do well the the normal Cadence is supposed to be weekly um but with all the with all the chaos between the hack
(1:04:13) and all the court hearings you know I've done some like breaking news updates for my own personal sanity though I'm trying to get back to to once a week okay awesome go uh go subscribe if you're if you're interested in all this stuff I've been I I went back and read your back catalog a couple of weeks ago just to get a better understanding what's happening here and um it's very valuable information because it's it's so Niche and uh yeah and it's it's complicated and if you don't if you don't know the
(1:04:45) history you know and this took me a long time to learn as well it's like oh like so much of what's happening right now you saw in the early 2000s and so much of that had to do with something else so yeah it takes a while to to learn and and if you're uh a nerd like me and you're interested it's a great resource I hope it is a great resource uh speaking from experience Jason please enjoy the rest of your night in the Netherlands and thank you so much for joining us this been uh an incredible conversation yeah thanks for
(1:05:17) having me all right peace and love freaks take care


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