You’ve likely been following the fallout from Synapse’s bankruptcy earlier this year. BaaS provider Synapse filed for Chapter 11 bankruptcy in April, leaving its clients, including Evolve Bank & Trust and multiple others, unable to verify and manage funds. In all, around $85 million in consumer funds are missing due to discrepancies in Synapse’s records.
Adding to the confusion, the dispute is ongoing in court, and because Synapse is a fintech and is thus unregulated, regulatory bodies are unable to protect consumers, many of whom are still missing their funds.
As a result of this nightmare, the FDIC has advanced a notice of proposed rulemaking for what it is calling Requirements for Custodial Deposit Accounts with Transactional Features and Prompt Payment of Deposit Insurance to Depositors. The regulatory body is currently taking public comment on the rule.
As it currently stands, the rule applies to bank accounts that fit into three categories:
- The account is established for the benefit of beneficial owners
- The account holds commingled deposits of multiple beneficial owners
- A beneficial owner may authorize or direct a transfer through the account holder from the account to a party other than the account holder or beneficial owner
Here are five things banks with accounts that fit these categories should know about potential implications the rule may have on them.
Strengthened recordkeeping requirements
Advanced recordkeeping should already be part of a bank’s routine. However, the proposed rule is specific in its requirements, stipulating that banks working with non-bank entities (as in a BaaS partnership) must maintain accurate records that identify the beneficial owners of custodial deposit accounts that are held on behalf of consumers, which is typical in a BaaS agreement. Maintaining records of custodial accounts will help regulators ensure that deposit insurance can be quickly and accurately provided in the event of a bank failure.
Continuous third-party records access
The proposed rule states that if banks rely on non-bank companies to manage custodial deposits and their records, the bank must have continuous, direct access to records held at the third party organization. This requirement aims to prevent disruptions to operations, as what we saw in the Synapse bankruptcy case earlier this year. Ultimately, if banks have transparent access to third party records, they can help customers maintain access to their funds.
Annual compliance and validation
Under the new rule, FDIC-insured, BaaS-enabled banks will be required to conduct an annual, independent validation to verify that their third party partners are maintaining accurate deposit records. Banks will send the records, which must be accurate and compliant with the FDIC’s standards, to the FDIC and to the bank’s primary federal regulator. The purpose of this stipulation is to ensure consumers are able to access their funds without delays and to increase the reliability of custodial funds arrangements.
Consumer protection and transparency
Consumer protection is the underlying reason behind the new proposed rule. A large piece of this provides clarity about FDIC insurance. As such, BaaS-enabled banks will be expected to ensure that their consumers fully understand the coverage and protections of their deposited funds, particularly when dealing with non-bank custodians.
Heightened money laundering
The document also emphasizes that banks must exercise strengthened internal controls and anti-money laundering (AML) compliance requirements. Notably, the ruling also emphasizes that banks must ensure that their third-party partners do not facilitate financial crimes.
This week’s proposed rulemaking highlights two truths in financial services. First, the additional requirements can potentially add burdens on banks that are already weighed down by multiple reporting responsibilities. Yesterday, Vice Chairman Travis Hill voiced his concern, saying, “I recognize that certain types of pass-through arrangements have become much more complex in recent years, exacerbating the potential risks…” Hill said, however, that he is voting in favor of the proposal, explaining that, “improving recordkeeping and reconciliation practices (1) can reduce the likelihood of another Synapse-like disaster in the event of a third-party failure, and (2) may result in a more orderly resolution in the event the bank fails.”
The second truth today’s proposed rulemaking underscores is that the financial services industry needs a national fintech charter that can monitor, regulate, and enforce third parties that manage and handle consumer funds. Banks have long been subject to strict regulations and reporting requirements. But should banks that have conducted the proper due diligence be held responsible for the actions (or inaction) of their third party partners? It is time for fintechs to step up and share the responsibility.
Photo by Maksym Kaharlytskyi on Unsplash