CMA Hrishikesh R. Nampoothiri
Email: hyadu12345@gmail.com | Phone: 7560938431, 9446629725
“We created these words like neobank, digital-only bank, and fintech bank, but they are really just pass-throughs for various banking aspects.”
– James Wester
The 2008 financial crisis marked the rapid proliferation of technology-driven financial service providers worldwide. Operating beyond the traditional reach of brick-and-mortar banking systems, these platforms introduced peer-to-peer systems supported by digital infrastructure. This evolution paved the way for the emergence of Banking as a Service (BaaS).
Banking as a Service (BaaS) is a business model enabling non-banking businesses to offer banking services through their platforms. Services such as bank accounts, cards, loans, investment solutions, and liquidity management can now be extended to customers via BaaS platforms.
This model represents a semi-open banking framework, empowering organizations outside the traditional banking sector to provide banking services. As a result, even small towns now have access to advanced technologies like scan-and-pay and tap-and-pay systems, driving digital adoption further.
BaaS leverages Application Programming Interfaces (APIs) to allow banks to create and maintain platforms offering a wide range of banking functions. This enables third-party companies, even those without banking licenses or expertise, to provide seamless banking services by utilizing the infrastructure and regulatory compliance of partner banks.
While the innovation-driven world demands such advancements, challenges persist. Fintech companies often prioritize technology over compliance, unlike traditional financial institutions, which leave no margin for error in risk management.
A concerning trend is the overshadowing of financial fundamentals by technological progress. This gray area of risk and compliance was starkly highlighted by the bankruptcy of Synapse, a BaaS provider, which disrupted consumer accounts and exposed significant vulnerabilities in the system.
Evolve Bank and Trust partnered with Synapse, intending to expand its footprint. However, Synapse failed to fulfill its obligations, mixing customer funds into FBO (For the Benefit Of) accounts instead of maintaining proper ledgers. When Synapse went bankrupt, $85 million in funds was unaccounted for, leaving customers in chaos.
To make matters worse, customers were denied insurance coverage as Synapse, being a fintech, was not eligible for FDIC insurance meant for banks. The incident highlighted critical risks associated with fintech partnerships and the need for robust compliance measures.
The failure of Synapse underscores the importance of stringent risk management and compliance in fintech programs. Key recommendations include:
Clearly Defined Roles: Agreements between banks and fintechs must define roles, monitoring mechanisms, reporting frequency, periodic audits, and processes for addressing deviations.
Account Differentiation: Banks should distinguish individual sub-accounts from general pooled accounts, especially when middleware companies are involved.
Contingency Planning: Partnerships must include contingency plans to address operational risks, such as account ledger outages.
Leadership and Training: Both banks and fintechs should have leaders with expertise in risk management and compliance. Regular training and monitoring systems must keep pace with changes in the financial world.
James Wester aptly said, “We added an entire layer of technology and technologists, oftentimes without considering compliance. However, a bank is a real thing. It is a licensed institution that is regulated, and fundamentals like risk mitigation and ledger management should never fall by the wayside.”
While technological advancements are inevitable, compliance must remain non-negotiable. It should be an integral part of financial services, regardless of their size or nature.
