Losing access to funds can be a shock to customers of financial technology companies.
Since FTX was forced into bankruptcy in November 2022, the news media has extensively covered the fall and flames of several major crypto companies. BlockFi, Celsuis, Voyager, and other lesser-known companies soon followed. Cryptocurrency companies have been heavily criticized, and in some cases deservedly so, but what about the failures of financial technology companies offering traditional products? Customers are often not aware of the risks and underestimate the consequences of failure, exposing them to higher risks from non-crypto providers.
Financial technology (fintech) companies that offer bank-like products are a hidden risk to customers, and in most cases, customers seem unaware of the risks they assume when using the services of such companies. .
As an example, in April 2024, a range of fintech providers ceased operations or experienced significant disruption. This is because Synapse Financial Technologies, the behind-the-scenes provider servicing these fintech companies, has declared bankruptcy. Companies such as Copper, Mainvest, Yotta, Juno, YieldStreet, and many others were affected.
Similar nonbank fintech companies such as Mercury, Brex, Fold, and Wise offer bank-like services to their customers, but as they grow, so does the potential impact on their customers in the event of a failure. It will be.
FTX logo. (Photo by Jakub Porzycki/NurPhoto, Getty Images)
In the case of FTX and other crypto-related bankruptcies, it is only now, nearly two years after the companies ceased operations, that customers have begun to expect some of their funds back. Large bankruptcy cases often take years to process, and customers often receive only a portion of their funds back.
Customers of some fintech companies affected by the Synapse bust were shocked to find they couldn't access their funds. It's been almost six months now, and for some customers, there's not even a timeline for when they'll be able to access their funds. It is not even clear how much of the funds will be returned. Jason Mikula has detailed the aftermath in FinTech Business Weekly.
As customers have repeatedly explained to the court during Synapse's bankruptcy hearings, they may have believed, or been led to believe, that their deposits were insured in the event of a failure. That wasn't accurate.
Failure of virtual currency company
Cryptocurrency, and Bitcoin in particular, is a new and exciting asset class that offers investors risks and rewards that are uncorrelated with other assets.
History has taught us that in new things that promise high rewards, some of the early promoters may have the weakest understanding of ethical and legal behavior. In the United States, we can look back to land-related fraud during the gold rush and stock promotion fraud in the early 20th century. The Securities Act of 1933 and the Securities Exchange Act of 1934 were enacted to curb abuse and protect investors.
Some crypto market participants appear to be forced to repeat history. The remains of the crypto industry pioneer include serious criminal activity at FTX and questionable business models of some crypto lending companies, including high-risk activities that have led to countless failures at traditional lending companies. It was.
Only a few people were sounding the alarm about these companies before they went bankrupt.
Customers did not understand that they were at risk. The failure of these cryptocurrency-related companies had a significant impact on certain customers and had a negative impact on all customers. Because these companies did not advocate strongly as an alternative to traditional banks, few, if any, customers relied on them to the exclusion of traditional banking relationships.
fintech companies
Some customer-facing fintech companies are pitching themselves as an alternative to the traditional banking sector. These fintech companies appeal to specific customer groups because they offer customer experiences and a set of products and services that traditional banks cannot offer.
Fintech companies do not operate completely independently and require the services of what are commonly referred to as “partner banks.” Bank relationships are needed for a variety of reasons, including retaining customer deposits and accessing traditional payment systems.
US banks are exiting the partner banking business, and we discussed the withdrawal of bank support for customer-facing fintech companies in an article published earlier this month.
While banks are subject to strict supervision, required capital levels, and safety and soundness standards, fintech companies are not subject to these strong regulatory requirements. Fintech companies typically need to obtain some kind of regulatory license to operate, but those licenses are light years away from the highly regulated operating environment of U.S.-chartered banks. There is.
Federal Deposit Insurance Corporation headquarters (Photo by KAREN BLEIER/AFP via Getty) … [+]
Fintech companies are also not covered by the Federal Deposit Insurance Corporation (FDIC). The FDIC insures depositors against bank failures, and as reported on the FDIC website, since FDIC insurance began in 1934, no bank failure has resulted in a loss of insured funds. Not a single depositor lost money. There's no question that FDIC insurance is one of the many reasons for the strength of the U.S. banking system.
The FDIC only insures the failure of banks, not the failure of fintech intermediaries. Therefore, as long as the bank remains in good standing, if the fintech fails, customers could be fully exposed if their funds were not properly protected.
The FDIC operates to ensure that bank customers have continued access to their funds. In very rare cases, when a bank is in trouble enough to require FDIC intervention, insurance agents typically do so after the close of normal business hours and have their customers' accounts cleared by the time the bank reopens the next business day. will be transferred. Become a well-capitalized company. The goal is to ensure that customers are not affected.
Customer funds entrusted to fintechs are kept with banks, but there is a possibility that they will not be compensated if the bank goes bankrupt. FDIC pass-through insurance is the insurance you can rely on in the event of such an event, but there are certain conditions that must be met in order for such insurance to apply. Therefore, customers of fintech companies rely on fintech companies to maintain all the terms of their pass-through insurance, so that their insurance is even guaranteed in the extremely unlikely event of a bank failure. there is no.
Customers expect their funds to be safe at all times, and banking in the United States is virtually synonymous with FDIC-insured banking. Fintech providers are not necessarily safe or insured. There is such a gap in consumer protection between FDIC-insured banks and non-bank fintechs that comparisons are virtually meaningless.
move forward
Financial innovation is generally a net positive, and exposing customer funds to risk, especially when the customer does not fully understand the risks they are taking on, is by definition a net negative.
The current system of standalone fintech companies that treat traditional banks as account collectors and infrastructure providers should be phased out. Sustainable growth is found by combining the strengths of the traditional banking system with the innovations of the financial technology industry.
Joint ventures between banks and fintech companies are the way of the future.
Through joint ventures, the fintech industry could be integrated into a well-regulated banking industry, allowing customers to benefit from the safety and security of banking supervision. With the responsibility for ensuring the safety of customers' funds shifted to banks, they will likely be more attentive to the management of fintech companies. Standards for capital, technology, compliance, and management of fintech companies are required as banks are expected to provide securely managed, uninterrupted customer service and fully comply with all applicable regulations. It becomes.
When it comes to financial innovation, the banking industry must be in a leading position. Banks need to take the lead in these operations when it comes to governance, compliance, and ensuring safety and soundness.
Fintech companies need to find banks to participate in joint ventures. Banks need to identify the ideas, technologies, and teams they want to partner with and engage them in strategic discussions. But the economy needs to be fair, and that means banks need to be heavily involved in the upswing.
U.S. customers are entitled to the protection of a highly regulated banking system whenever they entrust their funds with an organization that provides services similar to banks.
