Banks will have to closely monitor accounts maintained by fintech partners to prevent customers losing access to their money should a fintech fail under a new proposal from a key federal banking regulator.
The Federal Deposit Insurance Corp. wants all banks to either maintain a ledger of “for benefit of” accounts that third-party fintechs open to pool customer accounts, or have direct access to a ledger maintained by a fintech so they can reconcile the accounts each day.
The proposed rule released Tuesday would apply only to FBO accounts that have “transactional features,” meaning the customers use the money in the accounts to pay bills, make purchases, or conduct other transactions. The FDIC’s board of directors voted unanimously to release the proposal, which applies to all federally insured depository institutions.
Doing so would allow banks to know how much end-user money they’re holding on a real-time basis so they can either distribute it to customers should a fintech fail or easily apply deposit insurance protections, the FDIC said.
“FDIC staff believes these records of beneficial ownership would be useful to the IDI in the event of a disruption affecting the account holder, as they would enable the IDI to determine the identity of the owners of the funds it is holding on deposit,” an FDIC staff memo accompanying the proposal said.
The proposal comes in the wake of the April failure of Synapse Financial Technologies Inc., a fintech banking-as-a-service provider, that has resulted in millions of dollars in customer funds being frozen at a handful of smaller banks.
“Complete and accurate deposit account records for these arrangements are of critical importance when consumers are relying on these products to manage their daily financial needs,” FDIC Chairman Martin Gruenberg said at an agency open meeting Tuesday.
The proposal will also help banks maintain anti-money laundering and anti-terror financing requirements, he added.
Customers Locked Out
Andreessen Horowitz-backed Synapse served as a go-between linking partner banks with fintechs such as Yotta, Juno, and Dave Inc. that provided gamified banking services to gig workers and crypto investors, among others.
Among the services Synapse provided was opening and maintaining “for benefit of” accounts for the other fintechs.
Discrepancies between the records Synapse held of customer accounts and those held by its banking partners, such as West Memphis, Ark.-based Evolve Bank & Trust, were exacerbated when Synapse failed.
Thousands of customers have been locked out of accounts holding millions of dollars, making them unable to pay bills, buy groceries, and fund small businesses.
“These problems could’ve been identified much sooner if the partner banks maintained better records and conducted frequent, routine reconciliations,” FDIC Vice Chairman Travis Hill, a Republican, said in supporting the proposal.
The FDIC’s rule seeks to address those issues by requiring daily reconciliation of the accounts either by the bank or a fintech. In cases where the fintech handles the reconciliation, banks would have to maintain direct access to the third-party ledger and have an outside reviewer check the accounts each year.
By requiring daily account reconciliation, the FDIC proposal could boost trust in the banking system for customers, said Adam Rust, the director of financial services at the Consumer Federation of America.
“Banks can’t put the deposit insurance fund at risk in the name of fast profits, and in turn, regulators cannot permit banks to outsource a foundational aspect of trust in banking to tech firms,” he said.
Fintechs and their partner banks have already set up best practices for maintaining and reconciling customer account records that have largely worked well, Ian Moloney, the head of policy and regulatory affairs at the American Fintech Council, said in a statement.
“Rather than creating additional regulatory burdens to combat idiosyncratic issues identified by the agency, we need a fresh set of standards informed by interdisciplinary dialogue and the lessons we have learned from past successes and challenges,” he said.
Scope Questions
Hill also raised concerns about the scope of the proposed rule despite his support for sending it out for comment.
Anywhere from 600 to 1,100 banks would be implicated by the proposal, but only a small number of banks are heavily involved in the fintech partnerships the rule aims to govern, he said.
“Under the proposal, if a bank has one deposit account covered by the proposal, the bank would need to fully comply with all aspects of the rule,” Hill said. “This seems excessive, given what could be a substantial compliance burden.”
Top bank executives would have to provide an attestation each year to the FDIC or another primary federal regulator that they have been appropriately reconciling such accounts.
Hill also raised questions about the attestation requirement given the gender and racial discrimination scandals embroiling the FDIC and Gruenberg, who has said he will resign his post once a replacement wins Senate confirmation.
FDIC officials said on a Tuesday call with reporters that agency examiners have been raising concerns about FBO account reconciliation to banks for some time, and that the agency has filed several related enforcement actions.
The FDIC exempted other types of third-party FBO accounts from the proposed rule, such as custodial trust accounts and accounts set up by broker-dealers.
The proposal will be open for comments for 60 days following publication in the Federal Register.
Given the unanimous support among the FDIC’s board members, the agency is likely to finalize a rule governing the reconciliation of FBO accounts even if Donald Trump, the Republican nominee for president, wins this November’s election and reshapes the FDIC’s board.
“Regardless of future administration, it really does address some of the core issues that emerged in the Synapse-Evolve debacle,” said Jonah Crane, a partner at the Klaros Group, a financial advisory and investment firm.
The FDIC also voted 3-2 Tuesday to adopt final guidance to tighten bank merger reviews.
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