A new rule may make banking-as-a-service partnerships too difficult for small financial institutions

The news: The Federal Deposit Insurance Corporation (FDIC) just proposed a rule that would require sponsor banks to track the identities and balances of fintech customers. The move has major implications for those financial institutions already in or looking for banking-as-a-service (BaaS) partnerships.

How we got here: In a recent briefing, senior FDIC officials told journalists that the regulator had been considering rules along these lines for several years, per the New York Times. The collapse of Synapse offered a tangible example of what they were trying to prevent.

• The FDIC  has received over 1,000 customer complaints related to Synapse since its troubles went public and more than 10 million customers lost access to their funds.

Since the Synapse collapse, federal banking regulators have reiterated that fintech disputes and funds fall outside of their purview. 

What the new rule entails: Though the FDIC has drawn the line at extending insurance to cover these consumers’ funds, it still aims to reduce the harm such customers could experience in the future. It seeks to improve recordkeeping for FI deposits placed by third-party nonbank companies on behalf of consumers and businesses. To comply, partner FIs must:

• Be able to identify actual owners of funds in certain custodial accounts, even when funds from multiple customers are pooled into a single account, enhancing deposit insurance protection
• Reconcile individual account owners daily, even if they use a third-party recordkeeper

The regulator says the rule would apply to accounts that meet these criteria:

• They were established for the benefit of beneficial owners.
• They hold commingled deposits of multiple beneficial owners.
• They allow a beneficial owner to authorize or direct transfers from the account to parties other than the account holder or another beneficial owner.

The FDIC hopes this rule will help inform deposit insurance decisions and strengthen compliance to anti-money laundering laws, a major driver of regulatory enforcement actions in BaaS partnerships.

Potential fallout: The increasing cost of compliance could push more FIs out of this space—a trend already underway. Five Star Bank recently said it would end its BaaS partnership with Unit and exit the space due to the relatively small contribution BaaS made to its business—boosting its deposits by just 2% and loans by 1%, per Fintech Business Weekly writer Jason Mikula.

• The bank also cited “evolving regulatory expectations” as a key motivator.

Impact to fintechs: Those offering BaaS could see the new rule offering some much-needed reassurance to customers. Just recently, Yotta made headlines for filing a lawsuit against Evolve Bank & Trust for “gross misconduct” and “brutal theft” of its users’ funds. Its customers lost access to $25 million of their funds, and the lawsuit claims Evolve and Synapse misappropriated $50 million, per PYMNTS. News coverage like this isn’t helping BaaS expand.

Key takeaways: By itself, the rule around sponsor banks tracking fintech partner customers isn’t going to make or break BaaS partnerships. Banks should already have been tracking accounts this closely. But the plethora of enforcement actions shows that many have been struggling with BaaS compliance. Explicitly adding tracking requirements to compliance could be the proverbial straw that breaks the camel’s back for FIs already frustrated with disappointing returns.