FDIC Warnings on Nonbanks Point to Gaps in Deposit Insurance

They say there are no guarantees in life.

That sentiment applies to financial services — at least, depending on where you look, or what promises are made by nonbanks.

With traditional financial institutions (FIs), such as the banks that have been around for decades, even centuries, there are some guarantees. Up to $250,000.

For all other settings, and particularly with the digital-only FinTechs, neobanks, and generally speaking, the nonbanks … caveat emptor.

The continued fallout from the Synapse Financial bankruptcy, which saw depositors frozen out of accounts, will likely force a wider discussion about which depositors are protected by the government, where they’re protected, and even when.

Last month, while Synapse filed by Chapter 11 bankruptcy and dueled with Evolve Bank and Trust, 85,000 of Yotta’s customers — holding a total of $112 million in savings — were locked out of their accounts. Copper, another FinTech that used Synapse, announced in May that it will shutter at least some of its offerings, including bank deposit accounts and debit cards.

In the partnership model that brings FinTechs together with banks, questions remain as to just where deposits are held and whether they might be insured or not. The FinTechs, largely unregulated to date, act as middlemen and provide infrastructure and software to help provide banking services for companies that are not banks.

The gaps come when some of these firms offer Federal Deposit Insurance Corporation (FDIC) insurance, partners do not, and consumers may not necessarily understand just where their funds are held.

Deposit insurance, tracing its roots back about 90 years, was set up by the government as an independent agency to help foster trust in the U.S. financial system — specifically, traditional FIs — and to help prevent bank runs that now seem to be shorthand for the Great Depression.

Evolve was the entity in the Synapse drama that, as a bank, falls under the purview of the FDIC. But deposit insurance is there, and is activated only in the event of a bank failure. Evolve didn’t fail, and so insurance coverage (which extends to $250,000 per account) was not triggered.

The FDIC’s Warnings

In a June post on its website, the FDIC said: “The easiest way for most consumers to have confidence that their money is safe continues to be opening an account directly with insured depository institutions, like FDIC-insured banks and savings associations.”

But the FDIC also noted that “increasingly, some consumers are choosing to open accounts through nonbank companies (typically online or through mobile apps), such as technology companies providing financial services (often referred to as fintech companies), that may or may not have business relationships with banks.”

PYMNTS Intelligence has estimated 10% of consumers surveyed said that their primary bank accounts are with digital banks and 25% had used neobanks or FinTechs to access at least some banking services.

The complexities of some of the FinTech/banking relationship — and the implied gaps — are detailed by the FDIC, as its post noted that “even if they claim to work with FDIC-insured banks, funds you send to a nonbank company are not eligible for FDIC insurance until the company deposits them in an FDIC-insured bank and after other conditions are met.” (emphasis from PYMNTS).

After the nonbank places your funds on deposit at a bank, “records must be kept to identify who owns the money and the specific amount that each person owns.”

At least some of that record keeping and clear delineation of ownership has been, well, a work in progress as Synapse had been reported to be commingling funds. And, in a nod to the “caveat emptor” exhortation above, PYMNTS reported last month that “cease and desist” letters had been issued to several companies for violations of the Federal Deposit Insurance Act.

The act prohibits individuals and entities from “making false or misleading representations about deposit insurance, using the FDIC’s name or logo in a manner that would imply that an uninsured financial product is insured or guaranteed by the FDIC, or knowingly misrepresenting the extent and manner of deposit insurance.”

Through the past few months, the letters have been issued to companies like Prizepool, AmeriStar and virtual wallet firm Organo Payments.

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