Konrad Alt and Patrick Haggerty
The Synapse bankruptcy is raising fresh concerns about the challenges of protecting depositors whose funds are held in FBO accounts when a critical partner fails. In this case, Synapse’s collapse is exposing issues that can surface when a fintech platform suddenly folds. But one need only think back to last year to remember that FBO accounts also present unique depositor protection challenges when a fintech’s bank partner fails. In this post we look back at what we learned about FBOs in 2023 from the failure of Silicon Valley Bank (SVB) and why it’s still just as relevant today. In a subsequent post, we’ll take a closer look at the additional issues raised by the Synapse collapse and what they mean for the use of FBO accounts in bank-fintech partnerships going forward.
Those who managed FBO accounts at Silicon Valley Bank in 2023 learned three things:
Using the concept of “pass-through” deposit insurance, the FDIC holds that customers whose funds are in FBO accounts enjoy deposit insurance protection up to applicable limits so long as the program manager maintains the requisite account records;
Deposit insurance limits apply to customers whose funds are pooled in FBO accounts just as they do to all depositors, so long as the FBO account manager can provide the information necessary to determine the insured proportion of their FBO account balance; and
In the event of a bank failure, if the FDIC cannot make that calculation and therefore determines, even preliminarily, that your FBO account enjoys only $250,000 in deposit insurance, the rest of the account balance could remain frozen, leaving your business in a world of hurt.
While most of the chatter around FBOs today centers on what happens when a fintech platform fails, the potential failure of a fintech’s partner bank remains a critical risk. The lessons learned in the wake of SVB’s collapse are every bit as relevant today as they were a year ago.
Neobanks, p2p transfer services, prepaid card programs, payroll services, bill payment services, brokerage sweep programs, health benefit account providers, crypto exchanges, stablecoin issuers, and more all depend on FBO accounts. These accounts permit nonbanks to efficiently embed insured deposit products and payment services into their customer offerings.
For businesses that maintained FBO accounts at SVB, their immediate challenge when the bank failed was that their account at SVB was frozen. To restore access, account managers had to provide the FDIC the information it would need to identify the account holders included in their FBO balance, aggregate their balances with other balances the same account holders might have at SVB (either directly or through other FBO accounts), do the math, and determine the amount of each customer’s insured balance.
But getting this data to the FDIC raised another set of questions: how and in what format should it be provided? These questions still have no clear answers. The FDIC has provided detailed guidelines and a dedicated channel for data submission to only one type of FBO account manager: deposit brokers. The agency has offered other FBO account managers no direction whatsoever for preparing or submitting the data required to unlock their customer funds - meaning the pass-through deposit insurance that FBO customers should enjoy as a matter of law could easily be, as a practical matter, unavailable.
We believe the SVB experience highlights a type of business continuity risk that managers of FBO accounts everywhere should stop to consider. History teaches that bank failures will continue to occur from time to time, often with little warning. If your bank fails, the FBO accounts upon which your business depends can be frozen for an indeterminate amount of time. In that moment, the fact that your customers enjoy pass-through deposit insurance doesn’t help much. Although the FDIC will make your customers whole in the long run, to the extent of their coverage, your business and customers alike could suffer enormous disruption waiting for that process to play out.
Future events could mitigate this risk. Congress could expand the deposit insurance safety net, possibly to all depositors or possibly to some smaller subset, including some or all FBO accounts. More likely (given the generally bleak outlook for legislation of all sorts), the FDIC will eventually clarify its guidelines and adjust its processes to provide FBO account managers with the clear direction they need when the chips are down.
Sadly, neither of these events appears imminent.
Fortunately, for FBO account managers wishing to take the mitigation of this risk into their own hands, some practical steps are available:
Establish and maintain redundant bank relationships and FBO accounts, structured to enable you to shift essential business activity quickly from one bank to another in the event of bank failure or other business discontinuity.
Maintain FBO account records in a format consistent with the data fields and formatting the FDIC requires for deposit brokers. While agency personnel expressly disclaimed the applicability of those requirements to other non-FBO accounts, the information the FDIC needs from FBO account managers to calculate deposit insurance coverage does not depend on the account managers’ underlying business models. It seems a good bet that whatever guidance the FDIC eventually provides to FBO account managers will look a lot like, and possibly just like, the guidance deposit brokers already have.
Work with your partner bank or BaaS platform to ensure the bank can receive and process information from your subaccount ledger to support FDIC insurance calculations.
Large banks with at least 2 million deposit accounts have been required by the FDIC to maintain such systems. Businesses that rely on FBO accounts but do not depend on Durbin-exempt interchange may consider partnering with one of these large banks. Under the rules applicable to them, their systems must be capable of ingesting broker files in a standardized format and making insurance determinations within 24 hours of failure. (SVB, with less than 150,000 deposit accounts, had no such system). Businesses that rely on FBO accounts at a large bank covered by the FDIC’s rule should test their files against the bank’s system.
An earlier version of this article first appeared in Fintech Nexus.
NOTE: An “FBO” account, for those unfamiliar with the term, means a deposit account maintained at a bank “for the benefit of” a third-party’s customers or end users. If you run any kind of business in which you take in funds from large numbers of customers, you likely park those funds at a bank, where they are held on deposit in a pooled (or “omnibus”) account for the benefit of your customers.
Photo by Verne Ho.