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Digital banking platforms, or neobanks, have surged in popularity due to their convenience and high interest rates. However, recent failures and warnings have raised concerns about the safety of your deposits with these platforms. Here's what you need to know.

The collapse of Synapse, a key fintech middleman, has exposed significant risks in digital banking. Synapse was responsible for connecting customer-facing fintechs like Yotta with traditional banks that hold customer deposits. When Synapse declared bankruptcy in May, it abruptly shut down critical systems, freezing over $265 million in deposits for more than 100,000 Americans. Yotta, a lottery-style savings app that relied on Synapse to manage transactions through its banking partner Evolve Bank & Trust, saw 85,000 customers locked out of their accounts. Many users believed their funds were protected by Federal Deposit Insurance Corporation (FDIC) insurance, as advertised on Yotta's platform, but found themselves in financial limbo due to Synapse’s failure.

The Synapse debacle has broader implications for the fintech industry, particularly for apps like Cash App, PayPal, and Chime, which also rely on partnerships with banks rather than holding deposits directly. The incident highlighted that while these fintechs offer innovation and ease of use, they introduce vulnerabilities that can leave users at risk when intermediaries like Synapse collapse .

These incidents have prompted regulators to issue warnings, emphasizing that not all funds held through digital banking apps are fully protected, particularly when these apps serve as intermediaries between consumers and traditional banks.

Neobanks are digital-only financial institutions that offer banking services primarily through mobile apps. They provide several advantages, such as better user interfaces, higher interest rates on savings accounts, and easier access to accounts compared to traditional banks. However, there are important risks to consider.

Many neobanks are startups, which inherently carry a higher risk of bankruptcy than established financial institutions. Their business models, while innovative, are still untested over the long term.

Unlike traditional banks, neobanks themselves are not insured by the FDIC. Instead, they partner with FDIC-insured banks, meaning your money is technically held at these partner institutions. However, if a neobank fails, there may be delays or complications in accessing your insured funds.

Multiple government organizations protect depositors in times of trouble. The Federal Deposit Insurance Corporation (FDIC) is the main one, insuring up to $250,000 per depositor, per insured bank. That means if a bank fails and goes out of business, the FDIC steps in to manage the situation. It will either transfer your insured deposits to another institution or issue you a check for the insured amount, typically within a few days. Any funds over the $250,000 limit are at risk unless the FDIC can recover additional funds by selling the failed bank's assets. Similar to the FDIC, the National Credit Union Administration (NCUA) insures deposits at credit unions up to $250,000. For brokerage accounts, the Securities Investor Protection Corporation (SIPC) protects against the loss of cash and securities, such as stocks and bonds, held by a customer at a financially troubled brokerage firm. This coverage is up to $500,000, including a $250,000 limit for cash. So, as long as you’re at an FDIC, NCUA, or SIPC-insured institution, your money is safe up to those limit amounts.

The process is not exactly the same for neobanks that rely on partner banks to hold their customers’ deposits. The Federal Deposit Insurance Corporation (FDIC) confirmed that these nonbank companies are never FDIC-insured themselves, even if they partner with FDIC-insured banks. The funds only become eligible for FDIC insurance once deposited into an insured bank, and certain conditions must be met. Additionally, if the fintech company fails, the FDIC insurance does not protect against the company's insolvency. Consumers should be cautious and verify whether their deposits are indeed covered by FDIC insurance. So, getting your money back depends on whether your neobank has actually transferred it to an insured bank and kept detailed records as to which bank holds your funds.

Not necessarily, but it’s important to be cautious and make sure you understand how your neobank stores and records your deposits. We use a few great digital platforms and reached out to everyone to better understand how they protect our money.

Here’s what to do:

1. Verify FDIC Insurance: Ensure the neobank partners with an FDIC-insured institution and that your deposits are within the $250,000 insurance limit. If they promise greater insurance limits than that, reach out to understand how they might be spreading your deposits across multiple partner institutions. M1, for example, partners directly with FDIC-insured B2 Bank, which holds customer deposits. M1 also uses a cash-sweep program to distribute funds across multiple partner banks, maximizing FDIC coverage up to $5 million for its High-Yield Savings accounts. However, if M1 or B2 Bank were to fail, the funds at these banks would still be insured, but there could be delays in accessing your money due to the intermediary structure.

2. Understand Fund Management: Check how the neobank manages and distributes your funds. For example, M1 provides a list of partner banks on your monthly statement, giving you insight into where your money is actually held.

3. Assess Customer Service: Contact the neobank's customer service to gauge their responsiveness and clarity in explaining how your money is insured. If you don’t get a timely, clear response, consider reducing your balances. Transparency is paramount in this process. We put some of our platform recommendations on hold due to poor customer service responsiveness from certain platforms.

Questions to Ask Your Neobank:

1. Is my account FDIC-insured, and if so, what is the coverage limit?

2. Which partner banks hold my deposits, and how can I identify them?

3. What happens to my money if your neobank or a partner bank fails?

4. How quickly can I access my funds in the event of a failure?

5. Are there any scenarios where my deposits might not be fully protected?

Digital banking apps can offer more convenience than traditional banks, but they’re not the only places offering high-paying savings accounts. Big banks typically offer lower interest rates because they don’t need to compete as aggressively for deposits. However, smaller, insured banks and credit unions can offer similar rates to neobanks with potentially more stability. See rates here

It’s never easy to plan for the worst-case scenarios, but in times of crisis, you’ll be happy you did. By understanding how neobanks operate, what protections are in place, and the right questions to ask, you can make informed decisions about where to keep your money safe.

Keep building,

The Scoop Team