Intensified Scrutiny on Banking-as-a-Service Institutions by Regulators

In a significant move, Blue Ridge Bank's former CEO Brian Plum has stepped down, and the bank is re-evaluating its focus on Banking-as-a-Service (BaaS) to refocus on community banking. This decision comes amidst increased regulatory scrutiny following the banking crisis this spring, which involved the collapse of three regional lenders closely tied to the fintech sector.

The increased focus on BaaS programs is due to their operational complexity, and regulators are attempting to recalibrate their supervision of these banks. According to Konrad Alt, a partner at financial services advisory firm Klaros Group, more robust, larger, and mature fintechs prefer to have direct dialogue with their bank rather than have that intermediated by some platform, even if the platform is good.

This shift in regulatory focus is also affecting middleware providers like Synapse. Following the decision by Mercury to end its relationship with Synapse and work with its partner institution, Evolve Bank & Trust, directly, Synapse had to let go of 86 employees, representing 40% of its workforce.

The increased regulatory oversight is not limited to Blue Ridge Bank and Synapse. Fintechs selected by banks as partners for operating BaaS programs, such as Solarisbank, N26, Finleap, and Trade Republic, are also facing increased scrutiny. All these companies are prominent Berlin-based fintech companies involved in innovative banking and financial services.

Cross River, another BaaS powerhouse, has also been hit with an enforcement action by the Federal Deposit Insurance Corp. this year. However, unlike Blue Ridge, Cross River hasn't announced any plans to pare its BaaS program. Cross River CEO Gilles Gade expects regulatory scrutiny on banks supporting fintechs to increase due to the recent volatility in the banking sector.

The $9 billion-asset bank, which provides technology infrastructure for numerous payments, fintech, and crypto firms, has been accused by the FDIC of engaging in "unsafe and unsound" practices related to fair lending laws and regulations. As a result, the bank is not allowed to enter into new partnerships with third parties or offer new credit products without the FDIC's approval.

Interestingly, banks operating BaaS programs tend to have smaller balance sheets, meaning they don't necessarily fall under regulators' lists of firms that deserve heightened scrutiny. However, the recent incidents have highlighted the need for stricter oversight, especially given the operational complexity of these programs.

Regulators are less familiar with middleware providers like Synapse due to their non-consumer-facing nature, according to Alt. This lack of understanding could potentially lead to more enforcement actions against BaaS firms providing underlying banking services for fintechs.

In conclusion, the banking landscape is undergoing a significant shift as regulators increase their scrutiny on BaaS programs. Banks and fintechs alike are having to re-evaluate their partnerships and operations to ensure compliance with the ever-evolving regulatory landscape.