Why fintech cash accounts are drawing heightened scrutiny
Notoriously paper-thin margins have forced digital wealth managers to look beyond traditional clients for new sources of revenue. Promising targets? Customers of brick-and-mortar banks.
By partnering with chartered banks, Betterment, Wealthfront, Personal Capital, Acorns and dozens of other digital platforms, have added high-yield savings accounts — in many cases with market-leading yields — to their robo arsenals. The new partnerships leapfrogged the regulatory burden of obtaining a bank charter and allowed brokerages to effectively offer the same banking products.
However, such cash management products are more complicated than traditional savings and checking accounts held at a single institution and require clients to pay extra attention, particularly when opening accounts, experts say.
And, regulators are taking notice.
“When startups enter a new market, there’s always risk involved,” says Eric Sandrib, a research associate at Aite Group. “Startups tend to roll out new products fairly quickly.”
One such risk — albeit a statistically small one — is FDIC insurance could lapse on a client’s assets while they’re being transferred between accounts to a partner bank, a process that could take three days or more, says Arielle O'Shea, a banking specialist at NerdWallet. Until the money enters a registered bank account, there is no guarantee it is insured, she says.
“It’s something consumers should be aware of.”
Kate Wauck, a Wealthfront spokeswoman, responds that, as with all sweep programs, the deposited funds receive FDIC insurance once they reach the partner bank and because broker-dealers who offer sweep programs are not banks, the funds are guaranteed by the SIPC. Wealthfront explains the differences to clients when the account is being opened, she says in an email.
Wauck adds that “we have a pretty arduous process for vetting banks,” and says that the firm works with a cash management intermediary firm, Total Bank Solutions, which deals directly with the banks.
Wealthfront did not comment on how partner banks are chosen or why. Betterment declined to comment.
The new offerings have certainly proved popular. In April, Wealthfront said it collected $1 billion in its first month after launching its cash product tool. (The Redwood City, California-based robo advisor eventually wants to offer mortgages as well.)
More than 20 million Americans live in a household without a checking or savings account at a bank, according to an FDIC survey. Approximately half of these individuals own or have regular access to a smartphone, according to the survey, meaning offerings from digital-first firms like robo advisors could see even more traction and a bigger uptick in assets in the coming years.
Since most digital platforms partner with a handful of partner banks, the firms advertise FDIC protection of up to $1 million on its website. However, the $1 million claim may prove akin to false advertising, according to experts.
The standard deposit insurance coverage is limited to $250,000 per depositor per bank, according to the federal agency. When assets are under the robo advisor’s control, they are subject to SIPC insurance and only become insured by the FDIC after the transaction, experts say, which could cause confusion.
Clients can inquire about specific insurance coverage by accessing the commission’s Electronic Deposit Insurance Estimator portal.
Consumers are also responsible for ensuring they stay within the FDIC coverage limit of $250,000 per partner bank, according to disclosures from multiple firms. Any held-away assets must be monitored by the client to ensure they don’t exceed the FDIC-insured limit. Some digital wealth managers allow clients to opt out of certain banks, but prospective clients will have to be aware of where their cash is going and when.
“These partnerships are unproven,” says Ari Socolow, owner and manager of BestCashCow.com, a site that publishes national savings rates. “One thing you learn [when dealing] with this type of regulation is that people can say anything they want. I find it a little concerning.”
FINRA says it will monitor how the cash accounts and bank sweeps accounts are being advertised to clients in the coming year, according to its 2020 Risk Monitoring and Examination Priorities letter. For example, the agency will check for compliance specifically including FINRA Rules 1017 and the Exchange Act Rule 15c3-1, which monitor business operations and communications with the public.
“While these bank sweep programs may offer useful features to customers — and in some but not all cases, offer higher-than-average interest rates — they have also raised several concerns about firms’ compliance with a range of FINRA and SEC rules,” according to the letter.
Socolow says clients will face “control issues” that may become a major problem for customers. “You're taking on risk that you cannot control because you don't know exactly when the money is being transferred or to whom. So the question really becomes — why do it?”
To help with transparency, some firms offering online banking tools provide statements to clients with the location of their assets. At Wealthfront, for example, clients receive monthly statements for their cash account that tell them exactly where and how much is with each institution, according to the firm.
In the case of Personal Capital, the robo advisor displays the program bank names along with the amount of deposits held in each account within the platform architecture, according to Dan Stampf, head of the cash management program at Personal Capital.
The Redwood City, California-based firm partners with UMB Financial Corporation to find suitable program banks, according to Stampf.
Personal Capital receives a fee from each program bank based on the aggregate daily closing balance of deposits held in program accounts, according to Stampf. The program banks are not directly compensated.
“Every program bank is FDIC insured and well capitalized,” Stampf says in an email. “Additionally, a further screening process exists and criteria has been established that program banks must meet to participate.”
Aite Group’s Sandrib is sanguine about online banking products and the processes that accompany them.
“We don’t see too many downsides of parking cash at a robo investor,” he says. “Maybe it is lacking a bit of transparency regarding who some of the partner banks are and when exactly which banks are holding client cash.”
But, Sandrib says, “we’re talking about savings accounts, which are not overly complex. These are tried and true products.”
While the vast majority of deposits will likely be insured, there are cases when firms have offered protections when none actually existed. In late 2018, for example, the online discount brokerage Robinhood had to backtrack on promises of a cash account which it said would pay a market-topping 3% interest. In reality, the accounts weren’t actually covered by SIPC insurance.
“Ultimately, there are protections in place and firms are starting to push those boundaries,” Socolow says. “For firms — who ultimately do not have liability — to say they are providing protection is very dangerous.”
Ultimately, the difference might come down to trust, says Ken Tumin, founder of the bank comparison site DepositAccounts.com. With banks you can easily verify their FDIC membership status and ensure that their website URL matches what the FDIC in its database, he says. “With these robo advisors and other fintech non-banks, it's a lot more complicated,” Tumin says.
The FDIC has also taken notice. In December, the agency’s chairman Jelena Williams delivered remarks specifically addressing brokered deposits — a term which broadly describes deposits made into a insured institution by a third party broker.
“As the banking landscape has changed, and the permutations of how deposits are structured and offered have expanded, the FDIC’s brokered deposits regime has struggled to keep up,” Williams says in the statement. “The result was the development of a fragmented, opaque legal regime that exists outside of the FDIC’s public-facing regulations, understood by only a select few.”
However, Congress would have to decide “whether and when” a review of the brokered deposits statute would be deemed necessary, adds Williams. Until then, her agency is willing to uphold the law as it stands, she says.