When a bank fails, the Federal Deposit Insurance Corp. tends to act quickly to protect customers’ money and arrange for a healthy bank to buy the failed one. This process happened most recently on May 1 when First Republic Bank failed. But what happens if a neobank fails?
A neobank, such as Chime or Current, is a financial tech company that often partners with a bank to offer FDIC-insured checking or savings accounts. But a bank partnership doesn’t mean a neobank failure would be identical to a bank failure. So let’s break down how accounts work at neobanks and what can happen to your money if you’re at a neobank that fails.
FDIC-insured accounts at banks vs. neobanks
Federal deposit insurance protects your money, up to at least $250,000, if a bank fails. Federally insured banks have FDIC insurance — which can be disclosed as “Member FDIC” — and credit unions have the equivalent insurance through the National Credit Union Administration.
Neobanks are fintech companies that usually provide online checking accounts, and sometimes savings accounts, on a mobile app or website. Neobanks offer an easy sign-up process and often forgo monthly fees on accounts. They can also attract people with consumer-friendly services that banks don’t always have, such as direct deposit up to two days early and fee-free overdraft coverage. Their accounts usually have FDIC insurance in one of two ways.
Most neobanks, such as Chime, Current and Greenwood, have a partnership with one or more banks that enable their customers’ money to be held in FDIC-insured accounts at these banks. These nonbank neobanks manage the consumer-facing experience, including the banking app, website and customer service, while a bank handles the money in accounts behind the scenes.
Some institutions, such as SoFi, Varo Bank and Green Dot’s GO2bank, are fintech companies and banks, meaning they have bank charters and are federally insured. If one of these institutions fails, the FDIC will step in to safeguard the money of the bank’s clients. Given their tech focus and checking accounts more akin to nonbank neobank products, these online banks may still be referred to as neobanks. For this article, we’ll focus on the nonbank fintech firms.
Related: Is the deposit insurance system broken? Nine things you need to know about how your bank accounts are covered — and how the system could change.
A neobank failure might mean delays in accessing funds
In a July 2022 fact sheet, the FDIC stated that “by federal law, the FDIC only insures deposits held in insured banks” and only if a bank fails. In other words, FDIC insurance applies if a neobank’s partner bank fails but not if a nonbank neobank does.
Let’s say a nonbank neobank fails. “If your money is at [a] bank, you’ll probably eventually get it back, but we don’t know what problems are going to occur” at the nonbank, says Lauren Saunders, associate director at the National Consumer Law Center. She says that potential issues from a nonbank’s failure could include a lack of access to your money, frozen accounts, transactions not going through, the nonbank’s app not working, or the account balance displaying a wrong number.
“Front-end fintech companies that are doing this banking as a service in partnership with a bank, what they’re good at is building apps and marketing,” says Suzanne Martindale, senior deputy commissioner of the California Department of Financial Protection and Innovation’s consumer division. “But the questions are always going to be on the back end. Have they thought through and baked in consumer protections in their product, including robust customer service?”
When the FDIC takes over a failed bank, the agency typically ensures that customers have continuous access to funds and services, such as mobile apps and branches. These regulatory actions don’t apply to a nonbank neobank.
“FDIC insurance isn’t going to help you get customer service” at a nonbank, Saunders says.
See: Banks under pressure: How to maximize your FDIC protection.
Recent neobank closures
In practice, several U.S. neobanks that have closed gave their customers time to withdraw their money.
The LGBTQ-focused neobank Daylight announced in May that it was closing operations on June 30, according to the website. The neobank, which partnered with the bank Pathward, said that banking customers’ money is safe and the decision to close was “unrelated to the wider banking crises happening globally.” In addition, the neobank said customers were given instructions for transferring money before the closure date.
The German neobank N26, which partnered with Axos Bank, shuttered its U.S. operations in January 2022. Like Daylight, N26 notified customers ahead of time and explained how to transfer money. For customers with funds left in accounts after closing day, the neobank stated that it would issue a paper check with the remaining balance to the address on file.
On the other hand, Simple, a popular neobank in the 2010s, which the bank BBVA acquired, had a difficult shutdown process in 2021. When Simple customers were migrated to BBVA, there were account access problems, an overwhelmed call center and an apology from the bank.
Losing access to funds is an issue at fintech firms
Access issues aren’t limited to neobanks that close. For example, the neobank Chime abruptly froze or closed customer accounts in 2021 in what the company said was a crackdown on fraud, according to the nonprofit news site ProPublica’s report. And in October 2022, news sites reported more than 100 N26 customers in Europe, including Ukrainian refugees, had their accounts suddenly closed.
Neobanks aren’t the first type of fintech company to partner with banks to offer FDIC-insured accounts. Prepaid card companies such as Netspend have done this since at least the start of the millennia. Prepaid debit cards work like debit cards but aren’t linked to a checking account.
“We’ve seen over the years a lot of problems with prepaid cards and the Chime account and others that have had difficulty with people accessing their money,” Saunders says.
Thousands of RushCard prepaid card customers were locked out of their accounts for up to several weeks in 2015 due to a technical issue. In addition, Walmart prepaid card customers experienced a shutdown for several days in 2016.
Tips when using a neobank
The relatively simple-to-join, low-cost banking experience of a neobank can be enticing, but keep these guidelines in mind:
- Confirm your account is FDIC insured and by which bank. Scroll to the bottom of a neobank’s website for a disclaimer or link to an account disclosure that names the bank offering accounts. Then, type that name into the FDIC’s BankFind tool to confirm that the bank is insured by the FDIC.
- Know the customer support channels and hours. If something goes wrong, can you call the neobank, set up a live chat or otherwise reach the bank? And at what hours? You might want to do a test run.
- File a complaint if issues arise that aren’t addressed. Keep records of the issues and your attempts to contact the neobank and file a complaint with the Consumer Financial Protection Bureau or another regulator.
- Know all your banking options. When choosing where to bank, remember that traditional banks and credit unions tend to be more established than neobanks.
These questions are vital in determining what happens to your money if a company goes under: “At the end of the day, the question to ask is, ‘Who’s holding my money? Where are my deposits being stored?’” Martindale says.
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Spencer Tierney writes for NerdWallet. Email: [email protected].
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