Building and Running a Successful Cannabis Banking Program

By: Paul Dunford, Co-Founder & VP of Knowledge at Green Check

As the cannabis industry continues to grow, financial institutions are increasingly exploring opportunities to bank cannabis-related businesses (CRBs). Engaging with the industry offers opportunities for growth, but with that comes some unique challenges. In my experience working alongside over 150 financial institutions I’ve seen it all, from large national programs ambitious to corner the market to very small local ones that aim to solely support existing members that move into the cannabis space. There is no “one size fits all” solution out there, but we can share insights from the most successful programs in our portfolio.

To grow a successful program, you first need to make sure that your team is all on the same page about why you’ve made the strategic decision to take on this high-risk line of business. These are the six most common reasons we’ve seen, in no particular order:

Low-Cost Deposits Expansion into New Markets Inclusivity and Serving the Underserved Fee Revenue Loan Opportunities Fintech Program Opportunities

Why is this key? Because the market will change and evolve over time and you constantly need to check to make sure your decision to bank cannabis continues to serve your financial institution in the way that you had intended.

For example, traditionally financial institutions were able to levy heavy account fees because there was very little competition. However, long gone are the days of charging $3,000 a month. In fact, we’re aware of a handful of financial institutions that have dropped their fees to zero in a very competitive adult-use market. We’re aware of one financial institution that was able to shift over to lending to compensate, and by being one of the few to lend in their market they’ve actually grown their program, pulling customers away from other financial institutions that are still charging hefty fees and not offering lending.

Truly successful cannabis banking programs accept that fee revenue is going away, faster in some states than others, and the next generation of cannabis banking is going to be heavily supported by lending to the industry. Because they are excluded from federal loan programs, like those administered by the SBA, there are far fewer lending opportunities available to cannabis businesses and operators than to other “normal” businesses. Currently, that need is met by a patchwork of private lenders, crowdfunding, and friends-and-family contributions. There’s clearly a need and it can be a profitable line of business for financial institutions without being usurious. For direct cannabis lending we commonly see a rate of prime + 3% or more, making it attractive to both operators tired of facing high rates and financial institutions that can derive a little bit more revenue than they would on a “regular” loan.

There are a few things to consider however:

Understanding Business Models Just as compliance analysts must be familiar with cannabis business models and valuations, your lending department also needs to have that industry knowledge. They need to understand concepts like the “green tax” and inflated valuations based on industry-specific build-outs.  Cash-Intensive Operations The challenges of dealing with high cash volumes may be something that your lending group isn’t familiar with, potentially increasing the likelihood of accounting errors. Collateral The most valuable assets associated with a cannabis business might be those that cannot be collateralized. One of the leading examples is the state-issued cannabis license itself. There is often a perception that a cannabis license is extraordinarily valuable, but that’s not always the case. In a state like Connecticut, under the medical program, there was a hard cap of 18 licenses for dispensaries and 4 for growers, so if anyone wanted to enter the market they had to purchase an existing business. However, in a state like Oklahoma that until recently did not have a cap on the number of licenses issued, coupled with a very low barrier to entry in terms of application fees, it may make more sense to get a new license than go through the process of trying to buy an existing one. This highlights the importance of understanding your particular market and how it might differ from that in another state. However, even in a state where a license is a valuable asset, keep in mind that some states won’t actually allow you to collateralize one. Consider your passport – it’s in your possession, you can use it to facilitate your movement internationally, but it’s not actually yours; it’s the property of the US government and they can revoke it at any time. It’s the same with cannabis licenses. In those states that do allow it, like Maryland, you may have to go to the state cannabis regulator to get their permission. Portfolio Risk While one could argue that loans to CRBs might ultimately be less risky than to other industries because of the highly-regulated nature of state-legal cannabis, particularly if you own the depository relationship and can see every dollar that enters and leaves their account, the fact remains that due to the federal prohibition on marijuana, a decision to lend to CRBs will impact your overall lending risk. Bankruptcy Implications and Receiverships Within cannabis as a whole, marijuana-specific businesses cannot take advantage of Chapter 13 bankruptcy protections, per the Office of the US Trustees. That means that your financial institution will have to come up with a plan to handle any loan defaults, keeping in mind that you cannot repossess cannabis products as they are a controlled substance and you would need a cannabis license to do so. You absolutely need to come up with a receivership strategy to handle these potential issues.

Once you’ve made the decision to bank cannabis, and there’s agreement at the Board and senior leadership level on strategic priorities, successful programs are built on top of the 2014 FinCEN Guidance, “BSA Expectations Regarding Marijuana-Related Businesses”. That’s the document that examiners and auditors look at to evaluate the effectiveness of your compliance program. Here’s what they will ask and expect you to have solid answers for:

Risk Awareness Your examiner will grill you to make sure you fully understand the risks that come with banking this high risk line of business, from the Board level all the way down to the tellers that might be accepting cash in the branch. Make sure you have a robust risk assessment available for them to review. Enhanced Due Diligence One of the primary tenets of the 2014 FinCEN guidance is that you need to demonstrate that you understand who is involved in these businesses, so you need to thoroughly vet your potential customers. A good way to demonstrate this rigor is to use a beneficial ownership reporting threshold more comprehensive than the usual 20% to 25% most financial institutions use. We recommend at least 10%, but we’d further suggest that you tie your threshold to what the state requires for disclosure in their license application. It can be as low as 5% or require the disclosure of 100% ownership. Anticipate Complex Beneficial Ownership Structures Multi-state operators (MSOs) and market consolidation can complicate your efforts to verify beneficial ownership because cannabis regulations require every MSO to essentially operate as a brand that establishes discrete corporate entities in each state. When an MSO operates in multiple states things can get complicated quickly. Continuous Monitoring The fundamental purpose of BSA/AML efforts is to keep bad money out of the financial system. You’ll have to demonstrate that you have a transaction monitoring solution in place to automatically review sales for compliance with state cannabis laws and flag potentially suspicious activity. The most commonly used transaction monitoring systems aren’t built to screen cannabis-specific activity so you’ll need to have a supplemental solution in place from a provider with experience in cannabis. This is particularly true if your financial institution has a large number of cannabis customers, where reviewing point-of-sale reports manually would be prohibitively slow and expensive in terms of person-hours required. FinCEN Reporting This one could not be simpler: you have to file your Currency Transaction Reports (CTRs) and Marijuana Suspicious Activity Reports (SARs) promptly. Your examiner will ask you to demonstrate that you are filing these on time – and we’ve learned that they monitor this to some extent and will reach out to financial institutions that are lagging behind. It’s highly unlikely that you’ll run afoul of your examiner by banking cannabis, but it’s likely that you’ll run into problems if you don’t file your SARs on time. Adaptability Be prepared to exit the business if legal or strategic circumstances change. This goes back not just to making sure you stay in alignment with your strategic goals, but also being aware that there is always a chance that the federal or state status of marijuana will change. How would that affect your decision to bank cannabis? Your examiner will likely ask you to describe how you’d gracefully exit the entire line of business (or just one customer/member relationship) if the legal and political landscape shifts.

Once you’ve built your program, you have to keep up with what your market will bear in terms of fees and services offered. As mentioned above, there is real competition in some markets now and for the first time cannabis businesses are able to shop around for their best option. They’re no longer willing to accept high monthly fees and they’re also starting to expect the following:

Fast and responsive onboarding Do you have tools to automate the data collection process and the internal resources trained to understand the specific needs of CRBs? Operating accounts and check writing Including ACH/tax payments, most CRBs would consider this the bare minimum set of services Online banking and remote deposit capture More often than not, this isn’t an issue, but check with your vendor Low (or zero) fees This isn’t always possible based on your market and your own financial model Cash handling If your current vendor does not work with CRBs, there are options that specifically serve the industry Lending Do you have the internal buy-in and necessary expertise? Debit cards for business purchases A very common ask that isn’t always possible – check with your vendor International wires Consider your correspondent banking relationships and, should they decline to facilitate cannabis wires, explore whether there might be alternatives available Integration with POS and invoice systems You’ll be requiring POS or invoice data for transaction monitoring purposes so CRBs want a “set it and forget it” solution

Cannabis banking can be an incredibly rewarding line of business, and financial institutions that are aligned on their strategic goals, ready to pivot as circumstances and markets change, are open to lending, and responsive to the needs of a more sophisticated customer/member are those that run the most successful programs. Regardless of asset size, market, or age of program, any financial institution can build and run a profitable program if they follow these best practices.