By Paul Dunford
Considering there is no other industry today where a business can be engaged in activities that are simultaneously prohibited under federal law but sanctioned by the state, banking cannabis (marijuana specifically) is inherently unique. Through FinCEN’s 2014 guidance, “BSA Expectations Regarding Marijuana-Related Businesses,” banks and credit unions have a blueprint for banking cannabis that ensures they can fulfill their own compliance obligations, but it unfortunately remains rather high level, stopping short of addressing operational specifics like the kinds of products and services they can offer and at what price. They do clarify that understanding the risks and rewards associated with cannabis is key to successfully banking the industry, so while that winning equation will be different for every financial institution there are certain things all programs have in common and ways that banks and credit unions can not just survive but thrive in an increasingly competitive banking environment.
Unrivaled transparency into the activities of the business
Even though these are highly regulated businesses that have been vetted by the state’s cannabis regulatory agency prior to licensing, there always remains an underlying concern that the legal marijuana market can be used as an avenue for introducing funds derived from the state-level illicit market. This means that financial regulators expect financial institutions to be able to demonstrate that banks and credit unions aren’t facilitating that kind of activity. A financial institution must be able to confidently assert to their examiners that every dollar that enters the institution is the result of a state-legal sale.
The extensive reporting requirements imposed on this industry means that it is relatively easy for a cannabis business to share with their financial institution more data than any other business in their portfolio. Consider a dispensary: the state cannabis agency requires them to have a point of sale system that can feed their mandated “seed to sale” program, which is a system where all cannabis businesses are required by law to report their activities to mitigate the potential diversion of cannabis products in the supply chain. This elevated expectation of providing transaction level transparency works to a financial institution’s advantage. When else does a bank or credit union have that kind of insight into the deposits and withdrawals of a business outside of cannabis? Where else can a financial institution expect to be able to see, in real time, the transactions generating the dollars that are deposited?
Financial institutions are also obliged to demonstrate greater insight into the beneficial ownership structure of these businesses than any other based on the emphasis FinCEN placed on beneficial ownership reporting. While the standard threshold for “regular” banking is 25%, most financial institutions are imposing a more aggressive threshold specifically for Direct marijuana businesses. We’re usually seeing between 5% and 10%, with some financial institution even requiring 100% disclosure of beneficial ownership.
Financial institutions know their cannabis customers/members better than any other, on a per-transaction basis, which suggests somewhat counterintuitively that the risk associated with banking these businesses might actually lower compared to, say, a cash-heavy restaurant that doesn’t have any kind of reporting system in place. With a restaurant you operate on faith in good intentions, with a cannabis business you operate on data.
Making a positive community impact
Despite advancements in electronic payment options, a strong majority of cannabis purchases are paid for with cash. Cash presents an inherent security risk because it’s easily moved, it’s relatively untrackable, and it’s easy to reintegrate into the financial system. Now this isn’t something that’s unique to cannabis per se, but the amounts associated with the industry are probably higher than what you’d see being deposited by a gas station or dollar store. Because cash attracts the attention of criminals, allowing cannabis businesses to deposit cash on a regular basis (as opposed to keeping it onsite in a safe) makes these businesses, their employees, customers, and community residents safer.
Providing financial services to cannabis businesses is more impactful on the ability of the cannabis industry to operate efficiently in a way that most outside of the industry don’t quite understand. There are restrictions on what kind of lending that a prospective cannabis entrepreneur can access. For instance, in 2018 the Small Business Association made it clear that Direct and Indirect cannabis businesses are ineligible for SBA loans. The same applies to other federal loan programs. Some states, like Illinois, attempt to provide alternative lending options through programs they run themselves, but access to capital remains an issue.
Consider that most if not all states have some form of what’s called a Social Equity Program, designed to provide opportunities in the legal cannabis market to those that have traditionally been disenfranchised by the long and destructive War on Drugs. These are folks that don’t necessarily have generational wealth or hard assets like real estate that they can bring to the table when building a business from scratch so unfortunately the ones that are best able to make their entry to the market are not “mom and pop shops” but large corporate entities, often multistate ones, that are more attractive to private investors and venture capitalists because of the scale and sophistication of their operations. A person coming from a background that has qualified them into a social equity program may have a criminal conviction on their record or live in a disproportionately disadvantaged community, meaning they face barriers to banking access even before cannabis is brought into the picture. Extending credit and banking services to social equity-eligible persons and businesses can quite literally change lives.
The opportunity to stand out in a crowded market
When was the last time that a financial institution was able to offer something totally new to an untapped market? Perhaps cryptocurrency, but that has been far from widely embraced by mainstream banks and credit unions due to the difficulties managing the risk associated with a fully online, volatile, unregulated securities market (several of which have blown up rather spectacularly in the past few years). The key difference with marijuana is that it is highly regulated on a state-by-state basis, licensed, inspected, and monitored throughout the supply chain by subject matter experts at state cannabis regulatory agencies. This can make the risk “worth it” to a financial institution.
Once a bank or credit union does decide they’re willing to offer services to cannabis businesses they instantly stand out from the pack. It’s a shame that many financial institutions remain discreet to the point that they don’t even have a page about cannabis banking on their websites because embracing the industry can not only help grow this line of business but it can also reinvigorate a struggling consumer banking program. For instance, a recent McKinsey and Company report that looked at the challenges facing a contracting credit union market found that as existing members age out they’re not being replaced by younger consumers that prefer “big banks”. However, they found that “Gen Zers and millennials […] may be more drawn to credit unions’ record of commitment to strengthening communities, protecting consumers, and ensuring financial inclusion.” These are all areas that intersect with cannabis, meaning that making a choice to bank the industry can be leveraged to demonstrate a commitment to serving the community and aligning with social equity causes, securing that all-important next generation of consumers. While this report was specific to credit unions, as Gen Z’s preference was seemingly for “big banks” we can assume that the same would apply to community banks as well.
In summary, cannabis banking programs offer a unique blend of opportunities and challenges that set them apart from other sectors. The rigorous transparency and compliance requirements associated with the industry provide financial institutions with unparalleled insight into their cannabis clients, while also presenting a chance to make a meaningful impact on community safety and social equity. Embracing cannabis banking not only positions institutions as forward-thinking leaders in a burgeoning market but also aligns them with the values of transparency and community support that resonate strongly with the next generation of consumers.
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