When Colorado became the first state to legalize recreational marijuana in 2012, the plant was (and continues to be) illegal at the federal level. Yet several Colorado banks jumped in, quickly opening accounts. Many of those banks were promptly swarmed with U.S. Drug Enforcement Agents. Everyone from tellers to bank presidents were warned that by servicing the cannabis industry, they could be arrested and held criminally liable under federal law. Most banks quickly backed away.
“It was very intimidating,” remembered Jenifer Waller, president of the Colorado Bankers Association. “They basically were being asked, ‘Do you think you’d look good in orange?’”
There were a few small banks that wanted to enter the business, however, “who really led the path on how to do it,” Waller said. These bankers had lived alongside their customers for decades, and saw no reason not to service their pursuit of a newly legalized business line. They worked with state and federal bank regulators, who were navigating oversight somewhat in the dark to establish the steps banks needed to comply with FinCEN guidance.
Since the November elections, 35 states and the District of Columbia have legalized either medicinal or adult-use marijuana, and interest in cannabis banking is increasing. And while the risks are better understood, Congress has yet to act on a proposal to provide bankers who service the industry a safe harbor. Still, bankers are increasingly looking at cannabis as a legitimate industry — and a business opportunity.
Edith Farrell, chief risk officer at Union Bank, Lake Odessa, Mich., pitched the case for banking the cannabis market to her board in 2018. At the time, deposits were hard to come by and she knew there was incentive to enter the market early.
She learned everything she could about the plant and the business, and talked to each of the bank’s regulators and stakeholders, including business partners, insurance carriers, correspondent banks, and any federal program affiliates. Whomever she could think of who might possibly be affected by the decision, she spoke to.
Understanding the regulatory guidance at this stage is essential. “[Bankers] have to understand the difference between federal and state law, and be able to take the FinCEN guidance that lays out the additional risk protocols that need to be in place to bridge the difference,” said Tony Repanich, president and chief operating officer of Shield Compliance.
The first successful cannabis bankers in Colorado were those who consistently communicated with regulators. Without federal legislation, Waller said, it’s really a matter of bankers following the FinCEN guidance, the state law, and working with regulators, openly discussing the necessary steps to manage and mitigate risk.
“It’s an all-in industry,” she said, and “it’s a very compliance-heavy, expensive industry to service.”
“It’s very simple in the abstract to talk about marijuana banking, and most people just think naturally of banking dispensaries, or maybe grow operations,” said Zane Gilmer, a Denver-based cannabis banking attorney with Stinson LLP.
Yet there’s nothing simple about determining what is and is not an MRB, or marijauna-related business. Each bank needs to establish the accounts within the industry they are interested in servicing, which businesses they’re not going to serve, and how they want to define those borders. “Stage one is working through those questions,” Gilmer said.
Gilmer compared the three “tiers” of cannabis banking accounts to three buckets of potential customers. Tier one accounts include the growers and dispensaries — operations that “touch” the plant. They require licenses, strict monitoring, and consistent Suspicious Activity Reports, which are regulators’ primary concern. Distinguishing between tier two companies (firms such as landlords whose activities support the “touchers”) and tier three accounts, those ancillary businesses that support second tier companies, will vary depending on the institution.
“There’s a lot of gray area, and that’s a gray area where the regulator has some discretion, and a bank has some discretion,” Repanich said. Banks have to be clear in their respective policies about how customers are evaluated from a risk perspective, and what the steps are to mitigate the risk.
Compliance varies for the three tiers. There’s not a lot of direct guidance on ancillary business regulation, Gilmer said, as “FinCEN guidance, the only guidance that’s out there, does not address tier two or tier three.”
Without guidance from the feds, “we are, as a collective industry, making it up as we go,” Gilmer said.
Banks must also ensure they do not accept “legacy funds or lingering profits” from the pre-legalization marijuana market, Repanich said. “Whenever you have businesses with a high degree of cash and a large illicit market that co-exists alongside a legal market, unsavory people want to attach themselves to these businesses,” Repanich said. From a banker’s standpoint, understanding the people behind the accounts is a vital aspect to compliance.
Compliance heavy lift
In March, a small credit union from Fraser, Mich., was penalized for inadequate compliance reporting for cannabis-related accounts. It was publicized as the first example of regulatory misconduct in cannabis banking. Under the enforcement action, Live Life Federal Credit Union was required to stop opening new cannabis-related accounts and file its missing SARs. The NCUA also required the institution to implement a transaction monitoring system by the end of April.
“In my opinion, they grew too big, too fast,” Farrell said. Lack of staffing resources, or a compliance infrastructure contributed to their troubles, Farrell said. “For any bank getting into cannabis banking, it’s complex,” Repanich said. “It’s about measuring your exuberance for serving these customers … with building a team that can manage the risk. And that team includes people and technology.”
Union Bank learned its lesson early. It took almost one full year before it implemented cannabis-specific compliance software, requiring backtracking and transferring data and information. “It would be a lot easier if we had that software in place to start with,” Farrell said. “It definitely streamlines the daily life of a BSA analyst.”
Gilmer agreed that not having sufficient compliance resources is a cannabis banker’s biggest mistake. “Many bankers and compliance folks know that this is a big deal, but I don’t think that they quite understand until they get into it, the amount of effort — financially and from a personnel perspective — that it requires,” he said, including additional third party vendor services to help monitor and manage the cash that’s coming through the system.
“When [bankers] hear compliance, they think, well, we do this all the time,” Gilmer said. “And that’s true, but not to the level that is required for marijuana banking.”
Even with compliance software, however, banking cannabis requires a new level of customer service and personnel investment. Account managers will collect 15 to 20 documents before opening a tier one cannabis account. And due diligence is an unrelenting pursuit.
Gilmer often gets asked to evaluate risk for banks, walking them through the potential doomsdays of the decision, and weighing them against the potential opportunities. “The Department of Justice isn’t coming in and arresting bankers; board members aren’t shutting down banks; FinCEN isn’t coming in and sanctioning banks,” Gilmer said. “We know how to do this in a relatively safe way that lowers the risk.”
Two things are related: Setting up a robust, thorough compliance program, and mitigating one of the biggest known risks on the back end, which is an enforcement action. However, it’s a risk that more conservative financial institutions just aren’t willing to take.
Some banks will be morally opposed to cannabis banking, said Karl Adam, president and CEO of the South Dakota Bankers Association. “And there’s nothing wrong with that. People can make those decisions and say, ‘as a bank, we choose not to bank these businesses.’”
But they’ll still have to navigate a new degree of scrutiny, and make sure they’re not banking the industry by accident. “At the same time, there could be opportunities and some rewards to being involved in the industry, if you can do it right,” Adam said. “Some banks certainly have an appetite for this, and some banks may not.”
Adam sees the community bank model as more suited for the business side of cannabis banking. “Some of the bigger banks have different fish to fry,” he said.
Community banks with multiple locations that are engaged with their existing business community, he said, are set up well to get started. “They’re going to say, if we don’t get involved, we might lose some of our core business.”
Farrell prioritizes understanding a cannabis business’s objectives, goals and needs. “If something goes wrong, I want them to come to me and tell me,” Farrell said. “You’ve got to build that trust with them so that they’re willing to share with you the information you need.”
Part of building trust is creating the infrastructure that makes compliance easy. “[Cannabis businesses] know they need to provide additional information to the bank,” Repanich said. “You can make it efficient for the customer to know what information needs to be provided.”
For community banks looking to diversify their portfolio and for a new revenue stream where they’re not having to compete with the big nationals, Gilmer said, “this is an opportunity.”
“If something went wrong, smaller banks probably wouldn’t be able to withstand the lightning strike like a bigger bank would,” Gilmer admitted, “but the upside for them is much greater than the nationals’.”
And community banks, which traditionally have a foundational focus on relationships, are set up uniquely to foster the necessary transparency for compliance.
Once marijuana is no longer a Schedule One drug at a federal level, many expect the bigger banks to move in, and the “Budweisers of the world,” to take over the production side, Farrell said. She hopes the cannabis businesses in her area are well established by that time so they can compete.
To bank the industry early means more deposits and additional revenue. But as competition grows within the marijuana industry in general, Farrell said, the upside will be smaller. “The longer a bank waits to … get involved, the less opportunity they’re going to have to take advantage of the revenue that could be made,” she said.
As of now, there’s enough volume in the business to make the industry attractive for banks. “There’s still opportunity out there,” Farrell said.
Ultimately, banks that have successfully banked the industry have started slow and walked carefully. What regulators want to see, “is that crawl, walk, run period,” Repanich said. “But the playbook has been written, and this can be done.”