Dope demand means US banks get high in risk
The number of US banks servicing marijuana-related businesses (MRBs) is surging. This lucrative clientele come with higher risks that banks will need to manage carefully, regardless of proposed laws designed to help. But sophisticated technology could also come to their aid.
Financial institutions offering services to MRBs bubbled up from 337 in January 2017 to 714 in June 2019, according to the Financial Crimes Enforcement Network.
They want to work with the US’ fastest-growing industry that will be worth an estimated $50 billion within ten years. This growth comes on the back of an increasing number of states legalising marijuana in one form another – 33 at the last count.
But this trend has caused widespread confusion as marijuana remains illegal at federal level, causing many banks to shy away from the industry and forcing many MRBs to transact in cash. To address this, US politicians passed a bill – the Secure and Fair Enforcement (SAFE) Banking Act – in September. It aims to give banks federally approved safe harbour when serving MRBs and their suppliers.
It is a welcome move. But it is not certain if and when the act will become law. Even if that happens soon, serious challenges will remain for banks in this space.
There will still be tension and contradiction between state and federal law, and financial institutions will still face much hard work on risk, compliance, screening and due diligence.
The legal marijuana industry is emerging from the black market with its lawbreaking culture.
Some legally licensed cannabis companies have been forced to close, and or faced large penalties due to poor accounting, cheating or just not following the rules.
Banking risk and compliance officers will find it tough to ensure that those involved are sufficiently clean, with no contravention of know your customer (KYC) or anti-money laundering (AML) rules, for example.
Even with legal protections, the compliance burden on banks will be much higher than for other industries. On the plus side, they will be able to charge MRBs more to compensate for that.
Julie Hill, professor of law at University of Alabama, and a specialist in banking regulation, said: ‘Financial institutions operating in the marijuana space violate federal laws as providing say a loan to an MRB means the bank would be conspiring to distribute marijuana. By facilitating customers’ credit card payments and providing checking accounts, the bank would also be aiding and abetting distribution.
‘MRBs recognise that the federal government lacks the resources to prosecute most marijuana-related offences. But banks are in a more precarious position. They are supervised by a variety of regulators tasked with punishing legal violations. While these regulators seem to be allowing a small number of banks and credit unions to serve the industry, they set a high compliance bar.’
Given the differences between state and federal law, figuring out what is and is not legal activity is the first major challenge for chief compliance officers and chief risk officers in banks.
They also need to separate businesses working with hemp rather than marijuana as they are two different plants. Hemp is federally legal – although there are some restrictions – but marijuana is not.
Under the Bank Secrecy Act, institutions must report any suspicious activity. But many feel they do not have clarity around what the requirements are, so such activity is hard to monitor.
Legal experts say this confusion will remain until the federal and state agencies finalise their rules around the various substances and uses.
Next, the lack of access to bank accounts forces MRBs to use cash, making them a target for criminals as it is difficult for regulators and officials to track their revenue. Banks need to ensure these companies have pinpoint accuracy in their records and accounting practices to remain compliant and audit ready.
The American Banking Association (ABA) said that, as the possession, distribution or sale of marijuana remains federally illegal, any contact with money that can be traced to state marijuana operations could be considered money laundering and expose a bank to federal enforcement action and other significant legal, operational and regulatory risks.
In addition to growers and retailers, many suppliers, landlords and employees are linked indirectly to the marijuana industry. This poses daunting legal risks for banks – including those that do not bank MRBs directly – as indirect connections to marijuana revenues could also be a compliance risk but are difficult to identify and avoid.
Legal proposals seeking to clarify and bridge the gap between state and federal law provide a solid start for discussion but not a final solution, said the ABA.
Andrew Hunzicker, managing partner at Dope CFO, said MRBs themselves face a maze of confusing laws, regulations and financial issues.
‘Similarly, if you want to bank these companies, there are so many state and federal rules and laws you must follow; lots of documentation you must ask for and retain on each customer…all kinds of financials and tax returns,’ he said. ‘Also, they must audit the firm and go through the financials every quarter. It’s challenging.
‘The banks already established in this market have their own division for cannabis businesses with compliance officers, auditors and [full infrastructure of staff]. But if they’re banking a cannabis company that has any kind of illegal activity, that’s a huge risk.’
Indeed, they risk federal prosecution and legal penalties that could include loss of their federal deposit insurance or their license.
To work with MRBs, banks will need a robust internal infrastructure of governance, people and technology to meet these challenges.
Banks will also need help from their insurance, compliance, and technology providers. Banks should conduct research and due diligence to make sure all local and federal laws on marijuana are covered during the onboarding process.
Data-driven compliance will be crucial. Those with sophisticated, enhanced due diligence and onboarding technology, including advanced KYC and AML processes should have a considerable advantage. Institutions with deep web search technology can conduct more thorough investigations into client backgrounds.
Due to the monitoring requirements, technology that can help build an efficient and fail-safe audit trail will be crucial.
The risks are great. But with proper preparation and oversight, and with sophisticated technological solutions, banks can access this tricky market cleanly and successfully, and support an industry that needs them desperately.