The federal government’s ambiguous guidance further compounds the uncertainty ...”
Engaging with marijuana firms exposes financial institutions to legal risks, including the potential violation of federal money laundering laws. Institutions and employees who knowingly engage in money laundering face federal prosecution. In addition to prosecution, there are onerous financial penalties. The penalty for money laundering is two times the amount of cash involved in the offense. For example, processing $250,000 in cash could result in a fine of $500,000.
The federal government’s guidance further compounds the uncertainty, as it can be revoked at any time, leading to liquidity risks and account closures.
On top of the legal and liquidity concerns, financial institutions must also grapple with reputational risks. The acceptance of marijuana-related deposits could potentially lead to negative perceptions among other depositors. Institutions are keen to avoid associations with businesses that might generate scandalous headlines and strain their standing as a trusted community bank.
STRATEGIC CALCULATIONS
Given these risks, few financial institutions are willing to work with marijuana firms. However, when Washington state legalized recreational marijuana in 2012, credit unions like Salal and Numerica ventured into providing financial services for marijuana businesses. Their experience is a valuable case study for bankers and businesses alike.
Credit unions saw themselves as serving an important need in communities concerned about the potential crime associated with a large, cash-only business. Potentially associated home invasions and violent crimes had occurred recently in other states that had legalized marijuana and did not have a banking solution. These credit unions felt that it was in the best interest of their communities to take cash off the streets and store it securely in a financial institution.
By embracing this new industry, credit unions financially stood to benefit as well. They sensed that legalized, recreational marijuana would be a multimillion-dollar industry. This was an opportunity to innovate, experiment and ultimately influence and lead the financial industry into the marijuana business. In 2014, Salal estimated that 80% of its future value would be driven by marijuana-related banking. In the short term, credit unions set account fees to cover costs. Roughly 75% of annual fees were used for personnel to manage these accounts and 25% covered overhead, out-of-pocket costs and compensation for the risk that the credit unions were taking. Credit unions eventually used deposits to fund loan activity but had strict rules in place to limit the liquidity impact of unexpected changes in marijuana regulations.
Officials in Washington played a critical role in helping financial institutions partner with marijuana businesses. Department of Financial Institutions (DFI) Director Scott Jarvis spent significant time working with federal regulators to develop guidelines and documents to help businesses and bankers figure out how to bank as legally as possible. Regulators in Washington wanted to facilitate revenue collections. Bank accounts created financial records and kept businesses from evading taxes in an underground economy. Moreover, they simplified the process of paying taxes. Without a bank account, firms hired armored vehicles to deliver monthly tax payments to the Department of Revenue.
BUSINESS ACCOUNTS
Credit unions developed highly customized solutions to banking with marijuana-related businesses. The account application process takes seven to 10 days and includes on-site visits along with a review of business license documentation, criminal background checks, funding and financial scrutiny and public records from the Liquor and Cannabis Board of Washington State. Credit union executives have dubbed this process as an intensified version of “know your client.”
Numerica had four full-time account managers dedicated to marijuana accounts who performed due diligence and onboarding. It established a “Canna-Committee” comprised of the chief risk officer, the lead marijuana account manager, corporate counsel, a member of the legal compliance team, a branch representative and the senior vice president of enterprise risk management to review each account. Approved accounts remained separated from other credit union accounts. In Salal’s case, the credit union employed a team of six marijuana account managers, assigned a personal account manager to each account and hired armored trucks to transport cash.
In the first year, Salal and Numerica opened only a few new accounts and established rules to reduce risks. For example, Numerica would only work with marijuana businesses operating in municipalities where it had a branch. In addition, it limited the number of accounts by self-imposing a rule that marijuana business accounts could not exceed 5% of total deposits at the credit union. Moreover, each account was limited to $5 million in deposits. As these credit unions learned how to safely open and manage these accounts, they expanded access.
Marijuana bank accounts require ongoing, special services. Credit unions must file Suspicious Activity Reports (SARs) each quarter for all marijuana accounts and Currency Transaction Reports (CTRs) for currency transactions over $10,000 per day. They must continuously monitor noteworthy events, changes and issues that the Liquor and Cannabis Board reports and follow legislative and judicial actions in addition to any other publicly available information that may affect their marijuana business clients.
The account fees paid by marijuana dispensaries reflect the costs of these customized solutions. Anecdotes from early account applicants suggest that the account application fees were $1,000, nonrefundable with no guarantee of approval. Minimum monthly fees varied but could be around $350. Account holders incurred additional fees for the number and type of transactions along with the cost of armored vehicles to transport cash to the marijuana firm. An anecdote from one marijuana business suggested that he was paying several thousand dollars per month in bank fees.
Credit unions are working with fintech firms to lower administrative costs so they can serve more marijuana dispensaries. Fintech has created compliance management platforms to make the application process and compliance requirements less onerous. In 2020, Salal joined fintech provider Shield Compliance, which offers products that automate compliance tasks such as daily monitoring and reporting and accelerate new member onboarding.
UNDERGROUND BANKING
In 2023, banking options will continue to be quite limited, even as 23 states have legalized recreational marijuana. Many businesses continue to operate in cash. Owners discreetly transport cash in duffel bags, paper bags and fast-food containers to conceal cash. In terms of alternatives, accessing banking services under false pretenses, i.e., “underground banking,” is time-intensive and risky. Small money orders, prepaid debit cards and department store credit cards with low spending limits are also options. Despite these efforts, most accounts get shut down and money orders and debit cards get canceled.
The need for banking alternatives has led to an explosion of fintech solutions that can replace many of the traditional banking functions. Nonbank financial institutions give marijuana business owners access to online payment platforms to pay vendors, landlords or employees. Fintech companies have also developed consumer-oriented solutions such as payment apps that allow customers to use debit and credit cards or pot vending machines that operate inside dispensaries and accept cash or Bitcoin.
Banking-as-a-service (BaaS) providers have emerged with products and services to help financial institutions and fintech companies work with dispensaries. Credit unions can partner with fintech providers who collect all relevant business data, provide a software platform that audits a company’s licenses, tax returns, financial statements and state records making it possible for them to conform to the Treasury Department regulations. These solutions integrate with point-of-sale providers, e-commerce platforms and data analytics software allowing businesses to connect their checking accounts to a digital payment solution.
OPPORTUNITIES
Fintech and local banks played complementary roles in creating a banking solution. The experience in Washington illustrates how credit unions, local and national banks and fintech services respond to uncertainty, risk and new growth opportunities. Local credit unions used relationships with their local community of financial regulators, business leaders, legal experts and state regulators to reduce uncertainty and limit the risks of working with recreational marijuana businesses. They invented a customized, small-scale model for providing financial services to marijuana businesses. Their solutions evolved over time but were labor-intensive, hyper-localized and emphasized due diligence, strict compliance and constant contact with state regulators.
Fintech businesses have developed a niche in the banking market by complementing these solutions. They built standardized products based on the credit union models, creating standardized products that allowed credit unions to scale-up their account offerings and comply with idiosyncratic local laws.