The Cannabis Banking Outlook for 2023

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The U.S. cannabis market is expected to continue its growth in 2023, with projected sales of $72 billion a year by 2030. That’s more than double the current market estimation of $32 billion annually. Today, 21 states and the District of Columbia allow adult cannabis use. According to the Pew Research Center, 43% of U.S. adults now live in an area that has legalized cannabis use. While not every state that has legalized cannabis use saw growth last year, the market as a whole continues to expand.

Meanwhile, last fall, President Joe Biden announced pardons for simple cannabis possession at the federal level and ordered a review of federal cannabis scheduling under the Controlled Substances Act. According to a recent survey from Data for Progress, the majority of likely voters support legalizing cannabis at the federal level.

But as the market expands, access to banking continues to lag. Congress has failed to pass the SAFE Banking Act, a bill aimed at normalizing banking for licensed cannabis businesses. Despite the lack of legislative progress, a playbook exists for banks to serve the industry in compliance with FinCEN guidelines; bank examiners continue to recognize the work banks are doing to meet their compliance obligations. Bankers considering this line of business can have confidence that the cannabis use space will continue to grow and keep banking services in high demand.

Three Trends to Watch
As the industry expands and attitudes toward cannabis evolve, financial institutions are facing new competition and pressures on their business models. We are seeing three significant changes.

  1. Cannabis industry consolidation is creating businesses that need access to the balance sheets that bigger banks can provide. As a result, larger financial institutions are entering the space. There are more financial institutions in the $1 billion to $10 billion assets space actively serving the industry today, along with a few banks with over $50 billion in assets. Considering just a few years ago these institutions were predominantly less than $1 billion in assets, this is a significant shift that gives cannabis businesses greater choice.
  2. Early entrants that gained cannabis banking expertise in their home market are leveraging that proficiency to provide services across entire regions, or nationally in states with legal cannabis programs. Some of this is driven by consolidation, as bankers follow their customers into other states. Others are seeking new customers in underserved or newly minted cannabis markets.
  3. Lending, both directly to operators and indirectly to landlords or investors, has emerged as a critical component of the cannabis banking portfolio. Not only is this a competitive differentiator for banks, it is also as a prime source of earning assets and a way to gain additional yield. Like all lending, however, it is important to understand the unique credit risks in this industry, which can vary greatly from state to state.

Competition Demands a More Customer-Centric Approach
Competition is creating pressure on financial institutions to operate more efficiently while delivering more client-centric services. When it comes to meeting compliance obligations, banks that employ strategies that achieve greater efficiency can dramatically lessen the burden on both their bankers and their customers. There’s now more clarity about what information offers the most value for risk management teams; bankers can tailor their compliance requirements to reduce risk and avoid creating unnecessary work streams. Technology that automates compliance tasks and aids in ongoing monitoring can also contribute to a better customer experience. As cannabis operators face increased competition and tighter margins, financial institutions that take steps to minimize the compliance burden can gain a competitive advantage.

Financial institutions are also introducing new pricing strategies to attract customers. Historically, banks priced these services strictly to offset or monetize their compliance function. Now, bankers can use pricing tools to benefit customers while creating value for the institution. For example, offering account analysis can encourage customers to maintain higher balances while generating noninterest income on accounts with lower balances.

The past year brought about significant economic and policy changes in the cannabis industry. In 2023, bankers can act with even greater certainty in the industry’s stability, investing in the processes, services and technologies that will improve the customer experience while supporting the institution’s bottom line. As financial institutions and regulators gain a deeper understanding of the compliance requirements for this industry, it is increasingly clear that the industry is not going backward. States that have legalized cannabis and are issuing new licenses offer banks an ever-growing opportunity to tap into the industry’s financial rewards with the confidence that positive momentum is on their side.

How Innovative Banks Manage Cannabis-Related Businesses

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The number of banks providing financial services to cannabis-related businesses (CRBs) has doubled in the last two years according to filings from the Financial Crimes Enforcement Network.

But, once a bank answers the philosophical question of whether it wants to participate in the cannabis industry, it must consider the more difficult question of how. Technology firms have sprung up to help banks fill this need, but assessing the value propositions of these solutions in such a nascent, complex industry can be a challenge.

Alan Hanson helped establish one of the first cannabis banking programs in the nation as the general counsel of Salem, Oregon-based Maps Credit Union back in 2014. In his experience, software “can gather the data, but really can’t evaluate the data” needed to manage CRB risk.

Many new compliance solutions gather data by tying into the point-of-sale systems used by CRBs and the seed-to-sale tracking systems run by the states. Hanson, now a Portland, Oregon-based attorney at Gleam Law, says these tools can typically match CRB sales to the deposits that come into the bank. However, they can’t always assess vital information, like where that money goes when it leaves a CRB account. For that, it’s important to have compliance staff that has a handle on their cannabis clients’ operations and vendor networks.

For example, if a CRB client misallocated funds from their dispensary to their grow operation, a well-trained banker could spot the discrepancy based on the use of funds to purchase special lights or tubing that aren’t required for a dispensary operation. Those types of distinctions can be harder for technology platforms to detect.

Technology is most helpful for managing the processes associated with onboarding, ongoing document collection, case management and reporting.

Some institutions, like Narragansett Financial Corp. bank unit BayCoast Bank, leverage their existing Bank Secrecy Act (BSA) solution — Verafin — for reviewing suspicious, flagged activities. The Swansea, Massachusetts-based bank supplements the BSA process with quarterly audits and support from employees with experience in both compliance and customer service. For more specialized monitoring tasks, the $1.9 billion bank uses spreadsheets and other traditional methods. As BayCoast’s number of CRB clients grows, so does its team. Chief Risk Officer Gary Vierra oversees the CRB program and estimates the bank needs one full-time employee for every eight to 10 CRB clients.

Other banks are looking to CRB-specific tools to help them get into cannabis banking without materially growing headcount. That was one of the goals for Marlborough, Massachusetts-based Main Street Bank, which has just over $1 billion in assets. It selected technology from Shield Compliance to help manage its CRB program.

Potential clients told the bank they needed a simple, single place to manage documentation requests and other communication with the bank. This led Main Street to select Shield, which provides automated compliance and document collection workflows in addition to BSA functions. Main Street’s team liked that the Shield interface mirrored Verafin, which the BSA team was already using, and estimated that the platform enabled it to launch its CRB program with about a third of the staff they would have needed otherwise.

CRB-specific compliance tools are gaining traction within banks, but there are other “silver bullet” solutions financial institutions should be wary of. The biggest one is companies that claim to help CRBs accept credit and debit card payments.

Currently major card brands do not allow CRBs to participate in their networks; forcing them to rely on cash causes significant, practical issues for these businesses and their banks. To address that pain point, some companies circumvent the prohibition by coding transactions in such a way that the networks do not recognize them as being linked to cannabis purchases — essentially masking the transactions as something else. “That’s not the way we do business,” Vierra says, “and most of the cannabis companies don’t want to do business that way either.”

Cannabis banking presents opportunities for banks to increase fee income and broaden their deposit base among a profitable niche. But with those opportunities comes the challenge of creating a compliant program for serving complex businesses. Technology can help, but banks need a solid understanding of the industry to succeed.

Potential Technology Partners:

Shield Compliance

Built by a former banker, Shield Compliance helps financial institutions manage CRB operations in a format that’s familiar to compliance officers.

Abaca

This company’s compliance specialists follow up on suspicious activity for the bank, and assist with identifying and vetting potential CRB clients.

Green Check Verified

This compliance platform provides a wealth of information to help banks understand the cannabis banking landscape nationally and within local markets.

Learn more about the technology providers in this piece by accessing their profiles in Bank Director’s FinXTech Connect platform.

Industry Moves Closer to Cannabis Banking

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In September 2019, the U.S. House of Representatives passed the Secure and Fair Enforcement (SAFE) Banking Act to address the emerging and increasingly urgent issue of whether banks can legally serve legitimate, state-legal cannabis-related businesses.

The bill would prohibit federal banking regulators from penalizing or criticizing banks for providing financial services to cannabis-related businesses, creating a safe harbor for institutions that serve the cannabis industry. It addresses the growing safety concerns of the industry for its employees and owners that operate cash-only businesses.

The U.S. Senate received the bill later that month and referred it to the Senate Committee on Banking, Housing and Urban Affairs. While the bill was a hot topic when it was introduced in the Senate, other matters and priorities may delay the measure’s progress. Once through the Senate, the bill would reach the president’s desk for final approval.

Regardless of the actions taken by the Senate and president, it is clear that addressing a depository institution’s ability to provide financial services to cannabis-related businesses without penalty or regulatory criticism is an important matter for the banking industry and for the government to address.

A Closer Look at the Bill
The bill provides safety to individuals associated with cannabis-related businesses by allowing them to use the U.S. banking system, which currently is inaccessible due to federal regulation. It would grant cannabis-related businesses access to financial services that most companies use daily, such as business checking accounts, electronic payment processing, employer-sponsored retirement accounts and small business loans.

According to the bill, a depository institution shall not, under federal law, be liable or subject to penalty for providing a loan or other financial services to a cannabis-related business. It prohibits federal banking regulators from:

  • Terminating or limiting deposit insurance solely because the institution provides services to cannabis-related businesses.
  • Prohibiting or penalizing banks from providing services to cannabis-related businesses.
  • Recommending, encouraging or incentivizing banks not to offer financial services to an account holder, solely due to their relationship with a cannabis-related business.
  • Taking any adverse or corrective supervisory action on a loan made to a person solely because the person either owns such a business or owns real estate or equipment leased or sold to such a business.

The bill also states that a depository institution may not be held liable, pursuant to any federal law or regulation, solely for providing a financial service or from investing any income derived from providing a financial service to a legitimate, state-legal cannabis-related business.

Looking Ahead
Banks should begin assessing their risk appetite as it relates to the growing cannabis industry in preparation for legislation that allows them to serve cannabis-related businesses without penalty or regulatory criticism at some point in the future.

Once the legal aspects are resolved, we expect that many banks will take the opportunity to serve cannabis-related businesses as a way to grow loans and noninterest income and obtain lower-cost deposit relationships. At the same time, we anticipate other banks will be cautious about serving the industry, given the stigma and reputational concerns.

Banks should follow their normal risk management practices when considering services to the cannabis industry:

  • Conduct research to understand the cannabis industry and related operations.
  • Consider your institution’s risk appetite and if you are willing to serve the cannabis industry.
  • Tailor policies to address cannabis-related business specific matters, such as underwriting requirements, collateral considerations, customer due diligence and suspicious activity monitoring.
  • Provide training to employees within the institution who will serve customers in the cannabis industry.
  • Monitor developments in the regulatory and governmental space as it relates to cannabis.

We also expect the Federal Financial Institutions Examination Council will develop and issue guidance and examination procedures soon for those depository institutions serving state-legal cannabis-related businesses.