Deconstructed: Cannabis Banking Regulatory Environment
The legal US cannabis industry is poised to close 2017 at nearly $10 billion in revenue, a ~35% increase from ~$7 billion at the end of 2016. With over 40 countries currently pondering some form of decriminalization legislation and a US market expected to more than double in size by 2021, cannabis remains one of the highest growth industries in the world. Legalization implementation in the world’s largest capital and consumer markets adds to this torrid growth in 2018; poised to be another blockbuster year for the industry.
A primary challenge for this industry stems from its limited banking options. While states have taken the first steps in addressing this issue, the entire cannabis industry is currently constrained by 368 banks that have varying levels of affinity towards it. Only a fraction of the nation’s 11,954 regulated banks and credit unions, this represents a 22% increase over the prior period showing banking growth lagging the industry by a wide margin.
Our testimony to the California Banking Working Group
Passed in 1970, the Controlled Substances Act (CSA) prohibits the manufacture, distribution and dispensation of cannabis. Thus, any transfer or deposit of money yielded from the sale of cannabis may be deemed “money laundering” in violation of the Bank Secrecy Act (BSA), also known as the Currency and Foreign Transactions Reporting Act. As a result, ~97% of banks, credit unions and credit card companies refuse to provide cannabis cultivators, processors and dispensers with financial services. Although several Department of Justice policy clarifying memoranda (including the August 29, 2013 Cole Memo) restrain enforcing the CSA in legalized marijuana states, any transfer or deposit of money yielded from the sale of cannabis may still be deemed money laundering by the seller and a BSA violation by the financial institution.
In its February 14, 2014 guidance, the Department of the Treasury’s Financial Crimes Enforcement Network (FinCEN) attempted to clarify the regulatory landscape by setting forth certain guidelines that financial institutions should follow with respect to providing banking services to marijuana-related businesses (MRBs), including:
- obtaining and reviewing an MRB’s information from licensing and enforcement authorities including application, license and registration documentation
- developing and understanding of an MRB’s normal and expected activity
- monitoring publicly-available sources for adverse information about business and related parties
- monitoring for suspicious activity, including FinCEN’s specified red flags
- routinely updating customer due diligence information commensurate with risk
Notwithstanding the challenging regulatory and compliance landscape, 2017 bore witness to some progress with respect to the availability of banking services for MRBs. FinCEN measures the number of MRB banks based on suspicious activity reports (SARs) filed as a result of “red flags” when a bank providing financial services to an MRB knows, suspects or has reason to suspect that a conducted or attempted transaction:
- involves, or is an attempt to disguise, funds derived from illegal activity
- is designed to evade BSA regulations
- lacks a business or apparent lawful purpose.
Because all MRB financial transactions involve funds derived from illegal activity, banks must file a “Limited”, “Priority” or “Termination” SAR with every deposit, withdrawal or transfer. Due to the significant BSA, Cole Memo and FinCEN compliance costs outlined below, most banks are incapable of profitably providing financial services to MRBs. Those that do often charge significant banking fees to MRBs to cover these compliance costs, exerting an undue influence on the profitability of cannabis businesses.
BSA, Cole Memo and FinCEN compliance costs include:
- If providing financial services to a business operating in compliance with state law or any Cole Memo priority, a financial institution must file a “Marijuana Limited SAR”.
- If reasonably believing that a MRB violates state law or a Cole Memo priority, a financial institution must file a “Marijuana Priority SAR”.
- If facilitating effective anti-money laundering compliance requires terminating an MRB relationship, a financial institution must file a “Marijuana Termination SAR”.
While banking continues to remain a significant challenge for MRBs, progress is being made. In addition, work is being done on the legislative front to address this issue. Presently before the House Financial Services Committee, the Secure and Fair Enforcement Banking Act (SAFE) proposes amending the BSA through issuing modified SARs reporting regulations that do not inhibit the provision of financial services to MRBs. In addition, the proposed legislation creates certain protections or “safe harbors” for depository institutions that provide financial services to legitimate MRBs. While very much a work in progress, these are significant steps forward in resolving the industry’s bankingchallenges.
The cannabis industry is experiencing explosive growth and major signs point to further acceleration. While the banking industry is lagging behind in adoption, signs of growth provide promise. Legislative tailwinds are working to provide increased protection to banks and can perhaps affect their regulatory and compliance costs in a positive manner. Cannabis taxes are already appropriated to dozens of state agencies, and governments have plenty of monetary incentive to make it easier for the banking industry to operate profitably.
Thank you to our partner, Hoban Law Group, for your contributions.