Solving the Cannabis Banking Issue: De Novo Bank/Credit Union or Acquisition—What’s Possible?

I field a number of calls from people wanting to start or acquire a financial institution to solve the lack of access to banking for the cannabis industry. So, what is possible and what roadblocks might you expect to face?

State vs. Federal Charters: People often view ‘state chartered’ financial institutions as the charter that ‘can’ bank cannabis entities. Logically, one could easily conclude that a state chartered financial institution falls under state law and legal cannabis funds are therefore acceptable to bank; pushing federal charters out of the picture. This is not the case. We are a state-chartered credit union with federal insurance; backed by the federal government and that ties state charters to federal examination, scrutiny and of course, regulations. The playing field is the same when it comes to cannabis. I would argue that state chartered financial institutions are perhaps more in tune with their community and entered the market sooner rather than later to solve a community safety issue.    

Private vs. Federal Insurance: Insurance is insurance and protecting the ‘insurance fund’ whether private or federal is what insurance companies do. The underwriting and monitoring processes are not that dissimilar.  It boils down to the safety and soundness practices of a financial institution and most of the requirements to obtain and maintain insurance coverage remain the same.  Having private insurance may provide a sense that a financial institution is ‘outside’ the federal channels but it does not effectively separate such from normal operating channels touching the national settlement and processing channels, and that is the issue with cannabis; not insurance.

Small vs. Large Financial Institutions: What I have noticed is that more of the financial institutions leading in cannabis banking are smaller institutions. Let me just say that this is not the case presently as I have fielded calls from three multi-billion financial institutions in just the last week; all looking at some form of cannabis banking. Larger financial institutions have a competitive advantage based upon efficiencies gained by size, greater earning assets, more sophisticated technology options, deeper brand recognition, etc. On the other hand, sometimes smaller financial institutions must compensate for the lack of ‘scale’ by increasing risk and ensuring relevancy. Banking cannabis is a perfect example; greater risk and certainly, relevancy to our communities. It is difficult for a community financial institution to ignore what is occurring so close to home. Ties to community are tighter with smaller financial institutions.

The question often arises as to whether or not the large financial institutions will swoop in and take over the business once cannabis is legalized nationally. Good question! In my opinion, the short answer is NO. It is difficult to mainstream cannabis accounts in a financial institution. They perform like Money Service Businesses on steroids. It’s a specialty banking situation and not for everyone. It requires dedicated resources and talent not readily available in the labor pool. When was the last time you ran into a cannabis banker? It is so specialized that the majority of financial institutions will not pick up the business. For the sake of safety and soundness, I often tell regulators they want a few solid financial institutions that do it WELL and optimize a portfolio for experience, comparative analysis and the ability to consistently fulfill BSA regulations. 

We will bank about $1.3 billion of cannabis related funds in 2018. If Colorado is a $1.6 billion market, how many Safe Harbors do they need? Take into consideration that our $1.3 billion is not a pure retail number since we bank wholesalers and ancillary service providers as well. In California, if you had 10 banks banking $1.5 billion each, that would cover the initial projections up to $15 billion. Also consider that the dedicated resources are expensive, which requires financial institutions to build a business case based upon volume. Five or six clients will not allow a financial institution to justify the resources necessary to bank the business well.

Bank vs. Credit Union: Credit Unions and banks have different structures, but that too, is not the issue. It boils down to risk tolerance. Let’s start with the difference between a bank and a credit union. We can rule out credit union acquisitions pretty quickly.  

  • Ownership: Credit Unions are not-for-profit cooperatives whereby all the members of the credit union, own the credit union. One member, one share. We have 32,000 members at Partner Colorado Credit Union; all of whom have one ownership share just because they are a member. My staff and I work for 32,000 shareholders every day and you cannot purchase their ownership share granted to them simply by participation. Termination of membership is the only means of giving up ownership (mergers can be an exception).
  • Regulations: We all operate under the same regulations, both banks and credit unions, state or federally chartered. Bank Secrecy, Anti-Money Laundering and FinCEN apply equally to both banks and credit unions. Different structure, however the same regulations. Credit Unions, however, have more restrictions on business lending, membership and investment options as examples. This is because they are owned by the members and a more conservative approach is regulated.
  • Governance: The credit union board consists of volunteers from the membership to represent owner/member interests. They are not paid board members and serve their members as a community service. Banks, on the other hand, more than likely, have paid board positions and often the board seats are held by primary investors. Customers are customers, not owners.  (Mutual financial institutions are excepted.)
  • Capital: Credit Unions cannot raise capital like a normal bank structure. The only means of adding to capital is through earnings, which is why growth is limited. If a credit union cannot increase capital at a sufficient rate, they must control growth; hence why so many of us reach a limit in our cannabis programs; capital restrictions. Banks, on the other hand, can do capital calls or sell stock/shares to raise capital; allowing for the growth they expect or desire. This very issue is where we, as a $400 million financial institution with a solid 10.3% capital ratio, run into issues. Without income, we cannot continue to grow the credit union without depleting our capital ratio and raising safety and soundness issues with regulators.

De Novo – New Bank Charter:  Starting a new charter is quite a bit more difficult than most understand and is not a quick process! Then, setting up the operations just to launch requires more time after approval. Adding the cannabis banking risk on top of that endeavor only complicates the matter more. 

The standards necessary to obtain the charter are not easy demands to navigate. 

  • The historical performance of a new charter is non-existent and cannot be considered. Only the resumes of owners and selected management can be used to determine probability based upon historical performance, but even such does not include cannabis industry banking knowledge.
  • The portfolio of a start up cannot be easily balanced between other lines of business to ensure against a concentrated risk of cannabis business, so not only does the new charter have to demonstrate the ability to manage cannabis, but to build a balanced portfolio of other business at the same time. It is not a singular focus.
  • The ability to attract and train new staff on cannabis banking management—where do you find that talent?

These are just a few considerations and all require regulators to gain comfort with the introduction of a new, high risk line of business. Hence, why I do not hesitate to take every opportunity to educate regulatory authorities on cannabis banking. Regulators do not dictate what financial institutions do; regulations do. However, banking executives do not underestimate the major role regulators hold when it comes to sustaining operations with safe and sound practices that meet regulator expectations.

Bank Acquisition: Having an established bank charter with historical performance is a real plus if considering an acquisition in which to introduce cannabis banking. The charter is already insured, has historical performance on which regulators can rely and hopefully, a balanced portfolio that will offset the introduction of a cannabis-based portfolio.

The only situation where I could envision a heavier portfolio concentration of cannabis would be in the situation where a ‘state bank’ is chartered specifically to bank cannabis funds and provide a banking channel that is not readily available to the industry; facilitating the safety of the community as well as the accountability and transparency of the industry. I am seeing successful movement in this area given the charter has maintained a historically safe and sound environment and has or will develop sufficient Bank Secrecy/Anti-Money Laundering processes to manage the risk.

The financial stability considerations would include solid financial status of capital, return on assets, delinquency control, and a solid management team to maintain the present safe and sound environment while introducing this new risk, requiring additional corporate demands.  Because of the severity of the risk with potential enforcement and/or prosecutor actions, enough attention from management across the top of the organization is needed. This endeavor touches all facets of banking within a financial institution and is not an isolated project monitored by a few individuals. It only takes one multi-million-dollar enforcement action to place a financial institution in an unsafe position. One cannot price a program for this risk!

Note: Opinions and statements contained in this article and others posted on my site reflect my personal interpretation or position ONLY and do not reflect the position of Partner Colorado Credit Union or Safe Harbor Private Banking.


Regulators, Legislators and Associations – Friend or Foe?

Let me just state right up front …. If you need positive reinforcement, acceptance or encouragement to venture into cannabis banking, give it up now.  Cannabis banking is NOT for the faint of heart.   We remain in a time where many continue to hedge their bets: trying to determine when to get on board, or wait it out to see where this goes, or jump in when it’s almost safe, or take a stand against providing services to the industry.   You might be surprised by the truth in what we have faced and continue to face.  Still on the bleeding edge here! 

It’s not that the subjects in this article are against what we do…. I interpret it to be more about affiliation with the cannabis industry.  What will people think about me if I serve this industry coming out of its black-market history?   

Honestly, I never thought I’d grow up to be a ‘Marijuana Banker’!  One credit union CEO here in town likes to refer to us as ‘Marijuanaville’ because we bank the industry; albeit at only 12% of our asset base…. The stigma remains.  Cannabis is just one division of the credit union and it remains our greatest risk.  My reputation no longer really reflects my years of being a normal CEO but now, one that banks cannabis, right?   I know I have been right out front on the topic, but sharing knowledge is a necessary part of the process to help bring more access to banking.

Cannabis Regulators:  Having met with different regulators in different states, I can advise that they want the business banked as much as the next agency.  Certainly, they don’t want to receive license and renewal fees in cash.  They have, in the last couple years, tried to find ways to support the banking system and make it easier for financial institutions to obtain the necessary information to remain compliant with FinCEN Guidelines, which is to ensure we, the financial institutions, are aligned with state activities as it pertains to cannabis licensees.  One state even thought to have a website for financial institutions to allow them access to necessary information on licensees.  It does behoove us to be aligned as we certainly don’t want to bank anyone the state doesn’t think worthy of a cannabis license.  The state, on the other hand, has access to financial records through legal channels to remove ‘bad players’. 

What does alignment with the state mean?  Financial institutions cannot make the mistake of serving non-licensed entities so if licenses are being delayed or revoked, we need to know and act accordingly. Likewise, violations and citations must be monitored by financial institutions.  A ‘one-time’ citation does not mean licensees must necessarily lose their bank account.  It depends again on the risk appetite of the financial institution and the guidelines they have established.  Licensees cannot depend on any one standard here.  I can tell you from our experience that it is dependent upon the type of violation, frequency or number of violations, and most importantly, how the licensee responds to the violation.  Our greatest concern is ‘how will you prevent such violations in the future’ unless, of course, the violation is so egregious that we don’t want to bank the risk.   

Financial Institution Regulators:  I have stated many times that our federal and state regulators are NOT taking a position for or against the cannabis industry.  The regulators are in place to ensure the safety and soundness of the financial system.  Take a step back into the great recession when financial institution failures were an unfortunate, regular occurrence and the American public tapped to provide bail out money.   This is what regulators want to prevent; no small task!

In doing so, they must evaluate each financial institution individually.  Here again, there is not a standard answer because all financial institutions have different risk tolerances based upon their history, experience and management choices. I can’t say we wanted the additional risk of cannabis banking when we started but we did think we could manage and contain the risk so as to keep our credit union in a ‘safe and sound’ position.  What we did not expect was the ever-emerging market issues that would cause a great demand to constantly mitigate new risks.

So, the question continues to be asked as financial institutions enter the cannabis banking arena…will regulators support this?  We have endured 9 federal and state joint exams since the start of our program in the last 3.5 years, where the normal number of exams would have been 3.  This was not necessarily just because regulators did not trust us to mitigate risks although ‘trust but verify’ would definitely apply here!  Additional exams were because the risk was so new to all of us and the size of our cannabis portfolio too big to ignore.   In order for us to continue banking the industry, regulators needed to be on-site more often to verify our risk mitigating strategies and learn the risk themselves.  How can one regulate a new market and line of business without learning it in great depth?  I would consider this a bleeding edge consequence that just comes with the territory; albeit, quite stressful on the organization and management.  

Just remember one key point here, regulators do NOT endorse any programs of any sort, they monitor and regulate.   They allow us to continue in the business based upon safety and soundness measures we put in place to do ONE thing, protect the financial institution.  We always know the difference when we see ‘Compliant’ programs being advertised…. One can strive to be compliant, but Bank Secrecy and Anti-Money Laundering standards are a moving target based upon the complexity of the financial institution portfolio.   

Legislators:  This is an interesting situation probably for legislators as well as those of us banking the industry. I recall our congressman telling us that early on when the word ‘marijuana’ would come up in committee that it was more than a bit humorous and a conversation that was difficult to broach or take seriously.  That was about 4 years ago.   I think banking professionals faced or still face similar situations in the board room.   How does one bring up the topic gracefully when so much controversy exists on a morale level?  One never knows how people will respond, but we do know that the national approval rate in support of legalization is somewhere around 65% at this point.

At the state level, this has become such a normal subject.  This is not the case in many other states yet and I continue to be surprised by the level of indifference at the federal level. I think it is a difficult up-hill battle for our legislators to bring the topic to a level required to address the conflict between state and federal laws.  Colorado Congressmen Perlmutter & Polis have not only shown support for what we are doing but have consistently tried to move legislation ahead to make life easier for those of us working in or serving the industry.  Even those legislators that were never in favor of legalization, like Senator Gardner, have openly fought for protective measures.   

One would think that with only 4 states in which some form of cannabis is not legal, that the battle wouldn’t be so uphill for our legislators to gain legislative support in Washington DC, but it appears that it still is.

From my experience, it is not that legislators in DC don’t think the money is better banked than unbanked.  Again, it’s being associated, or the fear of being associated, with intentionally working to help the industry flourish.  Look how many people still stay under the radar on serving the industry on any level to avoid that judgement.  Likewise, some financial institutions think lending would be a mistake because it sends a message ‘we support the industry and will fund growth’.  I don’t buy into that for more than one reason, but the first reason is that I would rather take DEBT money from another financial institution than INVESTMENT funds from the ‘unknown’ that require validating and verification.     I don’t think the scrutiny of transactions will be as severe as it exists today, but will be for some time yet.

This brings us to another question that begs to be asked…. Will proposed legislation open banking options for the industry?  I would say don’t hold your breath, but that’s a future article.   The good news is that there is a surge, a fast-moving surge, of financial institutions preparing to bank the industry…. It just takes time!  It can easily take a financial institution 6 months to prepare and implement a cannabis banking program.

Financial Institution Associations:  Financial institutions banking the cannabis industry are still so few in number that we are represented the same at the association level.   It is difficult to ask a national association to work with us to obtain more secure positioning when this situation impacts so few of their financial institutions, not to mention that many morale judgements continue to guide some decisions.  As I started the article, if you need a great deal of ‘outside’ support, you probably should not go down this path… this path requires thick skin and a sharp machete to cut the path… who cares about the horse and cart and in what order they are at this point?

Now, not all associations are the same.  We formed a MRB Roundtable of credit unions across the country that work together on education and advocacy as well as keep each other informed of potential roadblocks and issues that might impact all of us.  The California/Nevada Credit Union Association has been generous with us and took our group under their wings to assist in organizing our advocacy.  So, a big thanks to their assistance and leadership! 

Banking the cannabis industry remains in conflict with federal laws and the great majority of financial institution are federally insured.  So, can you buy or start a bank or credit union just to do cannabis banking and solve this national problem?  …. Next article!

 

 

 

 


Cannabis Banking and 3rd Party Support… On Board or Not?

Why do financial institutions fail to serve the cannabis industry? You’ve certainly heard that question enough. It’s probably a little more complex than many realize.  There are regulations, laws, complexity, reputation, etc. to consider. However, it is not just the financial institution telling you ‘NO’ because they won’t bank your cannabis business…. Third Parties play a major role in this national banking issue. A good question is whether they will continue to present roadblocks or will they see the need to work through this strange time where state and federal laws are in conflict? Remember, since most financial institutions are federally insured, federal laws cannot be ignored!

Not too long ago, I was emphasizing to a third party how we strive to follow the rules, prioritize compliance and at our very foundation, do not want to do anything wrong when, well, I had to pause mid-sentence, realizing what I was saying and just a bit embarrassed, finished very slowly with…. “OK, except maybe the big elephant in the room… banking funds derived from a federally illegal substance.”  That’s where we all get when we are in the industry long enough…. It becomes normalized and yet it is NOT! Until federally legal, banking is a violation.

Back to third parties…Let’s just look at a few of the third-party issues that may be still roadblocking your next bank account…. I know, who’s counting?  I cannot address all third-party issues we have and still face in just one article, so I will address just a few now and cover other issues in the future. Take into consideration that because I manage a credit union, I will speak from that perspective, but I am sure banks run into similar issues when considering whether to bank the industry or not.  

Corporate Credit Unions: REAL Roadblock to Consider !

Many credit unions process their financial transactions through a corporate relationship and rely on that processing daily to move money everywhere. By no means am I implying ALL corporate credit unions will roadblock you! However…. not once, not twice, but THREE times in just the last 30 days, I have heard that three different corporate credit unions will close credit union corporate accounts if they go into any type of cannabis banking. Coincidental? I don’t think so.  Even worse, a credit union could expect notice that may not provide sufficient time in which to make a transition elsewhere!  Talk about causing safety and soundness issues!  One would and should expect more from a corporate level banking relationship! You can certainly understand why financial institutions won’t bank the industry here as this is a real threat to operations.  Lucky for those seeking to bank the industry, there is an option.    

Later in the article I make a technical argument on depositing to our account at the Federal Reserve, so I must also provide one here in all fairness. A Corporate Credit Union, as I understand it, has their account at the federal reserve and then provides services from that one account to many financial institutions. If they view the money being deposited into this account as CANNABIS money, then, well, Red Flags. However, consider the question as to who really owns the money by the time it reaches the Federal Reserve. We are still navigating uncertain times and much is still left to individual interpretations…so which interpretation is right?   There are many processes not tried and true in banking and this merits further clarity for all financial institutions at some point.

Navigating this issue requires Financial institutions seeking to bank the cannabis industry to consider a direct relationship with the Federal Reserve. This can easily take months to establish and move operations from a corporate relationship to the Federal Reserve; not an easy process.  I suggest you protect yourself by carefully navigating around this situation. Maybe, open your Federal Reserve account prior to having any discussion with your corporate institution and consider having a third party (i.e., counsel) inquire on your behalf to see how your corporate has positioned itself and possibly protect your institution from negative preemptive actions.  By the way, we saved a great deal of money going direct to the Federal Reserve and taking out the middle guy – maybe that is a nice upside to consider. I’m not sure it would matter to try to name institutions because often enough, if one is taking a certain position, the others probably will as well.

Federal Reserve: Potential Roadblock, but maybe less than you think,

So, how we can place money into our Federal Reserve account? I think many have the perception we simply count, verify and then recycle it though our branches.  At $120 million a month, we’d have to recycle about $5.4 million per business day! Just think how much work that would be, not to mention the potential safety issue! Using third parties to move the cash at this level becomes imperative. Access to the Federal Reserve may very well be a hit & miss for financial institutions depending on their nearest Federal Reserve.  We have not had an issue using our Federal Reserve, but others have been blocked.

Here is how I view access on a very technical level…remember, only my opinion and I have had to rationalize or interpret many things in the last four years. By the time the funds are deposited to our Federal Reserve, it technically does not belong to the cannabis businesses, but rather belongs to Partner Colorado Credit Union.  Once the money has been counted and verified, the cannabis business is provided credit at that time.  The funds from all our businesses are then consolidated and carried to the Federal Reserve for one lump sum deposit into OUR Federal Reserve Account, not a cannabis account. Partner Colorado CU is responsible for ALL BSA obligations on the money entering the financial system. The Federal Reserve should and does count on our diligence and obligation to upholding anti-money laundering & BSA regulations and protecting the financial system from illicit funds. Hence, in our case, 8 Federal and State joint exams in 3.5 years to ensure compliance! Compliance, by the way, is not a set standard in the financial system, but rather compliance depends on the transaction complexity, source of funds, volume and many other things to set a compliance standard. Ultimately, it is a moving target always requiring improvements in internal processes. Compliance at one financial institution is not necessarily the same at another financial institution, so claiming a compliant banking program becomes a false sense of security.

Let’s consider another logical point here…. there are, according to FinCEN, nearly 400 financial institutions across the country presently banking cannabis businesses and they maintain a relationship with their Federal Reserve.  I would say that this speaks for itself… access has not been denied for the most part.

From what I have seen, the issue here is If you ask. what other possible answer could we expect than ‘NO’ based upon federal illegality surrounding banking the industry from a federal entity. A formal inquiry forces a formal response that most certainly would be based on the federal laws. If you ask, you might prepare for a potential roadblock.   I am very transparent about what we do, but this is one time, I didn’t ask for permission and hoped the Federal Reserve would support us. 

I was worried when we first started 4 years ago and just thought…well… we are in test and this will be one more test! If I fail the Federal Reserve test, we stop the test! About 3 months in, a Federal Reserve President was visiting our state, I decided to attend and speak to banking cannabis…. I held my breath once more, but I needed to know, not just exist in test. Will I get thrown out of the Federal Reserve? I wondered, and then thought … ‘better now when I am only 3 months into the program than a year or so later.’ Could you imagine the negative ramifications of closing a financial institution out of the federal system? I openly spoke to banking the industry at the Federal Reserve and was more than pleasantly surprised…. when the president of the Federal Reserve sought me out after the talk to thank me for working to improve safety issues surrounding the removal of excess cash from the community. I went home breathing much better after that!  I’ve said it a thousand times by now that most federal agencies want the money to be banked transparently, monitored and validated! They just want it done RIGHT!   Finding ‘RIGHT’ is the difficult part! 

Insurance/Bond Coverage: Potential Road Block!

Financial Institutions must carry many types of insurance coverage and coverage can be in question should a financial institution decide to bank the cannabis industry. No insurance is not an option for a financial institution!   Consider this conversation early in your research. Coverage could be negated when you file a claim or even terminated if not transparent with your insurer.  Additionally, consider, discuss and understand, the ‘illegal activities’ coverage in any contract. If a board is NOT willing to accept an unknown or untested situation here, banking the industry becomes a challenge and maybe even a ‘show stopper’. 

We (a group of credit unions serving and/or planning to serve the industry) recently asked our insurer to consider a new coverage and / or revised contractual language for those of us banking the cannabis industry. We are all willing to pay for the coverage. They listened and at least the conversation has started. Perhaps when enough of us are in the business, new coverage or better contractual language may present. 

Shout out to CUNA Mutual, our insurer, is required here! Not only have they continued our coverage, but, unfortunately, we have had to test that coverage and were NOT denied merely because we are banking the cannabis industry. Thank you CUNA Mutual! Another uncertainty clarified!

Safety in Numbers!!! It’s the name of the game at this point! As more financial institutions enter the market, it will get easier, but this is still a bleeding edge endeavor!   We have found a way to bank the industry, but far from the finish line where all financial institutions will have comfort doing the same.

Next week…. Legislation, Regulations, Associations… 4 years later, I’m surprised!

Note: Opinions and statements contained in this article and others posted on my site reflect my personal interpretation or position ONLY and do not reflect the position of Partner Colorado Credit Union or Safe Harbor Private Banking.