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

Posted on November 15, 2018

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.