Cannabis banking: Risk tolerance, CRBs, and compliance

Amy Bean, Hope Goodman
| 4/27/2023
Cannabis Banking Risk Tolerance CRBS and compliance

Staying informed on the cannabis industry can help organizations better mitigate cannabis-related risks.

While hemp and hemp-derived cannabidiol (CBD) are federally legal, other types of cannabis remain illegal at the federal level. However, expanding legalization at the state level means that cannabis-related businesses (CRBs) are increasingly seeking traditional banking services. Whether or not financial services organizations choose to bank CRBs, they need to stay up to date with ever-changing regulations, legislation, and the compliance environment. They also should consider their own risk tolerance, as the regulatory landscape of the cannabis industry poses a variety of potential obstacles that can bring increased risk.


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History of cannabis legalization in the U.S.

The legalization of cannabis is a complex subject. The compliance environment for cannabis and cannabis-related products requires notable expertise to navigate, as the legality changes depending on state and local jurisdictions. California became the first state to legalize the use of medical cannabis in 1996. In November 2022, Missouri became the 22nd state, including Washington, D.C., to legalize the recreational sale and use of cannabis.

From a federal perspective, marijuana is still classified by both the Food and Drug Administration and the Drug Enforcement Administration as a Schedule I controlled substance, which currently carries felony drug charges that include fines and possible jail time. As federal law prohibits the distribution and sale of marijuana, financial transactions involving CRBs could be considered transactions that involve funds derived from illicit activities. Under the Money Laundering Control Act of 1986 and the Bank Secrecy Act, as amended, covered banks and nonbank financial services organizations are prohibited from providing financial services to businesses that are engaged in illicit activities.

Because the federal status of cannabis remains unchanged to date, many financial services organizations continue to draw a firm line against initiating customer relationships with CRBs, while some organizations have attempted to fill the market gap that is generated by the risk management complexity. The high-risk nature of CRB customers limits the banking services that these financial services organizations are willing to offer.

CRBs have difficulty securing banking services, so they have an uphill battle to access additional capital and manage funds on a day-to-day basis. For example, some CRBs have paid interest rates of 22% or more to borrow capital. This barrier to market entry is one of several factors hindering industry competition and the industry's future growth opportunities.

Considering the various financial obstacles CRBs must navigate, the federal government has taken legislative action to lessen market frictions with the proposed Secure and Fair Enforcement Banking Act of 2021 (SAFE Banking Act). The SAFE Banking Act has been passed by the House of Representatives seven times, most recently in July 2022. However, the bill has not passed the Senate. The proposed act would provide a safe harbor to financial services organizations providing banking services to legitimate CRBs, protecting them from federal regulatory penalties. Some argue that the Senate’s approval of the bill would allow equitable access to financial services for CRBs and set a level playing field for the cannabis industry.

In recent months, a more expansive version of the proposed cannabis reform legislation, colloquially known as SAFE Plus, has also been introduced as a bipartisan solution more likely to successfully pass the House and the Senate. The Capital Lending and Investment for Marijuana Businesses Act (CLIMB Act), proposed in the House in June 2022, also shares a similar goal with SAFE Plus, but it outlines a longer term solution via public sale of securities to facilitate the financial and operational longevity of CRBs. Additionally, if passed into law, the Cannabis Administration and Opportunity Act, presented on July 21, 2022, would decriminalize cannabis at the federal level and expunge federal cannabis-related criminal convictions.

Industry growth

Various factors incentivize new states to legalize cannabis and related products, including increased tax revenue, the potential decrease of criminal activities related to cannabis businesses as large carriers of cash, as well as perceived physical and mental health benefits to users of cannabis. Cannabis has been legalized for medical use in 39 states and for recreational use in 22, including Washington, D.C. Because it already represents a substantial market in the U.S., continued legalization on the state level likely will continue to spur industry growth.

According to New Frontier Data’s report, "2023 U.S. Cannabis Report: Market Updates and Projections," with cannabis legalized in some form across 39 states, 73%, or 246 million people, live in a state with some form of legalized cannabis. In the next decade, the report estimates that 18 more states could legalize medical or recreational-use cannabis, yielding sales that could exceed $71 billion.

The cannabis industry creates many potential market opportunities – including opportunities for financial services organizations. As the industry’s customer base expands, CRBs likely will face increased pressure to sustainably grow their operations. Take California, for example: With only one dispensary for every 40,000 residents because of local regulatory restrictions, CRBs could expand their customer base through increased accessibility and tap into additional cash flows.

To bank or not to bank CRBs?

Many CRBs rely heavily on cash transactions due to regulatory restrictions and many banks’ reluctance to provide traditional banking services. This lack of access could become increasingly problematic as the industry becomes more widespread and lucrative. Financial services organizations of all sizes might consider clarifying their stance on providing banking services to CRBs as the presence of cannabis becomes more pervasive. Though federal legalization is still potentially years down the road, state-by-state legalizations demonstrate that retail cannabis is here to stay.

Safe and accessible banking services for CRBs could be beneficial for both financial services organizations and CRB customers. The risk of crime and fraud associated with high volumes of cash transactions could be reduced while also creating the opportunity for additional fee income for financial services organizations. Because many CRBs deal in high volumes of cash, they are often targets of crime, so having less cash on hand or dealing in fewer cash transactions means less chance of theft. On the flip side, by banking CRB customers, financial services organizations can increase deposits, and the monitoring costs of required heightened account analysis can be recouped through fee income.

If financial services organizations choose to bank CRBs, they must comply with local, state, and federal regulations. Additionally, they must adhere to initial and ongoing due diligence and suspicious activity reporting requirements as set forth by the Financial Crimes Enforcement Network. Banking businesses within such a cash-intensive industry represents a rare opportunity for consistent cash flow. As state-level legalization has expanded, financial services organizations have become increasingly adaptable, and some smaller organizations have even partnered with fintechs to onboard and monitor CRBs as customers.

If, on the other hand, financial services organizations choose to forgo banking CRB customers, they should analyze their risk exposure to effectively identify and manage any cannabis-related risks, including establishing controls and performing customer due diligence to confirm that CRB activity is not occurring. Because CRBs now are more widespread, more likely than not, CRB customers could already be on the books. For example, existing customers might unknowingly enter into CRB-related transactions. Without proper controls, financial services organizations could easily miss such activity and expose themselves to risk.

Mitigating risk

The cannabis ecosystem is ever evolving, so financial services organizations should stay apprised of what’s happening in the cannabis industry – even if they don’t bank CRBs. Though all types of cannabis are not legal on the federal level, some forms of cannabis are legal in many states, and the CRBs that operate in this industry need legitimate, safe financial services. While banking CRBs is beyond some organizations’ risk tolerance, those that do take them on as customers will need to establish internal controls, strengthen their anti-money laundering programs, and adhere to regulatory requirements.

Crowe disclaimer: Qualified organizations only. Independence and regulatory restrictions may apply. Some firm services may not be available to all clients. Given the continued evolution and inconsistency of various state and federal cannabis-related laws, any company should seek competent legal advice relating to its involvement in the cannabis industry, including when considering a potential public offering as a cannabis-related company.