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Entering the cannabis banking market

By Judith Sears –  Reporter, Independent Banker

October 1, 2022

When Oklahoma legalized the sales of cannabis for medicinal purposes in 2018, executives of $550 million-asset Blue Sky Bank in Tulsa, Okla., decided to take a close look at that market. “We realized that the cannabis industry wasn’t going to leave the state,” says Brian Schneider, CEO of the community bank. “We want to serve our community and provide banking services to the industries here.”

It’s a strategy that an increasing number of community banks are embracing. “We’re here to serve the diverse needs of a variety of customers,” says Chris Hartman, chief deposit officer for $1.3 billion-asset Cogent Bank in Orlando, Fla., which banks cannabis-related businesses (CRBs). “This is an underserved market, and we believe it will continue to grow.”

“Our compliance program, based on elevated risk, is very robust. We put the customers through an intense application process.”
—Chris Hartman, Cogent Bank

However, the ambiguous legal landscape complicates compliance; 47 states, the District of Columbia and four U.S. territories have legalized marijuana in some form, but it remains a Schedule 1 Controlled Substance at the federal level. That has made many banks wary of this niche.

In the absence of explicit federal guidelines, banks and regulators follow the 2014 FinCEN guidance and the Cole Memo guidelines published under the Obama administration. In practice, explains Neil Zick, president and CEO of $75 million-asset Twin City Bank in Longview, Wash., which began banking CRBs in 2014, the regulatory requirements align with standard Bank Security Act (BSA) requirements.

“The main ingredient is BSA,” Zick says. “They look very closely at knowing your customer and what the customer is doing, but BSA is the driving force.”

Hartman agrees that banking CRB accounts requires heightened due diligence and notes that Cogent Bank is highly selective in bringing new accounts on board. “Our compliance program, based on elevated risk, is very robust,” she notes. “We put the customers through an intense application process.”

Digital path to compliance

While the regulatory scrutiny is enhanced, community bankers agree that there are now some good digital solutions available that ease the compliance burden. “We found a solution that is compliance-based and has an automated application process,” explains Deborah Lin, AVP, cannabis-related banking lead for Blue Sky Bank. “We can upload docs securely. We’ve developed a workflow and we can go from application to submission to internal review, compliance review and final approval, all automated.”

Zick reports similar success for Twin City Bank. “Our third-party software tracks activity in the accounts, and we can compare what they’ve said they’re going to do and also what they report to the state,” he notes. “As a result, we can tell for sure that their activity is in line with their reporting with regard to sales to the state.”

In such an intricate regulatory environment, however, community bankers caution that it’s critical to evaluate vendor partners carefully. Cogent Bank discovered that some merchant credit card providers code transactions in a way that masks what the CRB-related transaction really is in order to claim that they’re compliant.

“We don’t believe that’s compliance, and we don’t partner with those providers,” Hartman says.

Lindsay Larson, Cogent’s BSA/AML officer, adds that it’s imperative to look at which transactions travel on which financial networks. If a debit card transaction travels the ACH rail, for example, it is legal. If it travels as a credit card transaction, it’s prohibited. “Make sure the provider has closed the loop and the transactions only travel the ACH rail,” she warns.

To address the increased regulatory risk and burden, community banks often assign dedicated personnel or provide specialized training for handling CRB-related accounts. Cogent Bank designates specific cannabis subject matter experts in each market it serves and channels prospects to these relationship managers for optimal service. In addition to Lin leading cannabis banking for Blue Sky, the bank hired a compliance staffer specifically for handling CRB accounts.

Cannabis financing: Not as clear cut

While more and more community banks are undertaking depository relationships with CRBs, banks have been much more hesitant to enter lending relationships. The reason is simple: the possibility that the federal government would seize assets if an account got into serious trouble. “We don’t want to own a grow house or a manufacturing facility that we can’t sell or gets forfeited,” Hartman says.

Nevertheless, Cogent Bank and Twin City Bank have taken small steps, both extending loans to real estate customers that lease to CRB tenants. “Generally speaking, if a business is in a strip mall, we’ve been able to show that the cash flow from the other tenants in the building more than covers the cash flow for whatever we’re lending,” explains Zick.

Hartman has observed an increased willingness among professionals to be associated with CRB-related transactions. “Early on, attorneys or title companies were unwilling to be in the space, but we no longer see that,” she says.

Mainstreaming cannabis-related businesses

The federal legal status of cannabis may remain in limbo for some time, but in many states, it is rapidly being integrated into the mainstream economy.

“Association with CRB seeps into a lot of areas,” says Steve Keen, ICBA VP of congressional relations. “It’s not as simple as drawing a line and saying, ‘We don’t bank in this niche.’ Suppose a bank does an agricultural loan for a fertilizer company that, in turn, sells to a company that is selling marijuana in Washington state. Suddenly, you’re banking a CRB business, at least tangentially.”

Schneider recalls that when Blue Sky Bank announced it would work with CRB-related accounts, it discovered lots of company in the business community. “You wouldn’t believe how many people would raise their hands and say, ‘Yes, we have this,’” he says. “I’m more convinced than ever that these deposits are flowing through every bank. Only those banks that are trying to understand that market realize this.”

“This is a meaningful industry in our state,” adds Lin. “It crosses over all businesses and is generating new employment and job growth. Economically, cannabis generates growth.”