The cannabis industry is among the highest risk segments a financial institution can bank. In no other industry do “legal and compliant” businesses coexist routinely with “illegal and non-compliant.” This places a burden on the financial institution to appropriately vet cannabis related businesses (CRBs) and monitor their ongoing transaction activity to ensure that illegal funds do not enter the regulated financial services industry.
As a former bank CEO, and a subject matter expert in cannabis banking, I have spent a good deal of time contemplating the risks financial institutions take in banking the cannabis industry. I have also examined the resources potentially required by an institution in order to do it safely without present or future regulatory consequences. It all begins with the right enhanced due diligence program to thoroughly vet the CRBs. This goes beyond a normal “KYC” program as it requires the institution to take additional steps in understanding the licensing, ownership (including beneficial ownership) and adherence to the hundreds of local and state laws and regulations, which are subject to constant change. Beyond that, the financial institution must develop a system of monitoring, auditing and reporting for each CRB account, which is typically beyond the scope of what they do for any other commercial industry.
Why Should a Financial Institution be Interested in Banking the Industry?
The good news is that the cannabis industry can be a significant source of profit and liquidity for a financial institution. While most institutions are not immediately in need of excess liquidity right now, that wasn’t the case a year and half ago and probably won’t be the case in the intermediate future. The cannabis industry represents a negative cost of funds on interest earning liabilities for a financial institution and a source of fee revenue (HDCS targets an additional 100bps of spread after all expenses). This can all be accomplished without “price gouging” the cannabis customers. Furthermore, because the cannabis industry has been largely locked out of basic financial services, cannabis businesses will be loyal customers and target rich prospects for a number of cross-sell opportunities.
It may be self-serving to say that I recommend that financial institutions hire external subject matter expertise before developing a cannabis banking program. But, that is why I created HDCS, and the truth is that there are very few people in the banking industry who have deep domain knowledge of both the regulated financial services industry and the legal and compliant cannabis industry. This is critical as the consequences of error in this industry can be significantly detrimental to the financial institution. Most likely, it is more efficient for an institution to rely on external subject matter expertise than to build and retain teams with this specific industry knowledge. This becomes even more important after federal banking guidance is issued and federal cannabis banking enforcement begins in earnest.
Today, roughly $20B in legal cannabis revenues are flowing through the U.S. banking system. The unspoken truth is that probably much more illegal cannabis revenue is also flowing through the system. Financial institutions in states in which cannabis is legal will have to contend with cannabis in one way or another. The financial institutions that choose to openly bank the industry need to put appropriate controls and processes in place. But once they do, they will find a loyal and profitable new customer base.
A Solution Created by Bankers for Bankers
We would be happy to meet with you to understand your objectives and risk appetite and share our view of the best practices involved in establishing a safe and profitable cannabis banking program. Let us give you a tour of our data portal and demonstrate what a risk-focused and profitable cannabis banking program could like for your financial institution. At HDCS, one of the many things that separates us from our competitors is that we have an affordable solution for vetting your cannabis customers created by bankers for bankers.
CEO and Founder | HDCS, Inc.