Access to a commercial bank account remains out of reach for many cannabis-related businesses in America. The Brookings Institution’s Aaron Klein explains why.
State-legalised cannabis has grown rapidly in America. Today one in five Americans live in a state that allows recreational cannabis and over 97% of Americans live in states that allow some level of medicinal cannabis.1 State-licensed cannabis has become a commercial enterprise with special marijuana dispensaries opening up to serve medical or recreational customers depending on the state. Commerce requires finance and thus cannabis-related businesses need commercial bank accounts for everything from accepting customers’ payments to paying their own employees. Banks are a heavily federally regulated industry and cannabis remains illegal federally.
While banks have begun addressing the needs of this new industry, they are far behind: out of the almost 11,000 banks and credit unions in America, less than 500 will serve cannabis-related businesses.2 These tend to be small, local institutions, leaving large segments of the state-licensed cannabis business unbanked. Estimates are that as many as two-thirds of cannabis businesses are unbanked.3
This banking gap is inhibiting achievement of several of the core goals of cannabis decriminalisation while also creating a large bureaucratic effort to document businesses that are hiding in plain sight. Solutions to the banking problem exist, even without an overall federal policy decision on cannabis. To understand how to solve the problem, first it is important to understand how banks operate in this grey area of cannabis.
Cannabis remains illegal under federal law. However, this does not preclude banks from accepting cannabis-related businesses as customers. After all, when you deposit funds at a bank, it accepts them regardless of how you earned the money.
The bank is required to ‘Know Your Customer’ (KYC), and if the bank suspects the customer got those funds illegally it must report this to the federal government. Thus, taking on a marijuana business as a customer means substantial reporting requirements by banks, as well as potential legal liability should the federal government reverse course and crack down on state-licensed marijuana businesses.
Bankers are somewhat conservative by nature, trying to avoid taking unquantifiable risk (this is usually a good thing). Once a bank customer has been deemed a suspicious actor, which all cannabis-related businesses are as they engage in federally illegal actions, America’s anti-money laundering (AML) rules set forth a lengthy set of reporting.
Banks are subject to regulatory scrutiny and potential fines not only for engaging with these firms but also if they fail to properly report on these engagements. One example is that such a firm would require suspicious activity reports (SARs) that cover every single transaction into and out of the bank account for a marijuana business. Miss one transaction and the bank is potentially subject to large penalties and fines.
The Financial Crimes Enforcement Network (FinCEN) is the arm of the U.S. Treasury Department that overseas financial reporting for AML activities. FinCEN attempted in 2014 to reduce regulatory burden and create a more streamlined SAR for cannabis-related businesses.4
This attempt was a good first step to reducing some of the regulatory requirements, but it is has proven insufficient to generate substantial interest by financial institutions in serving cannabis companies. The initial guidance did not succeed in part because while it streamlined reporting, a substantial amount was still required. The result is a continued de-risking and un-banking of the industry.
The regulatory structure for banking in America is more complex. To start with, FinCEN itself is not a bank regulator. It is an arm of the Treasury Department looking for financial crimes.
Each bank in America has a primary federal regulator. Bank regulators do not control the type of information required under the SAR system; FinCEN controls that. What bank regulators do is ensure that financial institutions are filing the proper procedures, rules and internal controls for their AML regime. This bifurcated system makes it challenging for bank regulators to reduce SAR burden.
The AML and KYC regimes in the US were not constructed to deal with a situation in which states were legalising a federally illicit act. A state-based legalisation system does not provide a safe harbour for a federally regulated and insured bank to not consider the proceeds from selling marijuana illegal funds. Whether that cannabis product is for medicinal or recreational purposes is also not relevant.
In the banking world the key distinction is whether cannabis is commercial. From a bank’s perspective whether the sale is related to state-licensed medical or recreational use is irrelevant. From the cannabis company’s point of view regarding the need for banking, from payment processing to payroll payment and everything in between, it is also largely irrelevant whether there is a medical prescription behind the sale.
An alternative structure where cannabis is permitted at a state or local level for use but not for sale helps illustrate the point. For example, the District of Columbia passed such legislation, permitting personal growing and usage but not commercial sale for those individuals. In this instance those persons do not really need a financial institution for payment services or commercial use.
Of course, they also need to be able to do everything from grow to cultivate to process and use the product themselves. Once a sale of cannabis occurs, involving payment, then banks become involved.
Impact on cannabis industry
The consequences of a cannabis company or commercial marijuana store being unbanked are severe. They must deal in all cash, not accepting credit or debit cards, cheques, or prepaid cards (in the US 10% of all transactions are on prepaid cards). More cash means more crime; robberies are often reported against these companies.5 It also can make it difficult for these stores to pay suppliers, employees, and even requires them to hire armoured trucks to bring cash to the government to pay their state and local taxes.
Financial technologies are unlikely to solve this problem. Crypto-currency is not widely used and even if used it is subject to a complex tax-reporting scheme as the U.S. Treasury views it as commodity not a currency.6 Payment companies like PayPal or Square may use digital wallets but they generally require a bank account at the ultimate end of the transaction in order to receive funds. Blockchain and other distributed ledger technologies are accounting mechanisms, not themselves forms of payment.
The banking problem is a byproduct of the federal government’s stance of continuing to keep marijuana illegal but also not taking active steps to stop states from operationalising a cannabis industry. However, it is solvable without a comprehensive solution at the federal level.
What’s the answer?
Start with the purpose of the AML regime: to identify criminal activity and to use the banking system to follow the money to identify criminals. This logic is predicated on the notion that criminal activity is hidden and that eventually the money needs to surface. With state-licensed cannabis the opposite is true: the activity is out in the open and the money is getting pushed into the shadows.
The solution is simple: treat any state-licensed cannabis-related business similar to any other state-licensed business for AML. This change needs to come from the Treasury Department’s FinCEN as they are the entity with the authority to set the rules. The bank regulators cannot make this change as their role is to monitor bank compliance with FinCEN guidelines.
This does not let the bank regulators completely off the hook. Bank regulators can and should provide guidance supplementing FinCEN’s new rules making clear that state-licensed cannabis-related businesses are no more inherently suspicious than other state-licensed companies that sell alcohol or tobacco.
There is one more step that bank regulators, particularly regional Federal Reserve (Fed) Banks, need to take: not using access to the payment system to block new financial institutions from serving cannabis businesses. In order to operate, any bank or credit union needs access to the nation’s payment system with what is known as a ‘master account’ at their regional Fed Bank.
The fed regional bank is not supposed to use this application process as a de facto screening process for new institutions. That is the job of that institution’s primary regulator and of the federal agency that grants deposit insurance.
However, the Federal Reserve Bank of Kansas City (KC Fed) refused to grant a Colorado state-chartered credit union (Four Corners) a licence because they were focusing on cannabis-related businesses. This use of power is probably beyond the KC Fed’s legal authority and certainly beyond the intention of the law.7 While the case worked its way through the court system, businesses in Colorado continued to suffer from being un-banked.
Different regional fed banks have taken different positions on cannabis banking. Without guidance from the Fed Board of Governors (the politically appointed arm of the federal government that overseas the fed regional banks), it is possible that similar problems may occur as state-licensed cannabis spreads to new states that are under the jurisdiction of different fed regional banks.
The best solution would be for the Board of Governors of the Federal Reserve to make a public ruling that no fed regional bank shall consider whether an applicant is planning to serve any state-licensed businesses in the decision process of granting of a master account.
The banking system is not meant to be used as a proxy tool to sort out America’s view of cannabis. When banking services are denied to an industry, it forces financial transactions to be made in cash. This makes crime more attractive. This increases public health risks. Ironically, this counters one of the primary goals of state legalised cannabis: to reduce crime.
Aaron Klein is a fellow in economic studies at the Brookings Institution and served as deputy assistant secretary for economic policy at the U.S. Treasury Department from 2009-2012.
- State Medical Marijuana Laws. 2019. National Conference of State Legislators. http://www.ncsl.org/research/health/state-medical-marijuana-laws.aspx
- Marijuana Banking Update. 2018. FinCEN. https://www.fincen.gov/sites/default/files/shared/277157%20EA%202nd%20Q%20MJ%20Stats_Public.pdf
- Rohrlich, Justin. 2018. Cannabis Companies Are Paying Federal Taxes in Cash and It’s Giving the IRS a Headache. Quartz, November 14. https://qz.com/1461947/the-irs-cant-handle-cannabis-companies-all-cash-tax-payments/
- FinCEN guidance for cannabis-related businesses can be found here: https://www.fincen.gov/resources/statutes-regulations/guidance/bsa-expectations-regarding-marijuana-related-businesses
- Chun, Rene. 2018. Ending Weed Prohibition Hasn’t Stopped Drug Crimes. The Atlantic, 7 December. https://www.theatlantic.com/magazine/archive/2019/01/california-marijuana-crime/576391/
- Bitcoin Basics. U.S. Commodity Futures Trading Commission. www.cftc.gov/PressRoom/PressReleases
- Conti-Brown, Peter. 2018. The Fed Wants to Veto State Banking Authorities. But Is That Legal? Brookings Institution. November 14. https://www.brookings.edu/research/the-fed-wants-to-veto-state-banking-authorities-but-is-that-legal/
Please note, this article will appear in issue 9 of Health Europa Quarterly, which is available to read now.