As I speak with bankers across the country who are considering launching cannabis banking programs, I am often asked about BSA/AML risk. Specifically, bankers want to know if they will still need to implement and maintain specialized compliance programs if the federal government legalizes marijuana, or at a minimum, recognizes state legalization programs.
In short, the answer is yes. The BSA/AML risk associated with serving cannabis-related businesses (CRBs) will not magically go away when Congress eventually passes marijuana reform legislation. I say ‘eventually,’ because while it may not happen this year or next, it is just a matter of time before we see policy changes at the federal level. This could take the form of the SAFE Banking Act (which would allow financial institutions to provide services to cannabis clients without fear of federal penalties) or even more comprehensive marijuana legalization legislation.
So, what are some of the risks credit unions face when serving CRBs, and why will enhanced due diligence continue to be required for this industry?
A Robust Illegal Market. The legal cannabis industry continues to compete with an outsized illegal market. According to data published by New Frontier last fall, the legal cannabis market in the U.S. is expected to reach $41 billion by 2025. The industry reached $20 billion at the end of 2020, so while the growth of the legal market is expected to be quite impressive, the illicit market is shrinking at a slower pace. According to some estimates, we are still dealing with a $65B illicit market. As you can see, while the cannabis industry is bringing in new users within the legal market framework, the illegal market is still going strong. As a result, BSA/AML requirements are unlikely to change dramatically because credit unions still have to make sure that funds coming through their doors are from legal channels.
Bad Actors. Whenever you operate in an industry with a strong illicit market, you have to guard against unsavory individuals who try to associate themselves with legal entities. To ensure that bad actors are not attaching themselves to good businesses, the enhanced due diligence conducted around the underlining beneficial owners, above and beyond what credit unions do for their typical commercial business client, will continue to be at a heightened level for a prolonged period of time.
Legacy Cash. Because the cannabis market existed as a cash business long before legalization, we know there is still a lot of money buried in people’s backyards or stashed in vaults in people’s basements that eventually wants to find its way into the legal banking market. Compounded by the fact that this industry continues to operate largely as a cash business, a strong BSA/AML program will help ensure that the funds coming into the credit union are from legal cannabis operations.
For these – and many other reasons – we expect bankers will need to invest in specialized BSA/AML compliance programs for the foreseeable future. While the added burden and cost associated with maintaining these programs may limit the total number of participants offering financial services to the cannabis industry in the short term, we expect competition from financial institutions to steadily increase as more states launch legal programs and we get closer to federal recognition. Credit unions that invest in a BSA/AML compliance program that harnesses technology to improve efficiencies and lower costs today will have a competitive advantage when the economics of the industry change over time.
Partnering with experts who can assist with BSA/AML programs, compliance technologies, and risk management policies required for banking this industry will help credit unions operate safely and pass their exams while gaining a first-mover advantage as competition grows.