Complex regulatory environment
Cannabis professionals across the legal industry are aware of the complex patchwork of federal and state regulations that are so inconsistent they create constant conflict between organizations that work with the plant and those that don't.
On the one hand, the shaky SAFE Banking Act has us on edge as it would potentially incorporate the cannabis industry into the traditional banking system, spurring economic growth and reducing financial risk. On the other hand, cannabis would have to adhere to standards such as the Financial Action Task Force (FATF), Financial Crimes Enforcement Network (FinCEN), and Know Your Customer (KYC).
So the due diligence required of cannabis professionals is a Herculean task. In a cash-only environment, how can these leaders grasp the issues they're facing when the legal landscape is constantly changing, let alone have the courage and understanding to navigate such situations? We have some ideas.
Risk Assessment and Mitigation
It's not ideal to lump all cannabis-related banking risks into one category — there are many nuances — but it's possible to analyze the risks from three dynamic perspectives: reputational, operational, and legal.
A single failure in any of these categories can cause long-term damage to your cannabis business, so it's important to assess and mitigate threats accordingly. More importantly, this is the first step to successful cannabis banking.
First and foremost, cannabis banking poses significant reputational challenges that credit union leaders should not ignore. Despite legalization at the state level, the industry remains illegal at the federal level, creating the perception of engaging in illegal activity. Indeed, changing the classification of cannabis would likely move the needle toward societal acceptance. As it stands, negative public opinion and increased regulatory scrutiny further increase the risks of cannabis banking.
In terms of operational risk, the cash-intensive nature of the industry increases the threat of theft and fraud. Similarly, complex regulations require strict compliance, further complicating the cannabis banking labyrinth. Thorough customer due diligence, transaction monitoring, and robust internal controls are essential to mitigate these risks and protect an institution's reputation.
The discrepancy between state and federal regulations creates gray areas and many legal risks for financial institutions. For example, money laundering is a major concern. This is mainly because cannabis's cash-intensive nature makes it highly vulnerable to such illegal activity. Tax evasion is also an issue financial institutions must be aware of, but unfortunately, this goes hand in hand with non-compliance. Finally, regulatory non-compliance is perhaps the most common risk cannabis faces.
Compliance Strategies for Credit Unions
As the cannabis industry continues to grow, credit unions face unique challenges in serving this sector while maintaining regulatory compliance. A robust risk management and compliance approach is essential for credit unions entering cannabis banking.
Adopt best practices
Building a strong compliance program is the foundation of successful cannabis banking. This program should incorporate enhanced due diligence procedures that go beyond standard KYC practices. Credit unions should thoroughly vet potential cannabis clients to understand their operations, ownership structures, and compliance with state laws.
Additionally, staff training and education is also a key component of an effective compliance strategy. Employees must be familiar with the intricacies of cannabis banking regulations, including the Bank Secrecy Act (BSA) and anti-money laundering (AML) requirements. Regular training sessions should cover identifying red flags, proper documentation, and reporting procedures. Remember, this knowledge needs to trickle down from management onwards.
Leveraging technology for compliance can greatly improve a credit union's ability to manage risk. Advanced monitoring systems can track transactions, flag suspicious activity, and assist in the creation of suspicious activity reports (SARs). Automated tools streamline the due diligence process and help maintain accurate records, allowing credit unions to effectively manage compliance obligations, including aspects such as cannabis insurance.
In the rapidly evolving cannabis banking industry, staying up to date on regulatory changes is paramount. Credit unions should establish a process for monitoring regulatory developments at both the federal and state levels and adjusting their compliance programs accordingly.
Product Development and Risk Management
In cannabis banking, product development and risk management go hand in hand. Credit unions must design customized banking products that address the unique needs of cannabis businesses while incorporating risk mitigation strategies. This can include dedicated checking accounts, cash management services, lending products, and more. Pricing strategies typically reflect the increased risk and compliance costs of serving this sector.
Reputation Management and Public Relations
Reputation management is an important consideration for credit unions involved in cannabis banking. Proactive communication with stakeholders, including members, regulators and the broader community, will help manage public perception. Developing a contingency plan is also essential to address potential reputational risks.
Remember, adopting industry best practices is key to long-term success. This includes working with regulators to align expectations, participating in industry partnerships to share information, and conducting regular risk assessments and audits.
Cannabis banking presents a great opportunity for credit unions, but they must strike a delicate balance between seizing the business potential and maintaining strict compliance. By implementing a strong compliance strategy, leveraging technology, and staying informed about regulatory changes, credit unions can navigate the complexities of cannabis banking while managing the associated risks.
Isaac Bock
Isaac Bock is Managing Director and Head of Strategy at AlphaRoot, a cannabis-based insurance company based in New York, NY.
