When it first hit my desk several years ago, the idea of “cannabis banking” was much different from what the industry knows today. At the time, only a few pioneers banked the industry, doing the hard work of figuring out how to provide services under guidance provided by the United States Treasury’s Financial Crimes Enforcement Network without raising the ire of regulators. Back then, most financial institutions collected enormous monthly fees to cover not only the risk but also the research and development required of early adopters in any new market.
This was “cannabis banking 1.0,” and it was most about taking cash and storing it safely as well as helping operators make tax payments. Over time we’ve seen that environment evolve through version 2.0, which encompassed checking accounts, payroll, and payments. Now, under an emerging version 3.0, full cash-management services and lending are becoming table stakes for establishing new relationships between banks and cannabis-related businesses.
At the same time as services expand and relationships grow between the industry and financial institutions, we’re seeing monthly fees driven down by a combination of competitive pressure and a more relaxed regulatory approach. The Massachusetts market is a good example: Monthly fees slid to zero at a number of financial institutions as at least fifteen of them vie for the companies that own slightly more than 1,000 licenses.
These “no fee” plays are possible because interest rates have risen significantly over the past few years, impacting the cost financial institutions pay to acquire funds. The cost of funds for cannabis deposits generally falls in the range of 75–100 basis points (or 0.75–1.0 percent). While not particularly interesting when the federal funds rate (the interest rate at which banks lend to each other overnight) was at ten basis points (0.1 percent), now that fed funds cost more than 5 percent (500 basis points), cannabis dollars become increasingly attractive to financial institutions trying to raise deposits while managing their net interest margin.
This is balanced nicely with the decreased risk of banking the industry. Regulators and examiners have gotten more comfortable and familiar with the requirements for banking the industry and the technology available to provide demonstrable evidence the money entering the financial system is the result of state-legal sales, not the illicit market. Good money in, bad money out.
The data available within this technology—in particular, sales data and peer analysis—allows the business-development and lending teams within financial institutions to participate more in the program. They now have more information about the performance of cannabis clients than they do about any other segment. This information supports the growth of traditional lending in the space, as credit analysts and lenders are able to see trends and patterns over time. In fact, they are able to monitor the performance of the businesses in real time as opposed to waiting for annual tax returns or quarterly financial reports.
Combine this data with emerging tools such as cannabis-specific risk reports and the ability to participate in syndication networks, and you’ve got a solid risk-management scheme in place for lending directly to cannabis operators. And the timing couldn’t be better for that opportunity. As the industry matures, a number of loans provided by alternative lenders willing to take the initial risk are coming due. Those loans are in need of refinancing in the immediate future. Due to the risk of working with operators early on, the initial loan rates were quite a bit higher than even high-risk commercial financing provided by financial institutions. To the benefit of the operators who have them, the performance on those loans provides an opportunity to show traditional financial institutions they are good credit risks and have the ability to repay.
Traditional lenders should be prepared to take out that higher-rate financing at a rate that is above average for their portfolio but significantly lower for the operators. This means cannabis businesses will save interest expense and raise their profitability, and lenders will be able to impact their revenue and net interest margin in a positive way. It’s a win-win.
It has been interesting to watch financial services in this industry evolve over the years, particularly when so many operators were unbanked just a few years back. Although some people expect banking to be normalized for this space, I don’t see that happening in the near future. Even with shifts in the federal government’s perspectives, as long as there are both illicit and legalized markets, there will be a need to keep illicit funds out while allowing licensed operators to have banking relationships as robust as those enjoyed by any other business entity.
My expectation is that the best practices that have been forming at hundreds of financial institutions that have been working with regulators in this new market will be the foundation for more consistent and clear guidance from those agencies once the federal government finalizes its thinking around how best to regulate the industry.
A community banker, fintech executive, and consultant with decades of experience in financial services, Stacy Litke employs her comprehensive view of the industry as vice president of banking programs at Green Check. Previously, she served as senior vice president of operations for a $900-million institution in Massachusetts.
