Banks increasingly are engaging in high-risk activities that can materially impact their inherent risk profiles as a means to increase loans and deposits or to reach a new customer base or market segment. Such high-risk activities, including cannabis banking, have more scrutiny around Anti-Money Laundering/Bank Secrecy Act (AML/BSA) compliance, legal and risk management activities. It is essential that a complete due diligence and risk assessment is done in an orderly, controlled manner.
The risk assessment process should provide an opportunity for the bank to see if any new product or service falls within the scope of its strategy and risk appetite. Additionally, the process should confirm whether adequate support and control infrastructure is in place. At a minimum, risk categories associated with these activities should include strategy, reputation, credit, operations (IT risk and third-party risk would be subcategories), compliance and liquidity risk. When evaluating higher risk activities, the legal and regulatory impact should be considered in terms of compliance (e.g., AML/BSA) and potential exposure to litigation. Public perception by new and current customers and investors is of paramount consideration before engaging in high-risk activities.
The current conflict between state and federal laws inhibiting banks from serving cannabis-related businesses is likely to be resolved by 2020, which potentially opens the door for more banks to dive into the cannabis business without a full understanding of its risks. Reconciling the cannabis debate would allow the profits from cannabis sales (estimated at $24 billion by 2025 by New Frontier Data) to be deposited safely within regulated financial institutions.
Meanwhile, the Financial Crimes Enforcement Network (FinCEN) has issued guidance clarifying BSA expectations for financial institutions seeking to provide services to marijuanarelated businesses, thus aligning the information provided by financial institutions’ BSA reports with federal and state law enforcement priorities.
The American Bankers Association (ABA) has been urging Congress and regulatory agencies to provide greater legal clarity to banks operating in states where marijuana has been legalized for medical or adult recreational use. Banks in those states, including institutions with little to no interest in conducting business with marijuana-related companies, face increasing legal and regulatory risks as the marijuana industry grows. Banks take risks when providing services directly to marijuana companies, forcing banks to reevaluate relationships that indirectly involve cannabis.
Support services provided by third parties to cannabis entities may also put banks at risk. Some banks have been faced with closing an existing account, terminating a banking relationship or turning away a potential customer because of a connection to cannabis. As a result, many marijuana-related businesses conduct transactions entirely in cash, which can make them targets for criminals and create potential risks for local communities.
The Cole Memorandum established a “safe harbor” for financial institutions providing deposit and lending services to persons and businesses involved in the marijuana industry. Recently, a Senate bill was introduced, called the Secure and Fair Enforcement (SAFE) Banking Act, which would provide clarity for banks serving legitimate cannabis businesses. Until a reliable government policy is determined, the rescission of the Cole Memorandum increases legal risks to banks that continue providing banking services to cannabis-related businesses and, potentially, vendors of those businesses and other related parties. This potential increased risk (e.g., criminal prosecution) means banks should consider reevaluating their participation in the cannabis industry as it increases AML exposure to institutions that offer loans to, or accept deposits from, cannabis businesses.
The FinCEN guidance requires that a bank conduct due diligence on the business, including:
- Verifying licenses and registration with the appropriate state authorities;
- Requesting information about the business and related parties (especially third parties) from state licensing and enforcement authorities;
- Developing an understanding of the day-to-day activities for the business, including the types of products to be sold and the types of target customers to be served (e.g., medical versus recreational);
- Conducting ongoing monitoring of publicly available sources for adverse information about the business and related parties;
- Conducting ongoing monitoring for suspicious activity, including for any of the red flags described in the FinCEN guidance or the Cole Memorandum; and
- Updating due diligence information on a periodic basis and commensurate with the risk.
If the due diligence identifies state illegality or another type of red flag, the FinCEN guidance requires that banks file a suspicious activity report (SAR) detailing the possible illegal conduct. If not, banks providing deposit or lending services to a cannabis business must file a SAR, notifying FinCEN that the bank is conducting banking business with a cannabis-related entity that is operating in accordance with state law. Banks that engage in banking for marijuana businesses can also file special-purpose SARs that distinguish among: (a) marijuana businesses lawfully operating in a state (requiring the filing of a marijuana limited SAR); (b) marijuana businesses that arguably may not be operating in a manner compliant with state laws (requiring the filing of a marijuana priority SAR); and (c) marijuana businesses for which the bank has concluded that a cannabis business was operating in violation of one or more red flags identified in the Cole Memorandum (requiring the filing of a marijuana termination SAR).
Leveraging your bank’s due diligence and risk assessment processes for introducing a high-risk product or service amongst impacted stakeholders can help your bank determine if high-risk activities, such as cannabis, fit well with the overall business plan. You can also determine whether such potential involvement aligns with your bank’s strategy and stated risk appetite.
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