How do you solve a problem like marijuana?

How the U.S. dual banking system is stymieing business growth

While President Donald Trump’s first month in office was marked largely by rolling back many of the Obama Administration’s regulations, the marijuana industry may be less worried about repeals and more concerned with stricter legal enforcement under the new president. Earlier this year, for example, the Illinois state treasurer wrote Trump a letter asking to ensure that banks servicing state-sanctioned marijuana businesses wouldn’t face criminal action. As it turns out, state legalization of marijuana comes with a number of financial considerations, as well as unique challenges that stem from differences in regulations between states and the federal government.

Medical marijuana is currently legal in 28 states, and eight states allow its recreational use. That means that more than half the nation is now invested in the substance. Business is booming: Legal sales grew 25 percent from 2015 to 2016, reaching $6.7 billion, and are expected to skyrocket to $21.8 billion by 2020, apparently becoming a bigger market than the NFL.

But such growth, it turns out, is complicated, because federal financial laws haven’t quite caught up. For many marijuana-related businesses (MRBs), it’s not clear what to do with the money they’ve made legally. Federal law still classifies marijuana as a Schedule I drug punishable by significant fines and jail time for anyone associated with the industry—and that includes banks.

The federal Controlled Substances Act (CSA) states that any financial institution servicing an MRB can be found to be facilitating money laundering. Moreover, the Bank Secrecy Act (BSA), enforced by the U.S. Treasury, requires banks to report customers’ “suspicious activity,” which includes money laundering and “other criminal activities, such as financial transactions associated with illegal drug activity.” Banks found to be violating these acts can expect to see criminal actions brought against them by the federal government, which can include major fines or imprisonment. An employee of a bank who repeatedly violates this law (for instance by providing ongoing services to MRBs) can serve up to ten years in prison or be charged a fine of $500,000. Banks take pains to comply with these laws—and as a result are extremely reluctant to provide services for marijuana dispensaries, growers, and other involved parties. And this puts the marijuana industry in a bind. Without banks, MRBs can’t fully operate—even in states where they’re legal.

In theory, this problem could be solved by taking advantage of the United States’ unusual dual banking system. Under the system, which in its current form dates back to the 1880s, banks may choose whether to receive a federal or state charter. Federally chartered banks (which are often the large, national banks like Bank of America or Chase) are required to follow federal laws, and state-chartered banks (which are often small or community banks like Sun Trust or Fifth Third Bank) follow state laws.

Problem solved, right? Banks in states that have legalized marijuana should obtain state charters and therefore be covered under the law. Unfortunately, it’s not that simple.

Even though state-chartered banks are overseen by state regulators, they are also subject to regulation from federal agencies—either the FDIC or the Federal Reserve. Both federal and state banks must be insured, and that insurance comes from the FDIC, even under a state charter. While the advantages of insurance are great, retaining those benefits requires a bank to comply with FDIC regulations, which enforce the BSA and are especially strict on “high-risk” industries. FDIC oversight also applies to third-party payment processors.

Some MRBs simply attempt to open bank accounts by concealing their true nature, which is a risky move. Others have appealed to the government to change the laws, like the Illinois state treasurer who asked President Trump to ensure that “reasonable financial institutions” would not face penalties for servicing licensed medical marijuana growers and dispensaries. However, given Attorney General Jeff Sessions’ stance on marijuana use, the administration seems unlikely to loosen these particular regulations.

Given these challenges and risks for banks, the most likely actors to fill this niche are actually credit unions. Like banks, credit unions can also be either state- or federally-chartered. Their federal charters come from the National Credit Union Association (NCUA), which is also their insurer and their regulator. The NCUA is also bound by the same federal laws as the FDIC, but doesn’t identify high-risk industries and has generally more favorable opinions on industries the FDIC doesn’t like (such as payday lending), which means that regulation is not as tight.

Notably, while all federally chartered credit unions must be insured by the NCUA, and most state-chartered ones are as well, some states allow private insurers for credit unions. This could be the breakthrough for MRBs, but it’s still unclear whether private insurers want to take on the risk of marijuana either, because they can still be found in violation of the CSA.

Still, many currently operating MRBs are serviced by credit unions, although a recent, highly publicized court case ruled against Fourth Corner Credit Union’s bid to become a marijuana-specific credit union in Colorado because it would be “facilitating criminal activity” under federal law.

As long as the dual banking system requires state-chartered institutions to be overseen by federal regulators, MRBs will have a difficult time getting financed. But MRBs aren’t giving up: Fourth Corner is appealing its case, and as the industry grows, someone will have to step in. The cannabis industry is expected to be worth $50 billion in less than a decade, which may end up forcing the government’s hand.

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