Banks Navigate Hazy Regulations to Serve Cannabis Businesses

Some financial institutions have created their own internal guidelines—from database tracking of a plant’s life cycle to old-fashioned site visits—so that their risk profile remains low and they remain in compliance with the broad intent of the wide swath of state and federal laws.

“The reason that bankers are so reluctant to get into this industry is primarily the compliance; [there are] very intensive compliance requirements, more than any other industry,” said Mel Barnes, chief operations officer at Oklahoma State Bank. The Norman, Okla.-based community bank began providing services to legal medical marijuana businesses in January.

Fewer than 700 banks and credit unions were actively providing banking services to marijuana-related businesses as of June, according to the Financial Crimes Enforcement Network, the anti-money-laundering unit of the U.S. Treasury Department, which tracks the number.

Over the past decade, 11 U.S. states have legalized the recreational use of marijuana for adults and 22 more allow it to treat certain medical conditions with prescriptions. But the use, sale or possession of marijuana is illegal under federal law. Hemp, a variety of the cannabis plant and used for its fibers that are woven into rope and textiles, was legalized nationally in 2018. But some states don’t allow possession of any kind of cannabis, including hemp.

“It is actually very easy for a hemp producer to inadvertently, or perhaps not, produce a product that is legally classified as [marijuana] rather than hemp,” said Dan Roda, co-founder and chief executive of fintech company Abaca in North Little Rock, Ark., which provides banking services to cannabis businesses. “They could be producing a full legal substance to produce an unlawful one, or one that should be produced in a heavily regulated environment.”

Some banking regulators have started to catch up and clarify their expectations. FinCEN said in guidance in July that financial institutions should tailor their anti-money-laundering programs to hemp-related customers’ risk profiles.

Sales of products with a high concentration of tetrahydrocannabinol, or THC, the chemical in cannabis that causes psychological effects, as well as products containing a high level of cannabidiol—a derivative of cannabis that has become a popular additive in drinks and foods—are estimated to total around $34 billion for 2020, according to New Frontier Data, a cannabis market research firm.

Mike Ford of Denver, N.C., reached out to his bank of 30 years to help with the launch of his industrial hemp-growing firm early last year. He was turned down.

“You bring the word cannabis up and they just put their fingers in their ears and say, ‘oh my God, go away,’” Mr. Ford, 50 years old, said.

His company, Square Inch LLC, relies almost entirely on online transactions for sales of hemp and products such as a sports cream that contains cannabidiol, he said. The alternative of sales through cash only would have made the business very difficult to maintain, he said.

“[Lack of] banking is what leads the industry to have a black eye in many ways,” Mr. Ford said.

Peoples Bank, a Newton, N.C.-based community bank, has offered banking services to hemp-related businesses, including Mr. Ford’s business. Marijuana for any purpose remains illegal in the state, but growing hemp, which contains less than 0.3% THC, is legal.

Peoples Bank’s compliance group set up detailed categories for the kinds of businesses they could encounter, from growers to processors to dealers, and has relied on documentation, site visits and lab tests to ensure compliance, said Heather Allen, a Bank Secrecy Act officer at Peoples Bank. The bank reports monthly on its risk indicators to its board of directors, and monitors its portfolio to make sure it remains “within our internal ability to manage it,” she said. The bank currently has fewer than 100 such customers in the hemp industry and is considering an expansion, she said.

The bank questions the businesses on every step, gathering details on what they are growing, how they are growing it and how they are harvesting the crop. For instance, such monitoring allows bank officers to determine whether cannabis flowers are being grown for extracting fiber or for cannabidiol.

Treasury’s FinCEN regulations require banks and lenders to confirm that hemp growers are compliant with the state, tribal government or the U.S. Department of Agriculture licensing requirements by either obtaining a written declaration from the clients or a copy of the license.

A spokesperson for FinCEN said the agency’s 2014 guidance regarding banking for marijuana-related businesses remains in place and the agency continues to review it. The agency also is tracking the numbers of depository institutions providing banking services to marijuana-related businesses through the Suspicious Activity Reports, or SARs, which are required if a bank provides services to a marijuana-related customer, the spokesperson said.

Banks are no longer required to file SARs on customers who cultivate hemp, a group of financial regulators, including FinCEN, said in December. But FinCEN said in July that financial institutions still need to conduct due diligence and monitor transactions for hemp-related businesses.

Abaca, the Arkansas fintech company, which has over 100 cannabis banking clients across eight states, works with chartered financial institutions to provide commercial banking services to regulated marijuana and hemp businesses, and relies on technology and data to manage the risks. The company uses databases maintained at the state regulatory level to follow the production cycle of each plant to when the final, refined product is harvested from the plant, Mr. Roda said.

Such investments in technology, staffing and training on regulatory reporting can make compliance expensive for banks, said Oklahoma State Bank’s Ms. Barnes.

But it is also an opportunity for the banks, she said. “Being able to figure out a way to have a banking relationship with this booming industry was our goal,” she said.

Write to Mengqi Sun at mengqi.sun@wsj.com