Despite the ongoing discrepancy between federal and state cannabis laws, the number of financial institutions serving cannabis businesses in states with legal cannabis programs has been increasing steadily. While most bankers initially entered the market to generate new sources of low-cost deposits and non-interest fee income, they have also discovered that the compliance and due diligence processes they implemented on the deposit side can be leveraged to mitigate credit risk. As a result, lending appears to be the next big opportunity for financial institutions to generate revenue and gain a competitive advantage in this fast-growing market.
Although lending to cannabis businesses introduces new risks, banks and credit unions serving this industry and passing their compliance exams have a key advantage: a deep insight into their customers/members. The added layer of transparency and data-sharing required to serve this industry successfully enables these financial institutions to apply judgmental decision making to evaluate lending requests and make informed decisions that support the cannabis company’s business goals while protecting the financial interests of the bank.
Deirdra O'Gorman, CEO of DX Consulting and Empyreal Logistics, is an expert on banking and compliance for highly regulated industries. She works with financial institutions across the country and offers her perspective on the lending opportunity.
How much interest is there in lending to cannabis companies?
We are seeing an increase in requests to assist banks and credit unions in building out their commercial lending programs to offer credit to cannabis customers. Most of these requests come from institutions that have a seasoned cannabis banking program and are ready to deepen the account relationship. Many of these institutions are already doing some consumer lending, such as loans to employees or owners. We advise that there needs to be a comprehensive and complementary approach to lending in this space. That is why we suggest financial institutions work on consumer and commercial cannabis lending programs in parallel to ensure policies and procedures work together to deliver a better customer experience and greater program efficacy.
What type of lending is being offered?
Most banks and credit unions are starting their programs with real estate lending. Equipment financing is of interest, but less common. Another newer concept in cannabis lending is factoring. Third parties are entering the cannabis space with accounts receivable/factoring lending programs, but most of them are not affiliated with a financial institution.
How should financial institutions deal with the issue of collateral?
This is tricky because there is no universal standard on collateral and every financial institution views the risk differently. Most states do not allow financial institutions to take the plant or plant-derived product as collateral, even in default scenarios, as the financial institution did not go through the rigorous licensing process. As a result, some banks and credit unions price for risk and treat these loans as unsecured, whereas others take on additional collateral or co-signers to mitigate exposure. A best practice is to review each loan on its own merits and work with your internal team, consultant, and legal counsel before embarking on your first cannabis loan.
What is motivating financial institutions to add lending to their cannabis programs?
In our experience, most financial institutions look at lending as a natural progression of their cannabis banking programs. Once they get a comfort-level with their customers and members, they want to help them expand their businesses. Also, with cannabis banking comes new deposits. Therefore, many financial institutions are entering lending as a means of balance sheet management.
As of the November general election, 35 states have legalized some form of cannabis, and of those, 15 states will now have adult-use programs. While in years past, only two or three banks would have launched a program in a newly minted legal state, we are now seeing that number double or triple. This means a first-mover advantage is no longer an option in most markets. If you are considering entering this space, please don’t hesitate to let us know how we can help get your program up and running.