State-Run Marijuana Bank Option Falters in California

Financial Services Law

A new study has cast a shadow on plans for a state-owned bank to service the cannabis industry in California.

After recreational pot became legal in the state last year, regulators considered the option of a state-run bank as a way to provide financial services for the burgeoning industry, but the California feasibility study put a damper on hopes for the financial institution.

What happened

On January 1, 2018, California joined the growing number of states legalizing the sale and use of recreational marijuana for adults. But the expansion of legal cannabis sales further aggravates a problem for members of the cannabis industry—how to obtain banking services when federal law still considers the drug illegal. The federal Controlled Substances Act bans the possession and sale of marijuana, leading the majority of cannabis businesses to run on cash. Some efforts have been made to alleviate the problem, particularly under the Obama administration. The U.S. Department of Justice adopted a hands-off federal policy that deferred to state governments, as set forth in the “Cole Memo,” a memorandum issued by then-Deputy Attorney General James M. Cole to all U.S. attorneys on the issue of enforcement of federal anti-marijuana laws in light of growing state acceptance. However, with the change in administration, those efforts ceased.

As California cannabis businesses struggle to obtain even basic banking services, the state has considered various approaches to remedy the problem. In 2018, state lawmakers introduced a bill that would allow the state’s banking department to charter limited-purpose banks and credit unions expressly authorized to provide banking services to members of the cannabis industry in order to enable them to pay taxes, rent, vendors and payroll. Although the bill died last year, a similar measure was prefiled in December 2018 for consideration in 2019 by the California Legislature.

In a further attempt to provide banking services for the legal cannabis industry, California is considering whether a state-owned bank to service that industry would be feasible; the state initiated a study last year into the financial and legal risks of such an institution.

But the results of the feasibility study dashed the hopes of legislators that a state-run bank presents a viable solution.

“Our conclusion is that no option for a public bank focused on the cannabis industry is feasible,” the report concluded. “All alternatives fail on both risk and financial grounds.”

The study considered three approaches to a state-backed bank for cannabis-related businesses: a bank set up exclusively to provide banking services to the cannabis industry; a bank that primarily provides banking services to the cannabis industry but also offers banking services to other individuals and businesses; and a correspondent bank (analogous to a bankers’ bank) that provides banking services to other commercial banks.

For each of the options, the study found the state could expect to spend $35 million on startup costs, incurred over a six-year startup period. The report noted a “high probability” that the Federal Reserve would not issue a master account to the bank, which is necessary for the bank to open and conduct basic banking functions such as wiring funds.

Significantly, the proposed bank would need just under $1 billion in capital and would lose money for 12 years before it could provide a return on invested capital, according to the study, with the state receiving its first dividends sometime between 2050 and 2055. The bank could also experience significant losses as a result of increased competition from other financial institutions if federal law changes and cannabis becomes legal. Also, the report speculates that in a worst-case scenario, if federal regulators chose to aggressively enforce federal law, the bank could be closed, bank employees criminally prosecuted and bank assets subject to confiscation.

The study also considered other options, such as a public credit union, the state purchase of an existing private bank and various fintech solutions involving payment technology such as cryptocurrency.

“Each of these options is ultimately dependent on access to national banking and payment processing networks, so each encounters the same difficulties overcoming the federal laws that are holding back access to banking now,” according to the report. “We conclude that none of these alternate solutions is feasible.”

Instead of a state-run bank, the study recommended that California designate a lead agency to help improve access to banking by the cannabis industry, in part by encouraging existing financial institutions to offer banking services to these companies. The agency should also support the provision of banking services to the cannabis trade through a combination of lobbying (at both the state and federal levels) and potentially via judicial action, the study suggested. “The only effective long-term solution involves legislative and regulatory changes at the federal level to allow the legal banking of cannabis-related funds,” the report concluded.

To read the feasibility report, click here.

Why it matters

The study appears to put an end to plans for a state-run marijuana bank, unequivocally concluding that in any form, a state-backed cannabis bank “involves unacceptable degrees of legal, schedule, mission and financial risk.” California State Treasurer John Chiang acknowledged that the solution now appears to lie with the federal government. “While [the study] may not lay out the path some of us had hoped, it did reinforce the inconvenient reality that a definitive solution will remain elusive until the federal government takes action,” he said. “[The federal government] must either remove cannabis from its official list of banned narcotics or approve safe harbor legislation that protects banks serving cannabis businesses from prosecution.” Whether the results of the state feasibility study will dampen the efforts of various cities within California to establish their own banks to serve the cannabis industry remains to be seen.