By Zach Fox

Stringent application of anti-money laundering regulations and a long history of aggressive drug enforcement are keeping banks on the sidelines when it comes to servicing the rapidly growing marijuana industry. Federal regulators issued guidance encouraging marijuana banking more than 20 months ago, yet some of the industry remains unbanked.

Gresham, Ore.-based MBank hoped to address the problem. The bank started opening marijuana accounts, including for Colorado-based businesses, in the second half of 2014. The experiment did not last long; the bank pulled out of Colorado in January and shuttered all marijuana accounts in April.

President and CEO Jefry Baker told SNL that the bank did not have the resources to manage any marijuana accounts because regulators expect banks to identify and prevent illegal activity.

"We're effectively responsible for trying to deter the criminal element," Baker told SNL. "We're a bank, and we're set up to do financial transactions. We're not the police."

Regulators have made Bank Secrecy Act and anti-money laundering regulations a priority in the wake of high-profile cases involving Wachovia Bank NA and an HSBC Holdings Plc unit allegedly offering services to drug cartels and terrorists. In 2012, the U.S. Senate rebuked the OCC for failing to catch the illegal activity earlier. Since then, BSA/AML issues have resulted in several banks paying out nine- figure settlements for inadequate policies and caused a virtually unprecedented three-year delay in a major bank deal.

Banks have been particularly skittish about processing transactions with what the FDIC deemed to be "high-risk activity." As part of guidance issued in 2011, the FDIC classified dozens of business types as high risk, including merchants involved in drug paraphernalia or tobacco sales. Meanwhile, the Department of Justice launched Operation Choke Point, a campaign that put pressure on banks to cut off funding to payday lenders and payment processors. After banks shuttered accounts for anyone involved in activities named in the FDIC's guidance — even entirely legal industries such as firearms, fireworks and pornography — and congressional committee investigations into Operation Choke Point, the FDIC backtracked and revised its guidance in July 2014.

It appears that revision and February 2014 guidance from the Financial Crimes Enforcement Network encouraging marijuana banking have failed to do the job. Banks still feel pressure from regulators to avoid holding accounts for anything resembling illegal activity. Marijuana remains illegal under federal law, but MBank's Baker said full legalization might still not be enough to open up banking services for the industry.

"Federal legalization would ease the burden in a lot of ways, but ultimately it's a shift in the regulatory environment about where does a bank's role begin and end," Baker told SNL. "And it needs to ease up a little bit. … I see our role as to raise our hands when we see something. But when you're looked at as one of the main sources to detect that sort of activity, that becomes really difficult."

David Kelly, chief risk officer for FirstBank, also told SNL that he thinks regulators expect banks to play an active role in preventing criminal activity and ensuring consumer protection. That can be particularly difficult for businesses with operations in other states with different laws. Further, when it comes to marijuana, the Drug Enforcement Administration has a long history of aggressively using civil asset forfeiture laws to seize property or cash suspected to be part of a drug transaction.

"The seizure laws are very favorable to the government, and you can lose your lien and your rights to your collateral and then you're looking at a huge loan loss," Kelly told SNL, referring to a mortgage on a commercial property housing a dispensary as an example.

To be sure, more institutions, mostly small ones, are opening up to marijuana banking. But larger banks continue to avoid the industry, and smaller banks do not have sufficient resources to service the entire industry. In Colorado, the first state to allow recreational marijuana sales to the general public, the state had issued 2,551 licenses for marijuana stores, cultivators, manufacturers and other facilities as of Nov. 2.

The Colorado Bankers Association told SNL there are currently 12 financial institutions servicing the industry, up from a report of eight institutions in July. All of the institutions are small in size and have been told by regulators to not increase the number of marijuana accounts, said Amanda Averch, director of communications for the association.

Lakewood, Colo.-based FirstBank is in a position to take on a lot of Colorado marijuana accounts. The $15 billion bank is the second-largest deposit holder in the state. But Kelly said the bank cannot handle marijuana accounts under the current legal framework.

"Until Congress does something, our current position is that we do not intend to bank marijuana because the risks are just too high," Kelly told SNL.

Another potential outlet for Colorado-based marijuana businesses is The Fourth Corner Credit Union, which secured a state charter in November 2014 with plans to exclusively serve the marijuana industry. But that institution's plans hit a snag when it applied for a master account from the Federal Reserve Bank of Kansas City. The bank denied the credit union's application for an account, citing the NCUA's denial of deposit insurance for the credit union.

While the credit union could have acquired deposit insurance in the private market, the master account is needed to be able to process checks, said Deirdra O'Gorman, president and CEO of the credit union.

O'Gorman said the NCUA's denial was confusing and did not offer clear reasons for the denial, which was the basis of the Kansas City Fed's decision. The credit union has filed suit against both entities, and a judge will hear oral arguments in December.

"We weren't given the typical due process that a credit union would go through," O'Gorman told SNL. "You typically have an opportunity to remediate."

The NCUA and Federal Reserve Bank of Kansas City both declined to comment on the lawsuit.

Marijuana businesses that have secured bank accounts tend to keep it quiet, at the request of the financial institution. Banks and credit unions that offer accounts likewise stay silent after securing accounts, fearful of raising regulatory ire.

"It's very difficult to get any kind of solid accounting of marijuana banking because … they keep it private," said Taylor West, a deputy director for the National Cannabis Industry Association. "But I can say that we haven't seen any institution step up and publicly say we're servicing this industry."

Elliot Klug, owner of Pink House, a chain of dispensaries in the Denver area, said he was finally able to secure a deposit account this year. Before that, Klug, whose dispensaries bring in more than $8 million in revenue per year, had to hide the nature of his business in order to get an account, a form of bank fraud.

Klug declined to name the institution or even identify whether it was a bank or a credit union due to a confidentiality agreement he had to sign in order to open the account. Klug said he still has to deal with large amounts of cash sometimes because other marijuana businesses, which might engage in wholesale transactions with Klug, do not have bank accounts.

"You don't realize how much you like being able to write a check until you can't write one," Klug told SNL.

As for compliance, Klug said he is only able to deposit cash at certain times, during a twice-weekly window, which matches some advice on banking marijuana from a recent credit union conference. Klug said the financial institution reviews all of his METRC reports, a state regulatory requirement to track marijuana plants from seed to sale. Also, the financial institution reviews all data from the dispensaries' point-of-sale systems and the manifests from wholesale transactions.

Klug said he obtained his account through word of mouth and that many other marijuana businesses have not been as fortunate. Those companies still deal largely in cash, which many see as a serious risk to a community's safety. For community bankers like MBank's Baker, an inability to offer local businesses a solution has been a "big disappointment."

"From a security standpoint and safety standpoint, it's baffling how [using cash is] an acceptable solution," Baker told SNL. "It's just really sad that's what we're going to force our citizens and industry to do. It's just baffling."