Is this the pot-banking fix?
Marijuana habits are pretty predictable.
Poorer young people tend to smoke pot, while older consumers tend to use concentrated products like marijuana edibles or vape pens.
While that conclusion may not be shocking, it's based on reams of proprietary data examined by NCS Analytics, a Denver-based firm that is building a data portal between banks, two states and marijuana-related businesses (MRBs) that sifts through information to alert bankers and regulators to suspicious activity.
“You can take one of our markets, drop a pin on the map, and I can tell you with a pretty high degree of statistical certainty what will sit on those stores shelves at what price point and at what sales volumes,” said Adam Crabtree, NCS' chief executive.
The portals are designed to encourage financial institutions to become more comfortable in banking marijuana-related businesses by making it easier for them to sort out good and bad actors.
NCS is under contract with Michigan and a joint powers authority in California to develop a data portal for both states. The portal will share the state’s tracking, licensing and tax data as well as pot-related firms' internal accounting software data, buyers demographic data and more.
Bankers and regulators may also see a benefit from NCS' machine learning software by getting their data aggregated and analyzed with a notification system that will alert banks and the state if there is an issue with a pot firm's business practices. Banks and the firms choose whether or not they want to opt in to the portal, and banks can see only their clients' data.
Banks currently are required to obtain individual licensees to supply data monthly or quarterly.
“Back in my banking days, I had to have clients fill out a form called a 40516-t,” Crabtree said. “That was a form so I could request their taxes from the IRS, and there was more than one occasion where the tax records that the client gave me and the records they gave the IRS weren't the same.”
A small number of banks and credit unions are interested in taking on the risk of banking pot-related firms despite having to spend significantly more on compliance, said Katrina Skinner, president of Safe Harbor Services, a credit union service organization wholly owned by Partner Colorado Credit Union that partners with financial institutions nationwide to teach them how to implement their own cannabis banking programs.
Skinner is working with three credit unions in Michigan that serve such businesses.
“They want to help ensure that the cash is off the streets, they want their local communities safe and they’ve been approached by some of the MRBs that need banking solutions that are already in their memberships,” Skinner said. “There’s no guarantee that banking them will be a profitable choice for the financial institutions.”
In a market like Michigan, new financial institutions will have to enter without knowing what other banks in the market are charging clients. While only a few financial institutions in Colorado bank pot-related firms, Massachusetts banks and credit unions are suffering from a price war because so many institutions have entered the field, Skinner said.
If there are not enough marijuana-related firms to go around, a seemingly lucrative business can turn out to be a large compliance burden.
The software will allow banks to have more clients per banker by reducing the cost of data entry and analysis, Crabtree said. For one midsize MRB, an auditor might have to review 1,500 pages of files. State and local regulators also struggle in new markets because of underreporting. Encouraging banks and MRBs to opt in to the data portal will make it easier for auditors to see the deposit data that should match the pot-related firms' tax data, Crabtree said.
“Honestly, it’s who they’re most afraid of,” Crabtree said. “If they are truly afraid of the local government, they’re not going to risk stepping out of line. But they might not think the state will visit them.”
Crabtree’s technology would also allow electronic transmission of data that’s already been verified by the state. “This way you're actually seeing the same set of books that the state regulatory officials are seeing,” he said.
In addition to sending alerts to enforcement agents, NCS’ software also generates questions for the regulators to ask a pot-related business that’s producing unusual revenue.
“One of the questions is about whether or not you ran any sales or specials. It’s an innocent question. If we look and see that’s where the price volatility is occurring, then everything checks out. Now, the bank knows its customer better for that KYC portion,” Crabtree said, referring to know-your-customer provisions.
The behavioral economics around weed consumption also helps the software determine when firms are underreporting harvests. Since pot flowers are taxed at a higher rate than the rest of the plant, businesses have an incentive to underreport how many flowers are being produced.
“We look at their efficiency ratios and we control by medium,” Crabtree said. “We have the ability to do the big bell curves and say it should fall at x percent and they are reporting y percent. That means that they are either incompetent or they are lying about producing product at that point in time.”
Pot-related firms may also overreport how much of the plant is being produced to sell batches because they are selling blackmarket weed that comes from outside of the business — a crime that can get a bank in trouble under anti-money-laundering regulations.
NCS is expecting a few more contracts this quarter, Crabtree said. In a few weeks, the company will hand over the portal to the state of Michigan. Once the portal goes live, it will be up to banks to sign on. Michigan’s contract is estimated to be $141,650; California has yet to settle on a price.
Michigan’s portal will be a relief to banks that have wrestled with uncertainty even after medical marijuana was legalized in the state. There are now three to five banks taking on MRB clients in the state, said Craig Aronoff, a Detroit-based CannaBusiness attorney and legal counsel for TruStrain, a software company that informs consumers and budtenders about the strains and products in the marijuana industry.
While medicinal marijuana was legalized in the state in 2016 and adult-use marijuana was legalized in 2018, the state administration's was antagonistic toward the industry until Gretchen Whitmer, a Democrat, took office in 2019.
“There’s been a maturity and evolution in Q1 that didn’t exist in Q4 of last year,” Aronoff said. “It makes sense to have an intermediary interface that puts banks, the state and MRBs on the same plane. Last September, we did allow financial institutions to have access to metric-related data, but never explained how they would get that data.”
Although the state only recently legalized the drug, the need for banking services has existed since 2010, when individual towns and cities began to tolerate the proliferation of pot-related businesses, but the businesses lied about what they were doing, Aronoff said. Until 2018, banks had to close these accounts as soon as they discovered the businesses were dealing with marijuana.
The California Cannabis Authority, a county-led joint powers authority that signed a contract with NCS Analytics in August 2018, convened to develop the data portal after a yearlong study by the state Treasury’s working cannabis banking group. In California, pot-related businesses have to be licensed with local and state governments, and several counties realized there was a need for more easily verifiable information at the local level, said Cara Martinson, executive director of the authority.
In 2017, the group set out to address the lack of banking services available to marijuana businesses. Other ideas proposed in a report released in November 2017 included a state-backed bank, a state-backed and privately owned bankers’ bank or corporate credit union, contracts with armored car services to collect taxes and licensing fees and an online data-sharing portal. The report also suggested organizing a multistate consortium that would educate, share information and advocate for policy changes at the congressional and corporate levels.
The California Cannabis Authority wants the portal in place so that bankers can bank pot-related firms more efficiently and cheaply. Unless marijuana laws change at the federal level, however, many banks will still be hesitant to join.
“It’s not a silver bullet,” Martinson said. “It might convince folks on the fence to open up a small percentage of their portfolio to cannabis clients.”