Nevada, New Jersey and Delaware were the first states to legalize Internet gambling and it's likely that they won't be the last.
A market forecast by H2 Gambling Capital projects that by 2017, 16 states will have legalized online gambling, as they all vie for their piece of the action in a business that by then is projected to generate more than $7 billion in annual revenue.
But if the legal Internet gaming industry is to realize its big dreams, it needs the help of the banking sector. And that relationship is off to a shaky start.
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Many of the nation's largest financial institutions say they won't process online gambling payments on their credit cards, even in the three states where Internet poker and, in some cases, other casino games became legal in 2013. That list includes JPMorgan Chase (JPM), Wells Fargo (WFC), Bank of America (BAC), Capital One Financial (COF), American Express (AXP) and Discover Financial Services (DFS).
The banking industry's caution is the result of several factors, including worries about anti-money laundering rules, a fear of negative press, and the fact that only a small amount of revenue is at stake right now, according to observers.
"If I was a financial-services provider, being ultra-cautious, I would want to sit back and wait a little bit," says Joseph Kelly, a business law professor at the State University of New York in Buffalo who has helped write online gambling laws in other countries.
The banks' stance carries a whiff of irony, given that during the woolly early days of online gambling, when the entire market was unregulated, U.S. gamblers commonly used their credit cards to make payments.
The more conservative approach to Internet gambling can be traced to 2006, when Congress enacted a law aimed at preventing offshore betting sites from accessing the U.S. banking system. The Federal Bureau of Investigation's April 2011 crackdown on the biggest online poker websites an event known as Black Friday added to the banks' wariness.
Until recently, there was little hope for legalized U.S. online gambling, due to the prevailing interpretation of a decades-old federal law called the Wire Act. But in September 2011, the Justice Department determined that the law should be interpreted more narrowly, paving the way for states to begin allowing Internet wagering.
Still, banks were caught off guard by the rather sudden legislative actions in New Jersey, Delaware and Nevada, says Ryan Rasske, president of Risk Gap Advisors, a bank consulting firm.
The banks' current attitude, he says, is: "We're not sure if we are properly prepared for this, number one. And two, we don't really know what this means" with respect to compliance with anti-money laundering rules.
Under current federal regulations, banks are allowed to block legal gambling transactions, if they so choose. Moreover, Visa (NYSE: V) and MasterCard (MA) leave the decision up to the banks that issue their cards.
"So it's up to the banks to decide, 'is this worth it or not?'" says Steve Kenneally, vice president at the American Bankers Association. "And each bank makes that decision differently."
At large banks that are wary of state-licensed online gambling, officials didn't want to speak about the reasons why. But interviews with industry consultants revealed five major concerns at banks.
First, banks have potential liability if they process illegal transactions, so in order to become comfortable with the online gambling business they need to be confident in their ability to distinguish state-licensed operators from unlicensed offshore firms.
Second, because Nevada, New Jersey and Delaware prohibit online gambling by children and people located in other states, banks need to become comfortable with the technology that's being used to restrict access to gambling websites.
All three of those states have requirements for verifying the age and geographic location of prospective gamblers. But that technology is relatively new. If it fails for example, if folks in Pennsylvania near the New Jersey border are able to log in and gamble banks fear that they will be held responsible.
"How do we do enough?" asks Elliot Berman, a risk management consultant to banks. "That's the problem that everyone is trying to work through."
Third, banks are concerned that criminals will try to use online gambling as a conduit for money laundering. Gambling has long been used as a way to hide the proceeds of crime, but bankers may believe that they need better controls to manage the risks associated with online transactions.
Fourth, federal banking regulators have flagged online gambling transactions as potentially carrying a heightened risk, because of concerns about consumer fraud and illegal activity. A related concern is that examiners will identify online gambling transactions as a potential reputation risk. So far, regulators have not drawn distinctions between state-licensed operators and unlicensed gambling sites.
"There is a heightened level of uncertainty around any higher-risk activity, and online gambling falls into that category right now," Rasske says.
Finally, some banks may worry that involvement with online gambling will bring negative media attention. "They don't want to get caught with horror stories about kids and problem gamblers," says Sue Schneider, a consultant to the online gambling industry.
Observers agree that none of the banks' concerns are insurmountable. But because the state-licensed online gambling industry is still tiny one estimate pegs 2013 revenue at just $30 million banks have little incentive to move fast.
"Although this is a growing area, it's not that big a business right now," says Anand Raman, a partner at Skadden Arps who has worked on online gambling issues. "And while the risks may well be manageable, banks are asking themselves whether the current volume of business justifies the added compliance expense and risk."
For gamblers, it appears that the restrictions on credit card payments have been a hassle, but not a firm barrier to funding their accounts. Numerous sources said that online casinos are having more success receiving payments through automated clearing house transfers.
The Borgata, an Atlantic City casino that now offers online poker in New Jersey, warns its customers that many banks place restrictions on credit card transactions, and offers online banking transfers and prepaid cards as other options. Ultimate Poker, an online operator licensed in Nevada and New Jersey, advises players that they can deposit money by bank wire, check, or at certain casino cages.
At the same time, though, the companies are trying to convince bankers that their worries are overblown.
"It's just a matter of getting these people up to speed about what's happening at the state level," says an official at one state-licensed online gambling firm. "I think once we get to the right people, we're seeing a loosening of the issue."
The online gambling firms are also trying to sort out why some transactions are getting rejected, while others go through.
"Bank of America, Wells Fargo and Chase seem to be pretty consistent in denials. But nothing's 100% denial," the gambling industry source says. "So it's hard for us to even understand how it all works."
The online gambling industry has long been waiting for a federal law that would set uniform rules across all 50 states, while providing greater clarity to banks, but the prospects for such legislation seem dim.
Federal banking agencies could issue regulatory guidance on state-licensed online gambling, but that doesn't appear to be imminent, either.
Still, observers believe that banks will eventually become less cautious. If more states legalize online gambling, as numerous observers predict, the customer base will grow. And ultimately that may be what's necessary to get the attention of the banking industry.
"I think it's an educational process," says A.G. Burnett, chairman of the Nevada State Gaming Control Board, which currently allows only online poker. "There has to be certainty that the activity is legal."