California became the first state to legalize medical marijuana in 1996. And as of last month, recreational use of pot is also legal.
Now it’s time for the state to take another bold move: to fix pot banking.
Since pot remains illegal on the federal level, most financial institutions will not service cannabis businesses. But California, as the sixth-largest economy in the world, can get more creative.
Previous efforts to bank cannabis companies have failed because of their inability to get master accounts with the Federal Reserve — and yet it’s a strategy California officials and others keep weighing. For example, California’s State Treasurer John Chiang has convened a cannabis group whose proposal hinges on getting a master account from the Federal Reserve. Already, commentators have concluded that their efforts are in vain.
But a California central bank, operating within the borders of California, would solve this problem. Cannabis firms cannot conduct business across state lines, and thus the majority of any state’s cannabis companies have no need to conduct interstate banking.
To succeed, California would need to embrace these three principles in developing its closed banking system: eliminate the problem of too much cash floating around the cannabis industry, dovetail with state cannabis regulatory agencies and create a lasting institution that survives any federal legalization of cannabis.
First, some background: When a legal cannabis business in California pays fees for permits or makes a payment to state taxing authorities, it often pays in cash. Where does this cash go? It doesn’t go into a vault and just sit there. California and local municipalities use this cash for their operating budgets and enforcement activities and deposit these funds into banks that do business with the state of California and local governments. There are literally tens of thousands of such bank accounts used for various state and local purposes; it is a fair assumption that some of these accounts are deposit destinations for cannabis cash.
For the new scheme, California would need to centralize what’s already happening. In this model, there is no need for the state to create a branch network to take in cannabis cash. In other states, credit unions have been on the leading edge of banking cannabis companies. California can partner with credit unions and other depository institutions to set up dedicated teller windows within the partner depository and take deposits directly. The local partner would keep the cash separate from its other cash deposits, and security trucks contracted by the Central Bank of California, or the CBC, would pick up the cash deposited at the bank. The truck would transport the money to the CBC, which would duly deposit it into federally chartered money center banks. Because the money is being deposited into accounts already used for depositing cannabis fees and taxes the money-center bank sees the client as the state of California, not the underlying cannabis businesses. A state is a completely different depositor than an illegal business. A state is not illegal.
To make this scheme work, embracing the second principle is also essential: The CBC must work in conjunction with other state authorities. When a cannabis business is licensed by the state, the CBC would automatically open a cannabis business banking account for the licensed cannabis company. In addition, all employees of cannabis businesses can get personal banking accounts if they wish. Furthermore, ancillary service providers to the cannabis industry (i.e., lawyers, accountants, landlords, consultants, etc.) who can show the CBC they derive funds from cannabis businesses or had their account closed at a FDIC institution because of such revenue would also be eligible for a CBC bank account.
Money from the CBC accounts can be moved from a CBC account to outside the CBC system by initiating a transaction with the CBC and have the State of California transfer the funds to the account holder’s FDIC insured account. A transfer from the state poses much less risk than does a deposit from a cannabis business. Remember, the State of California is thoroughly reviewing all cannabis transactions in its system via its integrated banking and licensing system. These will be clean deposits fully compliant with California law being recycled back into the national economy.
With these accounts linked under a specific license, not only can cannabis businesses issue checks and move funds between parties in the system, they can also create a state-level audit trail of all funds coming and going within the business. With regard to linking in other payment systems, there already are a few firms working on ways for cannabis firms to use debit cards and other payment cards. It is currently unclear how legal these systems are. Finally, the state can link the banking system to the state seed-to-sale system, which tracks all legal cannabis supply, to create an integrated money and product tracking system.
True, the issue of deposit insurance will come up as an argument against such a structure, because the system would not be backed by the Federal Deposit Insurance Corp. But as the sixth-largest economy in the world, California is a great counterparty for self-insurance. Through statute, California can place its credit backing and guarantee on par with the state’s municipal bonds. Alternatively, or in conjunction, California can start its own Central Bank of California banking insurance fund and fund the insurance reserve through a fee on each business bank account. Over time, the fund will build up a reserve and reduce the risk to California’s general budget.
The Central Bank of California should also be established so that it would survive and contribute to California’s economy if — or more likely when — cannabis is federally legalized.
In time, other states may follow a Central Bank of California model and, by linking the various closed banking systems created in each state, banks could move the funds across state lines without using the Federal Reserve. The system could evolve into one where California becomes the central bank to the cannabis industry on a national basis, and ultimately, helps the country as a whole stabilize the industry — regardless of what actions the federal government takes.
This structure would not solve all issues related to cannabis banking, but if it sticks to core principles and acts in a timely manner, California’s cannabis industry would rival, in size and economic impact, any industry in the world.