This article was originally published in American Banker BankThink (9 Dec. 2016). To read the full article online, click here (subscription may be required). Republished with permission. 

By Lisa Silverman, Managing Director, K2 Intelligence 

The 2016 election will be remembered not only for the memorable presidential race but also for what was effectively a national referendum on cannabis. Eight states passed laws allowing its use. Medical marijuana is now permitted in 29 states, and eight permit its recreational use.

The legal sale of marijuana has grown from a $1 million industry in 1996 to an almost $8 billion industry today, with predictions it will reach $23 billion by 2020.

But the state victories only amplify the disconnect between federal and state law when it comes to marijuana use, which preserves the uncertainty for banks about whether to get involved in the legal pot industry. That industry is booming, but for the most part cant bank its profits.

The state referenda don’t change the fact that the ever-growing number of organizations involved in the varied aspects of the legal sale of pot must store the profits in floor-to-ceiling vaults, pay their payroll taxes in large sacks of cash, and refuse payments made by credit card or check.

What is the legal issue? Despite marijuana’s growing acceptance in a majority of states, federal law prohibits marijuana’s use, distribution, possession, or cultivation. That usually keeps banks—supervised at the federal level—away. Along with heroin, ecstasy, and LSD, pot is still considered a Schedule I drug by the Drug Enforcement Agency—with no accepted medical use.

Banks—whether federally or state-chartered—must comply with federal laws and statutes, and expose themselves to potential criminal prosecution if they agree to conduct business with those involved in the legal cannabis business. As a result, many banks are refusing to open new accounts for marijuana businesses, while others are closing already-opened accounts.

This disconnect between federal and state law not only keeps billions of dollars out of the banking system but also creates huge opportunities for fraud, since the pot business is still a cash-based business. In an effort to address the conflict, curtail possible malfeasance, and force money into the banking system, the Financial Crimes Enforcement Network issued guidance in 2014 that implicitly acknowledged the necessity of banking the marijuana business.

As part of its guidance, FinCEN mandated banks to adhere to Bank Secrecy Act regulations and fill out a "suspicious activity report" for every transaction with a cannabis-related business. It also mandated extensive due diligence on bank customers in the marijuana business. At the same time, the Department of Justice issued similar guidance, de-prioritizing certain marijuana-related enforcement actions.

These regulatory steps created a possible legal framework for banks hoping to maintain cannabis-related customers. In August 2016, the Ninth Circuit Court of Appeals gave its support to the industry when it upheld a ban that prevented the federal government from spending money to prosecute people whose marijuana activities were legal in their states. Taken in tandem, these actions could be seen as a path forward for the banking industry.

Unfortunately, that has not been the case.

A look at the federal data indicates that on the surface FinCEN’s guidance seemed to be doing what was intended. The number of banks and credit unions willing to handle cannabis money rose from 51 in March 2014 to just over 300 in March 2016. However, closer examination reveals many of these institutions are one-off, unconventional credit unions that cannot support the industry at the required scale. Major banks avoid engaging with customers in the marijuana industry, in part because of the heavy regulatory burden placed on banks.

Even as FinCEN issued the guidance, the agency acknowledged inadequacies in the policy. One week after the guidelines were released, Jennifer Shasky Calvery, then the agency’s director, told attendees at an anti-money-laundering conference that only “legislative change can fully and completely address” the issue. Two years later, the American Bankers Association echoed that analysis, stating that while “we appreciate the efforts by the Department of Justice and FinCEN, guidance or regulation doesn’t alter the underlying challenge for banks. As it stands, possession or distribution of marijuana violates federal law, and banks that provide support for those activities face the risk of prosecution.”

Despite the growth of legal marijuana use at the state level, the incoming Trump presidency casts further doubt on banks catering to legal pot business. An administration that is skeptical of drug reform could reverse the Obama administration’s approach, and the president-elect’s selection of Sen. Jeff Sessions to serve as attorney general has already sparked unrest in the cannabis industry. At an April 2016 Senate hearing, Mr. Sessions called marijuana a “very real danger,” stating, “Good people don’t smoke marijuana.”

Still, many hope the sweeping success of marijuana ballot initiatives in the 2016 election could prove the tipping point that forces federal and state regulators to work together to enable the banking industry to serve the legal pot industry. Carefully crafted regulations enhanced with rigorous know-your-customer initiatives would create a framework in which legitimate business enterprises would finally be able to operate within a system designed to minimize money laundering and other fraud.

Failure to do this could send this growing $8 billion industry up in smoke.