One of the hottest topics in banking circles is whether the new industrial hemp businesses can be banked safely and profitably. These business opportunities have literally appeared overnight, as for decades it was simply unlawful to grow industrial hemp. The 2018 Farm Bill, passed in December, changed that.
As a beginning proposition, industrial hemp is not marijuana. The Farm Bill clarifies that “hemp” and Marijuana are derived from the same plant species, but hemp has (and by law must have) a Delta-9 Tetrahydrocannabinol concentration of not more than 0.3% on a dry weight basis.
It is Not Just About Farmers
Bankers must understand that the new industrial hemp marketplace involves much more than simply banking farmers. Rather, it will include businesses involved in transportation, warehousing, processing, manufacturing, distribution, financing and wholesale and retail sales. Banks typically seek to offer depository relationships, loans and treasury management services to its customers, and now face the question which of those services should be offered to hemp related businesses. Each have their own banking risks.
Adjust your BSA Procedures in Advance
Respecting opening account relationships, many banks focus on the regulatory risks when on-boarding new customers, and particularly with the Bank Secrecy Act (BSA). It all begins, of course, with the bank’s BSA Procedures document, which must have prior approval its Board of Directors. Adjusting those procedures will likely be required for most hemp related businesses. For example, the Know Your Customer aspect of the BSA may require obtaining a new category of records for hemp related businesses.
In states that have operating hemp pilot programs, the bank should understand exactly what licenses must be held, the parameters of the licensed activity permitted to its customer and how they will comply with the Enhanced Due Diligence requirements under the BSA in the event of a license holder’s license’s modification. A number of banks are even considering having the customer sign an additional certification type document in connection with new account openings. And without ignoring other BSA related questions, the bank’s BSA Officer should be able to explain to the board her or his understanding of how the regulators will view the risk categories into which certain hemp related businesses are likely to fall.
Prepare for the Unknown Credit Risks
Lending in this space will provide new challenges. First, banks engaged in agriculture lending need to understand that much remains unknown about the economics of farming the three common types of hemp. For example, new equipment likely must be purchased. Reports from the field indicate the hemp plant is destructive to most current drum-based harvesting equipment. There are also unknowns respecting other cost elements, such as row spacing, herbicides, labor costs and the like. Existing storage/drying facilities may also have to be rebuilt. Hemp is one of those products that can become immediately worthless if a field tests “hot” because of an impermissible THC concentration in the plants. On top of this, agricultural lenders will need to consider the fact that crop insurance is likely not available at this time.
A Changing Landscape for Workouts
Once a hemp loan is on the books, other safety and soundness factors come into play. In all emerging markets, and even mature ones, the possibility of the borrower’s non-performance is always a possibility. This can be particularly interesting when hemp or hemp-derived products are the bank’s collateral. This is a highly regulated industry and nearly every person who touches the plant and its products can be subject to different licensure requirements. Monetizing collateral is therefore problematic. The bank should understand the unique issues associated with securing, appraising and selling such collateral. Lastly, for those banks servicing wholesale and retail sales customers involved in CBD products, the Food and Drug Administration (FDA) holds a serious “wild card.” It is likely the FDA will regulate this space, including the possibility that certain CBD products, such as those in food or drink products, might be outlawed one day.
TMS Offerings Are Important
Banks also seek to offer Treasury Management Services to their business customers. Within the hemp-related business space, obtaining card services is an area of particular concern. Many retail vendors, and especially those with significant online sales, depend upon the ability of their customers to pay for a transaction with a credit card. Such sales may materially impact the retail seller’s P&L. However, current experience shows that some hemp related businesses are finding it exceptionally difficult to find financial institutions willing to act as an “acquirer bank” for the merchant processing services they depend upon.
Presently these hemp related businesses, at least those focusing on consumer sales of hemp-derived merchandise, like CBD oils, are finding it difficult to accept credit card sales, because the interested MPS’s appear to be unable to settle through domestic institutions and must work instead with foreign-based banks. This means that the prices charged to and the services offered are less than ideal, and in some cases, MPS’s have abruptly abandoned the market, leaving those merchants without a processor.
Where Do We Go from Here?
Banking hemp-related businesses is a tremendous opportunity for the banking industry, despite the great current uncertainties. Time and education are required. This is already happening in some states. Kentucky runs what could be considered the nation’s leading industrial hemp program in terms of breadth (approximately 56,000 acres authorized for 2019) and in maturity (purportedly reportedly the first state to apply under the 2018 Farm Bill). Kentucky’s banking industry and state regulators are already discussing opportunities and issues that must be confronted and resolved.
One recent educational forum included the state’s bankers meeting with Kentucky’s Department of Agricultural Commissioner, Industrial Hemp Program Manager, Department of Financial Institutions. The goal of this educational summit was to inform the banks about the fine details of the state’s hemp program and to allow those bankers to raise specific questions about compliance concerns and sound banking practices. Federal bank regulators also joined this roundtable discussion. It will take this type of cooperative dialogue in all the states to resolve the issues necessary to bring our nation’s banking infrastructure into play in support of this exciting new industry.
Bill Repasky is a member at Frost Brown Todd representing financial services clients in litigation, operations and compliance. He currently advises banks on servicing the new hemp related businesses and legal compliance issues arising from those customers.