For Banks, Marijuana’s Reclassification Could Clear a Path to Lending

In May the U.S. Drug Enforcement Agency began a process to reclassify cannabis from a Schedule I to a Schedule III drug. The public comment period on the proposal ended July 22 with nearly 43,000 comments, and now the agency must decide whether to officially downgrade the drug from a class that includes dangerously addictive narcotics like heroin to one with drugs that have beneficial medical uses and a low likelihood of causing dependency. 

The socioeconomic impacts of reclassification could be profound. For banks, meanwhile, the dilution of risk could also be significant. If the federal government seems to be moving toward legalization, cannabis could lose its stigma among some in financial services and break out as an attractive segment to bank, for those willing to put in the work to get educated. 

“There will be some banks that look at [reclassification] as a path to federal legalization and will no longer worry about reputational risk,” said Stanley Jutkowitz, senior counsel at law firm Seyfarth Shaw, whose practice includes advising the cannabis industry and its service providers. “Whatever concerns they had about the Fed seizing their loan collateral or suspending their banking licenses may go away.”    

Federal cannabis laws have spooked banks since California became the first state to approve marijuana for medical use in 1996. Despite widespread state legalization of the plant since then, the tacit threat of a federal crackdown and the tension between state and federal laws have pushed some banks away from the industry. 

In RMA’s 2024 Community Bank Survey, 89% of community banks said they don’t currently and don’t plan to bank the cannabis industry. In a separate RMA survey conducted in 2022, only 2% said they were making loans to marijuana-related businesses.  

Swings in federal enforcement policy haven’t helped. A decade ago, the Justice Department under President Barack Obama narrowed federal enforcement of cannabis laws to eight targeted areas, easing some restrictions in states permitting cannabis use.  

Then under President Donald Trump, the DOJ reasserted “the rule of law” and rescinded DOJ guidance from the Obama administration. The Biden administration’s “rescheduling” efforts represent a potentially ground-shaking start to loosening federal cannabis laws, although a second Trump presidency could again shift the approach at the national level.  

The Attraction for Community Banks 

Because states establish their own regulatory and policy regimes for marijuana, cannabis operations have a distinctly local flavor. Oregon, for instance, allows full vertical integration—from growing to retail outlets—of marijuana businesses within the state. Washington, right next door, prohibits it. Further south, New Mexico requires it.  

Banks making reputation, policy, and business decisions about the industry focus on their states of operation and the peculiarities of each jurisdiction, the federal legal overhang aside. That includes:  

• Considering local mores around marijuana and reputational and business risks related to customer opinion. 

• Carefully reading laws from state to state.  

• Understanding how cannabis companies function locally, including the largest multi-state operators (MSOs), since states still require the cannabis sold within their boundaries to be grown there too. 

Operating locally puts community banks in the cat-bird seat when it comes to assessing the on-the-ground realities of these businesses. One community banker participating in the 2024 RMA survey cited the industry as their bank’s number one opportunity for growth in the coming years “since there are not a lot of banks in the area that support this type of banking.” 

Some of these companies, though, pose an unusual lending challenge. Vertically integrated operators, for example, are equal parts agriculture, distribution, marketing/branding, and retail credits. Layer in heavy regulations and tie-ins to the healthcare system (medical use), and you have a highly specialized class of borrower with a broad array of risks. “It’s not like a banker who understands retail can jump right into lending to a [cannabis] dispensary,” Jutkowitz said. 

A Budding Lending Practice 

That’s where time, research, and legwork come in. For some already banking the industry, it has been a long, careful journey of regulator collaboration, risk identification, and data crunching. FVCbank, headquartered in Fairfax, Va., with assets of $2.3 billion, worked closely with state and federal regulators to craft acceptable practices for banking the industry in the states it serves.  

“We wanted to have an open and transparent relationship with our regulators,” said David Pijor, CEO of FVCbank. “Our goal was to build a best-of-breed cannabis program.”  

Initially, the bank didn’t service any companies growing or handling the physical product, instead dealing with holding companies further upstream in the corporate structure. In time and as regulators’ comfort level grew, it began offering deposit and treasury management services, including to some independent dispensaries, while laying the groundwork for an eventual entry into lending.  

But before it would extend credit, FVCbank needed to give and get assurances: in exchange for guaranteeing regulators that it would apply the same stringent lending criteria to cannabis businesses as it would to any other industry, the bank needed to know that regulators wouldn’t downgrade its loans simply because of cannabis.  

“Once both [federal and state regulators] said they wouldn’t, we could begin exploring what credit decisions were necessary to start lending to the industry,” Pijor said. 

After studying the experiences of companies in early-adopter states including California and Colorado, and examining a wide range of metrics, the bank found that four key elements had a big influence on creditworthiness: 

• Licensing: States offer either limited or unlimited numbers of dispensary licenses. Operators in limited-license states have “some guardrails and more control over their markets,” Pijor said, whereas unlimited-license states “are more like the Wild, Wild West.”  

• Tax Rate: The higher the state tax rate, the more it weighs on business results. 

• Policing: In states that do more to police the illegal marijuana market, legal businesses are more likely to perform well, Pijor said. Since the cost structure of the illegal market can make it more affordable and competitive, illegal markets that are not properly policed can erode the business of legal companies.   

• Market Evolution: Those states that first legalized cannabis for medical use tend to have more knowledge, infrastructure, and oversight in place to handle legalization for recreational use, creating a more stable operating environment for businesses. “They have learned along the way,” Pijor said, and often do better at supporting legal businesses than those that went straight to approving recreational use.  

A Trigger for Profitability and Lending? 

For the cannabis companies, banks, and accounting firms in the know, there’s another big change rescheduling could trigger: a way out of 280E. 

Section 280E of the U.S. tax code disallows any deductions or credits for charges incurred by any business conducting the illegal trafficking of Schedule I or Schedule II controlled substances. That means cannabis operators today must pay taxes against their full gross income without deductions, making them less profitable. Interest payments on bank loans, for example, are non-deductible on federal tax returns for cannabis borrowers. 

The industry has been lobbying for years to eliminate Section 280E, with no success. The way around it may be through this reclassification of cannabis to a Schedule III drug. “You can’t underwrite against something that might happen,” said Pijor, who acknowledged that reclassification and the elimination of 280E could take longer than people expect. “But if it does, every loan is easier to make because every cannabis borrower will be more profitable.” 

It remains possible, and even highly likely, though, that some states’ attorneys general and other organizations will file suits to block the proposed change. Smart Approaches to Marijuana, an alliance of mental and public health professionals funded by individuals and family foundations, for one, has vowed to challenge the rescheduling. It filed a lengthy comment urging the DEA to reject reclassification. With those kinds of threats hanging over reclassification efforts, the banking industry remains in a familiar state of uncertainty around the federal stance on cannabis, at least for now. 

Still, some may view this administration’s efforts as a fast-track to federal legalization and decide to jump in anyway. Risk managers “might advise less caution given the regulatory trajectory,” Jutkowitz said.