The Biggest Benefits of Responsibly Banking High-Risk Businesses

Banking high-risk businesses can be profitable and provide a much-needed community service if you know how to do it responsibly and expertly. It is a prime opportunity for credit unions looking to diversify their portfolios and add new revenue streams without competing with big national banks.

What is a High-Risk Business?

When credit union leaders think of high-risk businesses, they often initially think of serving businesses in the cannabis and hemp industries. So you might be surprised to learn that your local real estate broker, your insurance agent, the gym where you work out, your favorite local restaurant, the gas station where you fill up your car, and the fintech company whose software technology you use every day are all considered high-risk. A business is generally considered high-risk for these main reasons:

• It operates in an industry with frequently changing regulations.
• The risk of financial failure in the industry is high.
• It is a cash-intensive business.
• It lacks collateral to lend against.
• It operates in a start-up or unseasoned industry.

For credit unions that offer business banking, it may seem daunting to take on banking for an industry that is highly scrutinized and fraught with changing regulations. However, financial institutions that specialize in certain high-risk industries do quite well once they take the proper steps to establish a solid program.

Charting new territory can be fun and rewarding! It’s also a great opportunity to make a social equity statement by offering services to underserved industries in your area. Once you put together a well-thought-out program and combine it with the exemplary service that credit unions are known for, your membership base will grow from the businesses themselves, their employees and those that take notice that you are providing banking for their favorite restaurant, gym etc.  

I had first-hand experience with this in Washington State when Initiative 502 was passed in November 2012 legalizing state-licensed and regulated cannabis businesses. I saw it as a once-in-a-lifetime opportunity to be on the cutting edge of serving a burgeoning new industry that desperately needed to be banked. At the time I was the head of business banking at Salal Credit Union, Seattle. I pitched the idea to the senior management team and then did the research needed to be able to present it to our board of directors.

Not everyone was supportive initially, but I designed a program to mitigate the risks and win them over. The credit union opened its first account with a member of the cannabis industry in June 2013. We had a joint state and federal exam in September and the federal examiner told us to cease and desist. That was definitely scary! But because of the work put in up front and with the support of our board, state regulators and Governor, Jay Inslee the credit union continues to profitably provide much-needed service to the cannabis industry today. The CU also became a leading model of how to safely, soundly and profitably service the high-risk cannabis industry.  

Regardless of which high-risk industry you choose to serve, understanding the nuances behind each aspect of the business is critical. There are three key steps to successfully and profitably banking any industry.

Step 1: Which Industry

Research which industries are popular in your service area that are currently underserved, then determine what part of that industry you want to add to your membership base. It’s one thing to say you want to serve a certain high-risk industry, but you need to dig deeper to really understand the industry and then define what portion has an unmet need that you have the risk/reward appetite to serve.

For example, the hemp and cannabis industries are both highly regulated, very complex and specialized, so determining your target market is an essential part of being successful. You may want to focus on retail dispensaries, grow operations, manufacturing facilities or ancillary businesses. With cannabis now being legalized, licensed and regulated in some form in 40 states, if you haven’t been asked to bank the industry yet, you soon will.

Step 2: What Services

Determine your service offerings and what your competitive advantage in the marketplace will be. Understanding what types of services your business members need to successfully grow their businesses is essential. Are you going to offer deposit accounts only? What services can you provide: domestic or international wires, sweep accounts, cash logistics, in-branch cash deposits? Will you offer credit cards and/or loans, and if so, will they meet the needs of your target market or do they need to be tweaked? Will they be secured, unsecured or based on deposit balances? Are you going to offer them equipment loans, short-term business loans for expansion or working capital lines of credit for inventory? If you make collateral loans, do you know what you can legally take possession of in the event of default? If you offer commercial real estate loans, will they be for light industrial, retail, office or agriculture? Do you prefer single-tenant stand-alone, owner-occupied buildings or multi-tenant properties? You’ll need to define your geographic lending area as well, and it may be different than your core deposit area. Once you make these decisions, you’ll need to incorporate them into your credit policy.

Step 3: What Else Do You Need?

Review your system and staff capacities. Assess the need to purchase additional software, implement new systems, or add staff in certain areas. You will need to implement an onboarding and ongoing monitoring system that balances customer service with streamlined, compliant due diligence. No two businesses are exactly alike; learned behavior compliance software may take a little more work to implement up front but is well worth the investment.

Learned behavior compliance software monitors a business member’s daily transactions (cash deposits and withdrawals, wire transfers and ACH activity), combines that information with historical transactions and account profile data, then provides a comprehensive view of the normal account activity. Once this is established (typically within a few months of onboarding a new member), the system can create reports and provide real-time alerts on activity that is outside the norm. Having such a solution helps minimize false positives and, in many cases, reduces your suspicious activity reporting.   

Rather than adding yet one more thing to your branch staff’s already full plate, the best way to provide service to a high-risk industry is to assign an account manager to each business. This manager has is responsible for getting to know the management teams of the business accounts they serve and engaging them in regular interactions. By focusing on relationship banking, they will be able to provide quick answers to your compliance staff’s questions while still maintaining a positive, friendly relationship with the business.  

With large financial institutions shutting down small-business accounts and refusing to serve high-risk industries, the opportunities are there. An expert in this field can help you determine how to provide much-needed services to high-risk businesses safely, soundly and profitably. Is your credit union ready to make a difference? My experience shows that it can be done.

Carmella Murphy is founder and principal consultant of High Risk Business Solutions LLC.