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Willing to Take a Gamble? Don't Wager on High-Risk Activities Without a Careful Risk Assessment

author Michael Berman
4 min read
May 29, 2018

Sports gambling is the latest high-risk business opportunity to open up to banks, thanks to a Supreme Court ruling that overturned a federal law that severely limited the practice. Add that to state-level legalization of recreational and medical marijuana use, and financial institutions find themselves in unchartered territory.

What’s a bank to do? On one hand, both sports gambling and marijuana offer huge market opportunities estimated in the billions. Bank and credit union involvement in these activities, from providing banking services to providers to enabling payment transactions, can take money out of dark markets and increase transparency. On the other hand, there are reputational, compliance, and other considerations that make involvement potentially risky or undesirable.

For many community banks and credit unions, the debate ends here. The laws are too murky, the moral ground is too shaky, or the overall concept is too unpalatable. There’s nothing wrong with that decision. It’s an appropriate one for many institutions.

But others may be tempted to pioneer these markets. For those open to the idea, it all comes down to a thorough risk assessment, including a clearly defined risk appetite and controls. Some aspects to consider:

Sports Gambling

Customer due diligence

Sports betting has a reputation for being run by bookies and mobsters. Due diligence is necessary to understand the owners’ past, how the company operates, and its regulatory record.

Controls: Investigate both the business and its owners to assess the likelihood of the company operating in a legal, compliant and ethical manner. From regulatory authorities to policies and procedures and audits, find out everything you can and decide whether a particular customer is a good risk. Have a program in place to regularly monitor them.

Financial risk

If customers are unable to use their cards for sports gambling, they might seek out an institution that permits those transactions and move their relationship there.

Controls: Conduct market research to determine what types of customers and how many are likely to engage in sports gambling and determine the potential revenue loss if they were to leave. Monitor customer defections and wallet share to try and determine how many, if any, customers stop using the institution because it doesn’t permit sports gambling.

Will the institution’s competitors who support sports gambling be stronger, have a competitive or have financial advantage?

Controls: Assess the potential revenue as well as the costs of additional compliance measures. Monitor the market as a whole as well as the profits and ROI at institutions that allow sports gambling, particularly those similar in size, scope and market to see how they compare.

Reputation risk

Community banks and credit unions have a reputation for putting their customers first. Will allowing customers to use their credit card when placing bets online enable those with gambling problems? Will it contribute to the development of more gambling addictions?

Controls: Monitor customer behavior for indications of a gambling problem. Create a program to intercede and limit bets, if needed.

What will the community think of the institution entering this market?

Controls: Conduct research to find out how the community and customers will feel about the institution’s involvement. Is it likely to upset people, boost the institution’s reputation, or will people just shrug their shoulders?

Marijuana

Compliance risk

Federal law still classifies marijuana as a Class 1 controlled substance. That means that even though many states have legalized it, it’s still illegal at the federal level.

Controls: Banks and credit unions with state charters may be more comfortable banking marijuana dispensaries and growers than those with federal charters due to fear of losing their charter.

Money laundering risk

The drug business is known for money laundering. It’s important that any customer an institution banks only sells products grown by reputable growers (and not drug traffickers) and that it’s sold only to appropriate customers in appropriate amounts.

Controls: Understand the process the state uses for monitoring and regulating growers and dispensaries to minimize the likelihood of illegal product and sales. Washington state recently updated its “seed to sale” system for tracing sales and engaging in compliance. Colorado requires plants be tagged, yet in 2016, 47 licensed dispensaries were caught breaking the law and over $68,000 in fines were issued. Do these fines show a strong enforcement culture or a weak system? That’s up to the financial institution to research and decide.

Customer due diligence

Just because companies are in the same industry doesn’t mean they’re run the same way. Due diligence is necessary to understand the owners’ past, how the company operates and its regulatory record.

Controls: Investigate both the business and its owners to assess the likelihood of the company behaving in a compliant manner. From regulatory authorities to policies and procedures and audits, find out everything you can and decide whether a particular customer is a good risk. Have a program in place to regularly monitor them.

Financial risk

Serving customers in the marijuana industry will require extra compliance and due diligence. Will the cost of serving this market outweigh the benefits?

Controls: Determine how much revenue needs to be generated to cover costs. Create a tiered system where customers in the marijuana business pay more for products and services due to the added compliance expense and the limited availability of banking services for this market. Monitor costs and revenues to ensure ROI.

Reputation risk

What will the community think of the institution entering this market?

Controls: Conduct research to find out how the community and customers will feel about the institution’s involvement. Is it likely to upset people, boost the institution’s reputation or will people just shrug their shoulders? The institution could also quietly serve the market.

These are just a few of the risks and controls a financial institution should consider before entering a high-risk business. Whether it’s sports gambling, marijuana, cryptocurrency, or other emerging areas, it’s important to weigh the opportunities with the risks to determine how the activity fits into an institution’s overall approach to risk and whether it has the ability to mitigate those risks to an acceptable level of residual risk.

In short, conduct a thorough risk assessment to know if it’s worth the gamble.

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