Finance minister (FM) Nirmala Sitharaman is set to meet fin-tech leaders on 26th February to ‘reassure’ them and address complaints regarding stringent supervision by the Reserve Bank of India (RBI). It will be disappointing if the FM succumbs to pressure in an election year.
Consumers have undoubtedly reaped the rewards of fin-tech innovations. However, it is a matter of concern that the industry is using its financial prowess to resist strict regulatory action, as seen in the case of Paytm Payments Bank Pvt Ltd (Paytm Bank).
Was RBI's intervention hasty and disproportionate? Do we possess sufficient information about companies whose actions could affect millions of investors and consumers? RBI action against Paytm Bank is important in the context of timely regulatory intervention. Just five years ago, we witnessed the devastating consequences of RBI's leniency towards Infrastructure Leasing & Financial Services (IL&FS), a 347-entity conglomerate (with listed step-down subsidiaries) that defaulted in September 2018. (Read:
IL&FS defaults on Rs1,000 Crore Short-term Loan from SIDBI?).
The serious frauds investigation office (SFIO) had then filed an 800-page charge-sheet (Read:
RBI in the Crosshairs at Last– An Action That Was Long Overdue) accusing RBI of failing to impose penalties and initiate corrective action, despite detecting ‘non-compliance’ with exposure norms and other wrongdoing since 2015.
Paytm Bank too had allegedly ignored repeated warnings from the regulator (including a specific warning to the board of directors) leading to the crackdown. Although Paytm Bank is relatively tiny, its role in the operations of its parent company, One97 Communications' wallet business (Paytm), is significant. RBI does not seem to have taken into account that its actions would have a negative impact on investors, customers and 50mn (million) merchant associates of the parent (Paytm ) and unleash panic.
The regulator’s contention is that it is safeguarding depositors by being circumspect; providing too much information would create a scare scenario and lead to a run on the Bank and a bigger crisis, says a central banker. However, with a cap of Rs2-lakh on deposit acceptance, a run on deposits could have been easily contained.
On the other hand, as Andy Mukherjee of Bloomberg correctly wrote, RBI failed to pay attention to the impact on the parent, Paytm’s customers and merchants (
Paytm Fiasco Shows the RBI Doesn't Understand Payments) causing the very panic that it sought to avoid. Consequently, its cryptic release was followed by some relaxation, clarification and continuity, by allowing Paytm Bank’s nodal account to be shifted to Axis Bank.
Investors of One97 Communications (Paytm) were also badly impacted. They reacted to RBI’s action by dumping the stock which plummeted from Rs761 on 31st January to a low of Rs325 on 15th February. Following RBI’s clarification on 16th February, the stock rebounded to Rs395 at the time of writing. Let’s not forget that Paytm has frequently faced controversy and its market debut at Rs1,950—a discount of 9.3% to its issue price—has kept investors wary about the stock.
The lesson here is that regulators need to collaborate in assessing the potential impact of stringent regulatory action on closely regulated financial entities and listed companies. Despite SEBI’s comprehensive disclosure rules for listed entities, One97 Communications’ (Paytm ) investors were unaware that a small subsidiary had been ignoring repeated warnings from the banking regulator which would, ultimately, affect the operations of the parent company. Paytm Bank is unlisted; over 51% of its shares are held by founder Vijay Shekhar Sharma and it does not have a single annual report in the public domain. There is no way for investors to know if RBI’s warnings were reported to the board, elicited comment by statutory auditors or if the consequences of ignoring RBI’s warnings were ever discussed by the board of directors. All we know is that a couple of directors quit only after RBI initiated action.
There is another aspect to RBI action. Payment Banks, introduced in 2014-15, have become largely irrelevant after the raging success of UPI launched around 2016. Consequently, RBI has not mandated their listing –unlike the rule that commercial banks and even small finance banks have to be listed within a few years. However, having identified a gap in disclosure, RBI and SEBI would do well to close it by asking listed entities to upload annual reports/accounts of subsidiaries on their website.
At a time when not-for-profit organisations are also subjected to a sharp increase in disclosures, compliances and restrictions on use of funds, fin-tech companies can hardly lobby for relaxation on compliance or penal action.
Fin-techs may argue that regulatory dialectics (a term coined by Professor Edward Kane) are essential to their existence. It means finding ‘innovative’ ways to circumvent regulations designed to restrict their behaviour. While regulatory dialectics have often led to regulatory changes to legitimise their action, it can also lead to punitive action that shuts down their business. It is a risk they take with their eyes open. The fin-tech world cannot demand light-touch regulation as an entitlement nor can they brazenly ignore warnings by the regulator.
As they prepare to meet the FM, the fin-tech case is weakened by another RBI action, which went unnoticed, because the entity involved was not named.
Essentially, this entity positioned itself as a payment system operator, a business that is regulated by RBI, requiring registration and regulatory clearance. It facilitated businesses to make credit card payments to an unregulated entity that distributed the money to the third-party beneficiary, bypassing stringent know-your-customer (KYC) requirements, mandated by money laundering laws. This led to online payments by businesses, without traceability, at a time when even individual accounts are routinely frozen for failure to update KYC. Source say RBI issued a press release to halt its attempts at disinformation by the entity that operated outside the regulatory framework.
This is not the first time that RBI has shut down fin-techs that operated outside the regulatory framework. In 2022, the regulator clamped down on issuers of pre-paid instruments that failed to meet compliance requirements.
Heavy-handed regulation in financial services and healthcare is often good from the customer perspective, especially in India, where grievance redress is poor, slow and expensive. For instance, we are the only country that has 2-factor authentication in the form of a one-time password (OTP) for various transactions including credit cards. Credit card issuers had lobbied hard against this; but RBI’s insistence has significantly helped contain credit card fraud.
In contrast, we have been treated as guinea pigs for tech experiments with mandatory statutory filing systems such as Aadhaar, goods & services tax (GST) portal and MCA21. Those affected had no option but to put up with glitchy systems and poor redress. Do we want a similar situation with private sector transactions as well? Who will resolve issues when fin-techs exploit grey areas and scale up rapidly, only to collapse under the heat of fair regulatory action or poor business practices?
So, yes, RBI could have handled the Paytm Bank action differently, but it would be against public interest to treat fin-techs with velvet gloves by waiving strict compliance requirements.
Here are the actions taken by RBI against Paytm Payments Bank. One proxy advisor has shared the list in a communication to clients...
1. Prohibition on new accounts (June 2018 - December 2018): RBI stopped Paytm Payments Bank from opening new accounts and wallets because they were not following the rules. The ban was lifted later when they fixed the issues.
2. Show-cause notice for KYC violation (March 2019): PPBL did not check an account properly when it suddenly started doing a lot of transactions. This violated the rules about knowing your customer (KYC).
3. Rejection of payment aggregator application (November 2022): RBI said no to PPBL's request to operate as a payment aggregator until they get government approval for some investments.
4. Penalty for false information (July 2021): RBI issued a show-cause notice to PPBL on 29 July 2021 for submitting false information regarding the transfer of the Bharat Bill Payment Operating Unit by OCL to PPBL. The actual transfer was completed in March 2021.
5. Penalty for contravention of Payment and Settlement Systems Act (October 2021): RBI imposed a penalty of Rs1 crore on PPBL on 1 October 2021 for contravening the Payment and Settlement Systems Act, 2007.
6. Penalty for non-compliance (October 2023): RBI imposed a penalty of Rs5.93 crore on PPBL on 10 October 2023, for several non-compliances, including failure to identify beneficial owners and breaching regulatory ceilings in customer advance accounts.
7. RBI's action on Paytm Payments Bank: On 31 January 2024, the RBI imposed business restrictions on the bank, citing repeated violations of norms and non-compliance with multiple rules. The banking regulator barred PPBL from accepting fresh deposits and doing credit transactions after 29 February 2024.
