Why RBI Banned Paytm Payments Bank

Paytm is lately paying for a lot of things, and not necessarily in the way it intended.

After a much-anticipated public debut that ended in a colossal failure (post-IPO performance wise), Morgan Stanley threw it a lifeline with a much-needed ratings boost in December 2021. JPMorgan and Goldman Sachs concurred with ‘overweight’ and ‘neutral’ outlook respectively, towing target prices at a premium over spot.

The resuscitation efforts, however, were short-lived. The latest new crisis facing the company is a ban on Paytm Payments Bank (PPB) from taking new customers imposed by the RBI. This caused Paytm’s stock price to crash even further while leaving everyone with one question — where lies the bottom to this crash pit?

Oh, and a report on Vijay Shekhar Sharma’s recent rendezvous with rash driving made the stock dive even further! Not a good time to be a Paytm investor, indeed.

Why Retail Investors Stand to Lose (Mostly)

What I omitted to mention earlier was that Morgan Stanley also reduced its stake in Paytm around the same time when it gave it a gleaming Buy rating in Jan 2022. The investment bank has now downgraded its target price.

The story of Paytm’s debacle has triggered several questions in the regulatory and investing scene of public markets in India. While many believe that the company’s listing failure was a result of overinflated valuation, many opine that it is the flawed business model that is to blame.

Regardless, let’s look into the reasons as to why the RBI decided to cease and desist Paytm from onboarding any new customers to PPB, which was a major selling point for the company in recent times.

Payments Bank Refresher

Payments banks, unlike scheduled commercial banks, are the ones which carry out banking and financial transactions without issuing credit cards or loans (translation: take deposits, don’t give out loans). They were conceptualised and created by the RBI as a separate category to accommodate the rising wave of fintech institutions in India. The purpose was to enable customers to operate mobile banking transactions and digital payment with ease.

This is possible because the payments banks offer a bouquet of services to their customers through secured digital platforms. Unlike traditional banks, the portfolio of their digital services is quite savvy and expansive. Aside from receiving deposits, customers can avail seamless payment services on their portals ranging from bill payments, payment facilities, remittance services, internet banking, mobile banking, demand deposits, business correspondence, buying financial products like mutual funds and insurance etc.

On August 19th 2015, the RBI gave “in-principle” approval and licences to 11 entities to open payments banks in India. PPB and Airtel Payments Bank together command over 88% of the deposits in payments banks in the country.

As one of the first movers in the so-called open banking revolution, Paytm claimed a hefty market share of UPI transaction volumes. In fact, Paytm “wallet” was one of the first-of-its-kind features that shaped the process of digital money transfers in India.

Where’s the Glitch?

RBI cites “material” supervisory concerns observed in the bank, which is essentially codespeak for violation of data privacy laws. The action came on the heels of recent Bloomberg report which revealed two important facts:

1. PPB’s servers were sharing information with certain China-based entities which indirectly own stakes in the company.

2. The bank had onboarded customers without adequate know-your-customer (KYC) documentation which raised concerns about these accounts being used as hatches for money laundering.

When it comes to allegations regarding data-sharing, PPB isn’t the first bank to face RBI’s reprimand. American Express and MasterCard have both faced penalties for flouting data-storage rules, especially for the ones related to data localisation which prohibit companies in India from sending their India-based data out of the country.

However, PPB’s reprimand is aggravated on account of its Chinese association. India and China have shared a hostile political relationship lately. Several apps of Chinese origin have been banned and there have been vocal demands to reduce dependence on Chinese goods and services in India. In such a situation, the allegations bode really unwell for PPB and its parent company especially when its market value keeps touching new lows every day.

Let’s take a look at Paytm’s and PPB’s shareholding structure to give you an idea of how intricate China’s interest in the company really is.

49% of PPB is owned by One97 Communications, its parent company. The rest (51%) is owned by Vijay Shekhar Sharma.

FPIs (Foreign Portfolio Investors) and Foreign Companies jointly own close to 80% in One97, as per post-IPO filings.

In the portion reserved for foreign companies, Antfin (Netherlands) Holdings and Alibaba.com’s Singapore subsidiary hold major stakes with 24.9% and 6.2% of the total shareholding respectively. When combined together, they make up more than 30% of equity in Paytm which is a substantial interest by any measure.

Having said that, one could argue that a substantial Chinese interest in Paytm doesn’t necessarily translate into a substantial Chinese interest in Paytm Payments Bank. Well, not necessarily, but technically, yes.

As per the IPO prospectus, almost 33% of Paytm’s FY21 revenues come directly from PPB. Both have a close revenue-sharing arrangement under which Paytm also covers a bulk of the payment-processing charges incurred by PPB. Given that fact, it is plausible that whoever invests in Paytm claims scrutiny rights over the funds flowing in and out of the company. This gives ample scope for indirect intervention by Chinese investors in claiming quid-pro-quo privileges with PPB’s resources, like say, its massive user data trove. Not saying it happened, for certain, but it’s plausible.

On top of that, there is the issue of KYC redundancies in Paytm’s platform. The reasons as to why this could have happened are a) non-closure of dormant and inactive accounts, b) not re-doing KYC for users whose accounts are more than a year old, c) accepting more amount in deposits than mandated, or d) not complying with regulatory audits.

PPB showcases all key products and services of Paytm — Paytm Mall, UPI, Wallet, Deposit Accounts etc. Therefore, a ban on onboarding new customers for PPB is essentially a ban on onboarding new customers for Paytm.

What Happens Now?

What we know so far from RBI’s previous disciplinarian tactics is that their effects are far-reaching. Bans on customer onboarding, for instance, are usually long-term.

Case in point: The ban on Mastercard, which is yet to be lifted. Even HDFC Bank, the country’s biggest private-sector bank, emerged out of its credit card-issue ban after fifteen arduous months. Suffice it to say that when it comes to tech audits, RBI doesn’t play favourites.

But in case you’re wondering if the current ban on PPB adding new customers may turn into PPB being banned completely, that is unlikely. PPB has been adding nearly 0.4 million customers every month and has over 100 million KYC customers. All of Paytm’s 330 million+ wallet accounts and 150 million UPI handles are cross-linked on to the PPB platform. The company has also added many small businesses like petrol stations, restaurants and mom-and-pop shops as merchant partners for receiving digital payments through its networks. So, banning PPB altogether would cause a large inconvenience in the digital payment ecosystem in the country.

In fact, despite a ban, Paytm can still add new customers on its primary app and keep offering them wallet and account services due to the UPI-interoperability on its platform. However, maintaining this mode of operation will be expensive not just logistically but also in terms of unit economics. While PPB accounts can hold up to ₹2L ($2,612) at once, wallets can hold only ₹99,999 ($1,306.2).

Plus, with the ban adversely affecting a business that is losing capital every day, the wiser thing for Paytm to do would be to arrive at a compromise and turn itself into a small finance bank (SFB). This would not only make it a more financially-rounded institution but also open up lending gateways.

But that also means agreeing to increased standards of compliance and regulatory supervision, something that defeats the premise of being a payments bank in the first place. But why not accept a few checks and balances if it means taking off the handcuffs completely?

(Originally published March 15th 2022 in the TRANSFIN E-O-D Newsletter)