Banking Central | Will Board reshuffle help Paytm Bank to stay in the game?

RBI action against Paytm Payments Bank is probably the central bank's first major test in fintech regulation.

The unfolding of crisis at Paytm Payments Bank (PPBL) was a pivotal moment for the Reserve Bank of India (RBI) that marked its first significant challenge in regulating fintech entities.

The RBI, relatively new to fintech regulation compared to other central banks, set up a dedicated department just over two years ago in January 2022 to provide focused attention to this rapidly evolving sector. Since then, the regulator has launched various initiatives and divisions to foster innovation and competition in the fintech landscape.

Even the payments bank is a recent addition to India's broader banking system. The RBI created a category of payments bank in November 2014. It threw up opportunities for a diverse range of entities, including fintech firms, mobile network operators, and retail chains, to explore banking ambitions within a simplified regulatory framework.

The concept of a payments bank was aimed at serving entry-level institutions within India's financial ecosystem, ranked below small finance banks (SFBs) and full-service universal banks.

But why did the regulator allow such banks?

The RBI came up with a framework for payments banks following a Union Budget announcement in 2014 on licensing small banks and other

differentiated banks to cater to the credit and remittance needs of small businesses, unorganised sector, low-income households, farmers and migrant workers.

Even before that, the committee on Financial Sector Reforms chaired by Raghuram Rajan in 2009 had recommended licensing of small banks. It recommended allowing private, well-governed, deposit-taking SFBs offsetting their higher risk from being geographically focussed by requiring higher capital, a strict prohibition on related party transactions and lower allowable concentration norms.

These entities are authorised to undertake specific (non-lending) activities, including accepting deposits, issuing ATM or debit cards, providing payment and remittance services, acting as business correspondents for other banks, and distributing simple financial products like mutual fund units and insurance policies.

Enter, Paytm Bank

Paytm forayed into banking after surrendering its Prepaid Payment Instrument (PPI) licence and subsequently obtaining a payments bank licence. PPBL started operations on May 23, 2017 as one of the 11 applicants granted in-principle approval to set up payments banks. PPBL received its banking licence from the RBI in January 2017, with operations spanning across wallets, savings accounts, prepaid instruments, and the National Common Mobility Card.

However, regulatory concerns began surfacing soon, and PPBL faced allegations of breaching licensing conditions, including non-compliance with day-end balance requirements, inadequate arms-length transactions with affiliated entities, and serious Know Your Customer (KYC) violations. Despite regulatory interventions, such as supervisory restrictions imposed in March 2022, PPBL allegedly failed to rectify these issues promptly, leading to the recent escalation of regulatory actions by the RBI.

Board reshuffle: Too late too little 

In response to the RBI's stringent measures announced on January 31, PPBL initiated crisis-management efforts, including a board reshuffle at PPBL with founder Vijay Sharma stepping down and the establishment of an advisory panel (by OCL) chaired by former Securities and Exchange Board of India (Sebi) Chairman M Damodaran. However, these corrective steps may have come too late and perhaps too little to address the huge compliance failures. Probably the PPBL management and its Board failed to gauge the seriousness of the central bank's earlier warnings.

Clealry, the RBI's decisive stance against PPBL enjoys support from the government, reflecting a broader commitment to regulatory integrity and consumer protection. With the central bank signalling a transition away from PPBL services and urging customers to migrate to alternative providers, the fate of the embattled institution hangs in balance.

PPBL: Any takers, anywhere?

Any potential acquirer of the bank may hesitate to assume the control of PPBL due to the extensive KYC discrepancies, which could tarnish the brand's reputation. Consequently, PPBL's downfall may signal the end of ambitious banking aspirations for its founder VSS.

The PPBL fiasco underscores both the complexities and necessities of regulating the fintech space and makes robust compliance frameworks imperative for smooth functioning of the system. As stakeholders wade through troubled waters, the ripples of PPBL's regulatory challenges spread out to every corner of the country's banking landscape.

Banking Central is a weekly column providing insightful analysis of the sector's most significant developments.