India’s Central Bank Doesn’t Get Payments

(Bloomberg Opinion) -- When the Indian monetary authority began giving out restricted banking licenses to a new category of payment facilitators about eight years ago, it should have spared a thought to their orderly resolution — just in case it had to shutter any of them. As the deepening crisis at Paytm Payments Bank Ltd. shows, the regulator didn’t do its homework.

Last week, the Reserve Bank of India barred the institution from any further deposit or credit transaction in customer accounts, wallets or cards after Feb. 29. The logical next step is that the bank’s license will be scrapped, maybe as early as next month. 

This is just unnecessary chaos for 50 million merchants, most of whom are too small to afford credit-card fees and infrastructure. For a majority of them, online payments are synonymous with the Paytm app, connected to a Paytm Payments Bank account. No wonder then that when it comes to receiving funds over the country’s wildly popular smartphone-based money transfer protocol, this small, six-year-old bank has a near-24% share of transactions, more than any other deposit-taking institution.  

Ever since the 2008 Global Financial Crisis, regulators have been leaning on lenders to write their “living wills,” or plans to honor liabilities in case trouble on the asset side of the balance sheet leads to distress or failure. But a payments bank in India isn’t permitted to lend, and can take only 200,000 rupees ($2,400) in deposits, well within the 500,000 rupees covered by insurance. It’s less a bank and more a utility designed to grease the wheels of commerce. If one spoke drops off, there will be no financial hole to fill, only a commercial void that can be made whole by redistributing the business load.

It is here that the Reserve Bank has botched things up. The RBI’s press release detailed all the ways in which it was restricting Paytm Payments Bank. The statement didn’t have a word about what customers are supposed to do. In RBI’s mind, it’s shielding them: They have the freedom to take their balances out while being barred from bringing new money in. This hasn’t always been possible. For instance, the resolution of Yes Bank Ltd., which had a full-fledged banking license, was done four years ago by trapping funds while a rescue was mounted.

But depositor protection wasn’t the point here. The concern in the industry is from retailers: How are they to accept non-cash payments if credit transactions into their accounts are forbidden? The regulator ended up ignoring the very reason why it has allowed this category of banks to exist in the first place: facilitation of transfers.

The RBI’s unhappiness isn’t new. It stopped Paytm Payments Bank from onboarding fresh customers nearly two years ago. Last year, while imposing a fine of $650,000 on the bank, the regulator highlighted a number of violations, including failure to identify beneficial account owners and a video-based customer identification that allowed connections from IP addresses outside India. 

Onboarding of new online business has also been problematic at mainstream lenders. In October, the regulator stopped Bank of Baroda, the country’s fifth-largest deposit-taking institution, from signing up new customers for its mobile app. In that instance, bank executives across at least 10 cities had linked existing accounts without cell phone numbers to unrelated numbers to show new customers. To whom did these phones belong? Bank staff, family and friends, according to a report in Al Jazeera.

Let’s give the RBI the benefit of the doubt. Maybe the Paytm Payments Bank violations were really so egregious as to warrant a pack-up notice that will never be sent to regular lenders for operational or technological failures. (To be shut down, they have to blow up serious money on bad loans.) A CNBC report said that the RBI had discovered instances where thousands of accounts were linked to a single tax identification number.

The question is, who exactly is being punished here for alleged non-compliance? The bank has two shareholders: One 97 Communications Ltd., better known as Paytm, owns 49%. Vijay Shekhar Sharma, the founder, controls the remaining 51%. One 97 has lost $2.5 billion in market value in three days. It’s unclear if its stake in the bank was worth more than 40% of the firm, but the RBI’s move has triggered a crisis of confidence in Paytm itself. The wallet business, now housed within the bank, is up for sale, the Hindu Business Line reported. Shares of Mukesh Ambani-controlled Jio Financial Services Ltd., named in the report as a potential buyer, jumped almost 14% on Monday.

But Paytm  its wallets. That's the business Sharma built as India's fintech pioneer. A distress sale — perhaps to Ambani, the country’s richest tycoon — will be demoralizing for the country’s startup community. To think that it’s the RBI’s action that could end up engineering such an outcome would smack of regulatory overkill. Especially since Paytm says that neither the fintech nor the bank is being investigated for violating India's foreign-exchange controls.

There was a better way to handle this. The franchise value of the bank could have been cut to zero without hurting One 97’s shareholders disproportionately or its customers at all. The confusion in the wider payment industry would have been avoided. All that the RBI had to do was to return the wallets (along with a payment-processing license) to One 97 and find a new home for the bank accounts. It could all have been done in consultation with the bank’s board, which has been sleepwalking though the entire crisis. If the existing directors are too much in Sharma’s control, the regulator could have inserted its own representative to steer the board. 

It wouldn’t have been terribly difficult to reassure payers and payees: “From March 1, your account balance will move to XYZ Bank, and you’ll get three more months to complete a fresh know-your-customer check. Meanwhile, you can top-up your wallets and accept payments as usual.” Instead, the RBI’s communication last week was only about crime and punishment.

It’s obvious that the RBI doesn’t really get payments banks. So while it’s considering whether to kill Paytm Payments Bank’s license, it should ask itself if it shouldn’t just scrap the category and go back to something it understands reasonably better: deposit protection.

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• India’s Fintech Pioneer Lost More Than Its Bank: Andy Mukherjee

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Andy Mukherjee is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia. Previously, he worked for Reuters, the Straits Times and Bloomberg News.

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