Is Paytm Too Big To Obey?

The banking regulator's action against one of India's foremost startups has set tongues wagging in the financial and technological sectors. Opinions about how the regulator has been too tough on Paytm Payments Bank have mushroomed over the last week.

But there's a thing or two to be said about compliance culture in the Wild Wild West that is India's fintech world.

While there is due cheer and upbeat commentary about sky-high valuation and innovation, fintechs tend to forget that they are in the public service business. Business volume growth, employment and (elusive) profitability come only second to serving the user. And if you stumble on this crucial step, your business is as good as dead.

Complying with regulation is a non-negotiable. If you don't like the regulation, you need to lobby and convince the regulator that it needs to change. That's how the financial sector has always evolved, for better or for worse.

"Move Fast and Break Things" sounds radical for other things, but not when it comes to people's money.

Yet, the questions over the last week seem to suggest that the RBI may be acted too harshly.

In August 2015, Reserve Bank of India granted 11 in-principle nods to set up payments banks in India. Of the 11, only two approvals were to individuals, Sun Pharma founder Dilip Shantilal Shanghvi and Paytm founder Vijay Shekhar Sharma.

While Shanghvi surrendered the in-principle licence a year later, Sharma flew with it. In May 2017, Paytm Payments Bank commenced operations. Effectively, Sharma became the only individual in India to own 51% stake in any kind of bank.

Within a year of starting its business, in June 2018, the central bank barred Paytm Payments Bank from opening new bank accounts. The reason: the RBI found that day-end balances in deposit accounts were in excess of the Rs 1 lakh limit. It took about six months for the bank to resolve this issue and get the bar removed.

A few years later, in May 2021, the regulator found know your customer related compliance issues. This was followed by fresh restrictions on the payments bank in March 2022, where it could not add new customers.

In October last year, it imposed a Rs 5.39 crore penalty on Paytm Payments Bank for not meeting compliance. Finally, on Jan. 31, the RBI laid down the law and just stopped short of shutting down the payments bank.

Now, Sharma is doing the rounds of the RBI and the Finance Ministry seeking support against this action. Startup founders even rallied around him, writing a letter to the Prime Minister seeking intervention.

The core of the issue is that a regulated entity did not abide by rules of the game set by the regulator. There is no more insidious intent behind this issue.

As NDTV Profit reported last week, the RBI's worries on Paytm Payments Bank stem from the KYC issue. There were instances where over 1,000 accounts were linked to the same permanent account number, stoking fears of money laundering.

The payments bank and its parent company One97 Communications Ltd. were found to have not maintained one arm distance in operations, with financial and non-financial systems being co-mingled. Moreover, some compliance reports were also found to be forged at the bank.

By all measures these are serious violations of compliance norms, which cannot be overlooked. It directly led to RBI action against the bank, where the regulator invoked Section 35A of the Banking Regulation Act. This act allows the RBI to place business restrictions in order to protect the interest of depositors. The restrictions even led to an independent director quitting the board of the payments bank within a day, because she did not see any future to Paytm Payments Bank.

According to a person with direct knowledge of the matter, some of these concerns could have been resolved sooner, had there been constant communication between the RBI and the payments bank in the early stages of setting up. That did not happen because there was no clear point person dealing with the regulator.

The RBI has been clear that its actions have been proportionate to the violations by the payments bank.

"The emphasis is always on bilateral engagement with regulated entity," the Governor said.

RBI is always focused on nudging a regulated entity to take remedial action when needed, he said. It also gives sufficient time for taking corrective action, Das said. Only when "constructive engagement doesn't work" that the RBI goes for imposing business restrictions.

Whether there was any actual money laundering happening is not for the RBI to figure out. There are agencies like the Income Tax Department and the Enforcement Directorate which are responsible for it. But the fact that there was a door left open for potential malfeasance is enough for RBI to take due action.

Could the regulator have done any better in this situation?

Maybe allowing an individual to acquire 51% stake in a banking entity was not the best idea. Especially when the remaining 49% is owned by an entity where the same individual wields considerable influence. It just leaves too many open loops for potential future irregularities.

Maybe the RBI could have acted more swiftly and addressed any gaps on the board of the payments bank early on, so there were adequate checks and balances. A lesson from its playbook allows the RBI to appoint directors to monitor how entities with weak corporate governance take decisions.

Questions were also asked of the poor retail shareholder who has lost considerable value after investing in Paytm. The stock crashed over 40% since the restrictions were imposed. Of course, the straight answer to that is that the RBI is a regulator to protect the depositor, not the shareholder. Equity risk is assumed, but depositor risk is not a given in India yet.

These may be lessons for the regulator, but they do not in any way impinge on the right to take supervisory action on a regulated entity.

For all intents and purposes the RBI has made it clear that it wants to shut down Paytm Payments Bank. This of course led to concerns whether the parent app Paytm will survive this onslaught.

After all, Paytm surrendered its prepaid payment instrument licence to use Paytm Payments Bank's services. If the payment bank is to be shut down, Paytm will need to find other banking partners to offer payments services. With the amount of regulatory glare, and the short timeline available, it is difficult to foresee other lenders freely joining hands with Sharma.

Or maybe Sharma will prove naysayers wrong--like he has done many times before--and pull a rabbit out of the hat.

This is all part of an uncertain and unpredictable future. But one thing is certain: you can grow as much as you want but you cannot fiddle with the regulator's free hand. For when this hand turns into a hammer is anyone's guess.