FinTechNavigating RBI’s shifting Regulations on Paytm Payment’s Bank

INTRODUCTION

It has been observed that within the ever-evolving Indian fintech sector, a few notable companies shine, with Paytm being one of the prominent names. Nevertheless, recent developments have thrown this major player in digital payments into chaos.

The recent market performance of Paytm has been fitful, with its share price experiencing a significant decline. In 2020 and 2021, Paytm had a successful IPO, raising Rs. 18,300 crores with an IPO price band of INR 2080-2150 per share. However, as of March 22, 2024, the share price has dropped to INR 403.5, marking a substantial decrease from its initial offering.

This decline has been drastic, with the share price hitting the lower circuit limit for five consecutive trading sessions, resulting in a loss of approximately 50% of its value.

The market perception of Paytm has been influenced by recent regulatory actions, notably from the RBI, which have targeted Paytm Payments Bank (herein referred to as “PPBL”), a distinct entity within the Paytm ecosystem. These regulatory measures have indirectly impacted the broader company’s standing in the market, contributing to the challenges faced by Paytm.

TIMELINE OF EVENTS

• 2010: Paytm commences its journey as a mobile recharge platform.
• January, 2014: To broaden the company’s services, Paytm Wallet was introduced.
• 2014:  RBI released draft guidelines for “Licensing of Payments Banks” and “Licensing of Small Finance Banks in the Private Sector”.
• Late 2015: By this time Paytm had launched payment options for metro recharges, electricity, gas, and water bills. Additionally, Chinese firm Alibaba invests $680 million in Paytm, acquiring a 40% share.
• November, 2016: India announces demonetization, significantly benefiting Paytm’s operations.
• 2017: Paytm introduces Paytm Payments Bank. Simultaneously, Chinese investments in Paytm come under public scrutiny during the Doklam standoff.
• May, 2018: CobraPost’s undercover operation reveals that Paytm’s vice president sharing user data with the Government upon request and discussing the spread of political propaganda.
• July, 2021: RBI issued a show-cause notice to PPBL for submitting false information about the transfer of an operating unit from One97 Communications to PPBL.
• October, 2021: Paytm Payments Bank is fined Rs. 1 Crore for providing inaccurate information to RBI and contravention of the Payment and Settlement Systems Act, 2007.
• March, 2022: RBI imposes supervisory measures under Section 35A of the Banking Regulation Act, 1949 due to technological and compliance deficiencies.
• October, 2023: RBI levies a Rs 5.39 crore penalty on Paytm Payments Bank for non-compliance with regulations and Know Your Customer (herein referred to as “KYC”) norms.
• January, 2024: RBI notifies Paytm Payments Bank of persistent non-compliance, leading to operational restrictions from February 29, 2024. Subsequently, Paytm Payments Bank is prohibited from accepting new deposits, onboarding customers, or processing transactions. All nodal accounts linked to PPBL had to be closed by March 15, 2024. These restrictions, primarily targeting Paytm Payments Bank, also impacted the functionality of the Paytm Wallet due to their close integration.

RBI’S DIRECTIVE BANNING PAYTM PAYMENTS BANK

In a press release 2023-2024/1895 dated 16^th February, 2024 on “Action against Paytm Payments Bank Ltd. under Section 35A of the Banking Regulation Act, 1949” the RBI, while keeping in view the difficulties faced by the customers of PPBL, issued new guidelines to the following effect-

1. The deadline precluding deposits into PPBL e-wallets has been extended to after March 15, 2024 (from the earlier February 29, 2024), other than any interest, cashback, sweep-in from partner banks or refunds which may be credited anytime.

2. Withdrawal or utilization of balance services are to stay unaffected.

3. No banking services, other than those referred in (i) and (ii) above, like fund transfers (irrespective of name and nature of services like AEPS, IMPS, etc.), BBPOU and UPI facility should be provided by the bank after March 15, 2024 However, for the purpose of (ii) above fund transfers including AEPS, IMPS and UPI may be allowed anytime.

4. No change in the order to terminate the Nodal Accounts of One97 Communications Ltd and Paytm Payments Services Ltd maintained by PPBL.

5. No change in the order to settle all pipeline transactions in nodal accounts by March 15.

In response to questions that arose about “Business restrictions imposed on Paytm Payments Bank Limited vide Press Releases dated January 31 and February 16, 2024” the RBI provided the following clarifications –

Users will not be able to deposit any funds or into their accounts or top-up their accounts after March 15, 2024. This shall exclude interest, cashbacks, sweep-in from partner banks or refunds which shall be allowed to be credited. Additionally, RBI clarified that FASTags issued through PBBL shall no longer be valid and recommended those with PBBL issued/connected FASTag’s to have new FASTags issued.

REASON BEHIND THE CRISIS

RBI mandated the closure of PPBL stating “persistent non-compliances and ongoing material supervisory concerns within the bank.”

PPBL violated multiple regulations and standards set by the RBI, particularly in areas such as KYC, anti-money laundering, and cybersecurity. The company was discovered to have provided incorrect details and compliance documents to the RBI.

Additionally, PPBL shared its data, servers, and assets with other entities under One97, its parent organization. There was discovery of multiple accounts at PPBL that were made without adequate identification, potentially easing money laundering activities.

It was also found that multiple accounts at PPBL were linked to the same identification proof and involved transactions running into crores. Additionally, the presence of an unusually high number of dormant accounts raised further red flags.

Since 2018, the RBI has been imposing fines, bans, and doing audits on PPBL, but the organisation did not fix the problems. The violations were so grave that the RBI had to take regulatory measures to protect customers and keep the banking system safe.

CHALLENGES FACED BY PAYTM

a. Regulatory Scrutiny: Recently, Paytm has faced increased attention from regulators due to compliance and governance issues. The RBI is closely examining the company’s practices following concerns raised about certain operations.

b. Market Performance: Paytm’s stock prices have been fluctuating, leading to discussions about the company’s overall financial health. Investors are closely monitoring these changes in market value.

c. Competition and Market Dynamics: Paytm is encountering tough competition in the digital payment sector from newer, more agile fintech companies. This competition is challenging Paytm’s market share and position.

d. User Data Controversy: Controversies surrounding user data and privacy have emerged, prompting a re-evaluation of how Paytm manages data and its impact on user trust, especially in light of regulatory challenges.

e. Strategic Shifts: To address these challenges, Paytm is making strategic adjustments to navigate regulatory changes and rebuild market confidence. The effectiveness of these shifts will be closely observed in the upcoming months.

KEY TAKEAWAYS

i. Regulatory Compliance: Paytm’s experience underscores the critical importance of regulatory compliance and adherence to government directives for sustainable growth. Non-compliance with banking regulations and concerns regarding data security highlight the necessity for robust compliance frameworks within fintech companies.

ii. Geopolitical Considerations: The association of Paytm with Chinese investors led to strains in its relationship with Indian authorities due to geopolitical factors. This highlights the significance of making prudent investment decisions and conducting thorough risk assessments, particularly in politically sensitive environments where geopolitical tensions may impact business operations.

iii. KYC System Weaknesses: Paytm’s flawed KYC system, with multiple accounts linked to a single PAN (Permanent Account Number) and numerous non-KYC accounts, facilitated fraudulent activities. Strengthening KYC processes and ensuring compliance with identity verification standards are essential to mitigate risks and enhance security within fintech platforms.

iv. Management of Incentives and Agent Networks: Paytm’s incentive-driven account opening practices led to regulatory scrutiny and reputational damage. This highlights the importance of careful oversight in managing incentives and agent networks. Fintech companies need to balance their growth objectives with ethical considerations to avoid engaging in practices that may result in regulatory penalties or harm their reputation.

v. Emphasis on Data Security and Privacy: The Paytm case underscores the critical importance of robust data security and privacy measures in the fintech sector. Fintech firms must prioritize investments in state-of-the-art cybersecurity infrastructure, implementing encryption protocols, and conducting regular audits to identify and address potential vulnerabilities in their systems.

vi. Proactive Approach to Risk Management: The RBI’s action against Paytm underscores the necessity for fintech companies to adopt a proactive approach to risk management. Establishing a comprehensive risk management framework comprising regular assessments, scenario planning, and contingency plans is essential. By identifying and mitigating potential risks pre-emptively, fintech firms can effectively navigate regulatory changes and unforeseen challenges, ensuring the resilience and stability of their operations.

viii. Continuous Monitoring of Anti – Money Laundering (AML) Practices:
The Paytm incident highlights the crucial need for stringent AML practices in the fintech sector. Fintech firms should prioritize implementing robust AML measures, conducting regular audits, and staying informed about evolving AML regulations. Collaboration with regulatory bodies can provide valuable insights into best practices, helping companies maintain compliance and mitigate the risk of financial crime effectively.

AMLEGALS REMARKS

The crisis in the PPBL serves as a crucial reminder for the fintech sector, regulators, and the public alike. It emphasizes the significance of adhering to compliance standards, maintaining strong corporate governance, and facing public scrutiny while pursuing innovation and expansion.

It underscores that while fintech holds promise for revolutionizing finance, it must be founded on trust, transparency, and accountability. The downfall of Paytm, despite its obstacles, offers a chance for reflection and adjustment. As the company battles with these challenges, it highlights the ever-changing landscape of business and the necessity for resilience and adaptability.

– Team AMLEGALS assisted by Ms. Prishita Saraiwala

For any queries or feedback feel free to reach out to mridusha.guha@amlegals.com or jason.james@amlegals.com