'Persistent Non-Compliance' Triggers RBI Lockdown On India's Paytm Bank

February 6, 2024
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Following a “stringent” move by the Reserve Bank of India (RBI), Paytm Payments Bank may now be on borrowed time, but its licence remains intact — at least for now.

Following a “stringent” move by the Reserve Bank of India (RBI), Paytm Payments Bank may now be on borrowed time, but its licence remains intact — at least for now.

Last week, the RBI issued a new series of restrictions against Paytm Bank under Section 35A of the Banking Regulation Act 1949.

Due to “persistent non-compliance”, Paytm Bank was ordered to cease accepting further deposits and stop processing credit transactions by the end of February.

The ban on new deposits includes top ups of customer accounts in any form, including prepaid instruments and transports cards.

Paytm Bank must also cease processing funds transfers between accounts and offering other banking services, such as connections to the Aadhaar Enabled Payment System (AePS) and the Unified Payments Interface (UPI).

The only transactions that Paytm Bank will be allowed to process are withdrawals or spending of current balances, leading to speculation that the RBI is preparing to revoke the bank's licence.

Section 35A of the Banking Regulation Act allows the RBI to intervene in the operation of a bank when it deems the bank is conducting itself in a way that is “detrimental to the interests of the depositors”.

Under the same law, the RBI can intervene to prevent a bank from conducting itself in a “manner prejudicial to the interests of the banking company”.

But last week’s order is not the first time that the RBI has used Section 35A to impose restrictions on Paytm Bank.

In March 2022, the RBI ordered Paytm Bank to stop onboarding new customers with immediate effect, and to appoint an independent firm to conduct a “comprehensive audit” of its IT systems. That order was based on “material supervisory concerns” about the bank.

In its latest order, the RBI notes that the audit and a subsequent “compliance validation report” by external auditors revealed persistent non-compliance.

Along the way, in October 2023, the RBI also issued a ₹54m ($650m) fine to Paytm Bank for non-compliance with know your customer (KYC) and cybersecurity rules.

Customers concerned about UPI access

In the days since the RBI’s order, Paytm founder and CEO Vijay Sharma has assured customers that the Paytm payments app will continue to work as normal beyond February 29.

The Paytm app, which has more than 350m active users, is used to make payments via UPI, India’s real-time payments system.

In December 2023, Paytm was the third most widely used UPI app in terms of value transacted, coming in behind PhonePe and Google Pay respectively.

“For every challenge, there is a solution, and we are sincerely committed to serve our nation in full compliance,” said Sharma.

“India will keep winning global accolades in payment innovation and inclusion in financial services — with PaytmKaro as the biggest champion of it.”

In India, the tagline “Paytm karo” is similar to “Google it” in English, with “Paytm” acting as a verb.

Non-bank Paytm services will continue

Paytm is owned by One 97 Communications Ltd. (OCL), a larger payments company that trades on the Bombay Stock Exchange (BSE).

In a statement to investors, OCL noted that it was already working with multiple banks to offer its financial services prior to the RBI order, and will now shift its operations entirely over to these banks while dropping Paytm Bank.

For example, Paytm Bank was ordered to terminate the nodal account that connects it to Paytm Payment Services Ltd., a fellow subsidiary of OCL that offers acquiring and payment gateway services.

“We offer acquiring services to merchants in partnership with several leading banks in the country and will continue to expand third-party bank partnerships,” said OCL.

Meanwhile, OCL’s offline merchant payment network offerings, such as Paytm QR, Paytm Soundbox, Paytm Card Machine, will continue as usual and can also onboard new merchants.

Likely repercussions and risks ahead

Prakhar Tiwari, a partner at law firm Tatvika Legal in Delhi, said the RBI order presents a “formidable challenge” for Paytm bank and its growth prospects.

“The immediate repercussions are felt in customer trust and market sentiment towards Paytm Bank,” he told Vixio.

“Customers may experience uncertainty and potential disruption as the bank endeavours to address the issues highlighted by the RBI,” he added, noting that it remains to be seen whether Paytm has sufficient contingencies in place.

Tiwari also noted that the RBI order could affect a pending licence application by Paytm Payment Services Ltd. and its ability to onboard new merchants online.

“The order raises crucial questions regarding Paytm's IT infrastructure, operational risk management and adherence to anti-money laundering regulations,” he said, “and these concerns go beyond the payments bank.”

As for other fintechs, Tiawari said the Paytm example shows that the RBI will take “stringent” action for repeated non-compliance.

“This serves as a wake-up call for the digital banking sector to enhance operational conduct and align with compliance standards,” he said.

“In the long term, this incident could lead to more stringent regulations for fintech companies, potentially escalating operational costs and impacting the ease of doing business.

“However, it also offers an opportunity for the sector to fortify systems that can withstand regulatory scrutiny and enhance customer trust.”


     



     

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