The Reserve Bank of India suddenly brought down the axe on India’s biggest fintech success story—shocking the entire startup community. But as with most biz journalism, much of the coverage is Greek to the layperson. We explain what happened and why it matters—to the person who lives outside this bubble.
Wtf is the Paytm bank?
There are many different parts to the Paytm empire. This scandal focuses on its payments bank. Let us explain.
Say hello to the payments bank: In 2015, the RBI gave 11 entities a payments bank license.These are limited banks that cannot accept more than Rs 200,000 in deposits. And they cannot make direct loans to their customers—but they can act as a platform for other banks who can. The aim: financial inclusion of those unable to access a normal bank account:
[T]he policy objective was to broaden the access to financial services featuring an electronic bank account especially for low income households, small businesses and migrant labour using technology. Basically, these banks would offer deposit and withdrawal facilities, mobile payments and third party transfers at a low cost to achieve the aim of financial inclusion by expanding to the hinterland where the footprint of mainstream banks is limited.
The Paytm play: The company was the biggest beneficiary of the government’s big push toward digital payments—and away from a cash economy. The shock of demonetisation offered a huge assist—by making cash a risky asset:
[Vijay Shekhar] Sharma, who launched Paytm in 2009 offering mobile recharges, immediately saw the opportunities of the demonetisation move that would end up transforming the firm as the nation's premier digital payments platform. The government decision angered many Indians who for years used cash as their main mode of payments, but Sharma took out front-page ads with Modi's photo, calling it the "boldest decision in the financial history of independent India.”
Thanks to that “boldest decision” in 2016 there are 330 million Paytm wallets today.
The bigger banking dream: But the real money in the fintech business is in lending. So in 2015, companies like Paytm took a payments bank licence as a stepping stone—toward becoming a full-fledged bank. According to RBI rules, if the payments bank ran smoothly for five years, it could get converted into a Small Finance Bank. And that would mean Paytm could even get into the lucrative lending game. But for now—since it wasn’t allowed to lend—the Paytm Payments Bank built partnerships with other NBFCs—and took a commission on each loan. And it worked out quite well.
The mighty funnel: Those millions of payment wallets became a funnel for future banking customers. You open the wallet to pay for stuff—and soon enough you’re taking a personal loan to buy something else on your wishlist. More importantly, small merchants are now low-hanging fruit—who live in a Paytm world:
Let’s start with the kirana store owner. Now everything around him could be part of the Paytm ecosystem — the QR code for customers to scan, the soundbox that announces when a payment is received, and his [Paytm] bank account where he finally gets the credit.
Date point to note: Over 37 million merchants use Paytm’s services—and nearly 25% of all UPI transactions end up credited to a Paytm Payments Bank account.
Okay, sounds fab. So what went wrong?
The first sign of trouble: In March 2022, the RBI ordered Paytm to stop onboarding new customers. The reasons were mostly to do with its IT systems—which allowed data to flow to servers abroad. And the RBI raised red flags about the methods used to verify customers. For the most part, the move was reported as anxiety about “sharing information with Chinese entities that indirectly own a stake in the payments bank.” The entities being the ANT Group that held 24.7% and Alibaba that owned 2.4%.
Paytm bluffs it out: At the time, the company called all media reports "false and sensationalist”—and said it was fully compliant with rules about holding customer data inside India. But things did not exactly improve thereafter—when Paytm offices were raided by the Enforcement Directorate for its links to illegal Chinese loan apps. A RBI-ordered audit also found serious problems in compliance. The breaches kept piling up until all hell broke loose in January.
The RBI crackdown: The central bank directed the Paytm Payments Bank to halt all business activities. It was a “death sentence”—and worded to give zero wiggle room to Paytm:
After 29 February, no transactions will be allowed using any of Paytm Bank’s products: its savings bank account, wallet, Fastag, or national common mobility cards. Withdrawal, though, will be permitted till the balance in these accounts lasts. The regulator also restricted the bank from facilitating any kind of transaction—including immediate payment service, aadhaar-enabled payment system, and unified payments interface (UPI). And to ensure the bank does not find a loophole, it added a phrase: “irrespective of name and nature of product” for good measure.
The ‘scorched earth’ policy: No one expects the payment bank to survive this setback—especially since RBI has not given any roadmap that can get it out of hot water. All Paytm accounts of merchants will have to be moved to other banks—which is going to be brutal:
They will have to convince every single merchant to link another bank account to their UPI address instead of the PPB account. This will also likely change the QR codes. Now they will have to issue new QR codes, paste the new QR codes on the millions of soundbox devices wherever it is linked to PPB. This is a logistical nightmare.
Getting banks to accommodate the mass transfer of millions of accounts will be a nightmare, as well. Plus this: the RBI’s move has “triggered a crisis of confidence” in Paytm wallets—which some media reports say is now up for sale (to Mukesh-bhai, no less).
As The Ken puts it, “The RBI has nuked Paytm Bank’s 300 million wallets, 30 million bank accounts, 1.6 billion UPI transactions a month, and eight million Fastags.” The shares of the parent company—One97 Communications—fell by 40% soon after. That’s a loss of Rs 200 billion (20,000 crore) in its market cap in just three days.
But why so harsh? What’s the big sin here?
Paytm committed two cardinal sins—both driven by greed. And it started to break the rules at the very outset—in 2017—and ignored repeated warnings to mend its ways.
One: As we noted before, Paytm’s customers lived in a Paytm world. And that’s because there were no walls between the company’s bank and its payment wallets. The parent company One97 literally ran the bank’s operations:
This apparently led to violation of data secrecy where banks are supposed to ensure that no other entity has any access to the data of the bank. There should not be any sharing of resources, but they seemed to have done that.
Also this: The Paytm wallet app also served as the gateway to the Paytm Bank. You needed the app to open an account, access your funds and log into your account.
Two: Most egregious was the lack of KYC verification. The processes were so sloppy a single account linked to one Permanent Account Number (PAN) was operating more than a 1,000 wallets. That was just the tip of a gargantuan iceberg of non-compliance:
“There are major irregularities in KYC, which expose the customers, depositors and wallet holders to serious risk,” said a person directly in know of the matter. These included absence of KYC for a large number of customers, running into lakhs, PAN validation failures in lakhs of accounts, the source said.
Three: Many of the accounts held crores of rupees—violating regulatory caps for payment wallets. Also this:
The regulator also found an unusually high number of dormant accounts which are prone to have been used as mule accounts. “Out of about 35 crore wallet accounts Paytm maintains, RBI found as many as 31 crore being inoperative,” said another person directly in the know.
This in turn raised suspicions of money laundering. But Paytm had zero processes to monitor or report illegal activity—either to the Indian government or to international bodies like the Financial Action Task Force.
Point to note: One Paytm exec claims that RBI’s real problem is with the parent company One97 Communications. It went after the bank only because it lay within its remit. More so since ONCL owns 49% of the Paytm Payments Bank.
Ok, so this is a good thing… or bad?
There are many who say Paytm was essentially asking for it—brazenly ignoring repeated warnings. Others claim that the RBI has gone too far—causing serious collateral damage. In their eagerness to take Paytm down, they have ruined millions of small merchants. For instance, Bloomberg News columnist Andy Mukherjee writes:
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… The concern in the industry is from retailers: How are they to accept non-cash payments if credit transactions into their accounts are forbidden?
A group of startup founders have written to the government—expressing concern about RBI’s ‘over-reaction’. They want Paytm to be given a “clear and practical window” to fix its compliance issues. One of them even said “it can happen to anyone”—which makes you worry about the state of compliance in the fintech business.
The bigger picture: As with Byju’s—and other superstar startups—Paytm is also a cautionary tale of the ‘growth at any cost’ mindset—shared by founders and VCs. As Economic Times points out:
If entrepreneurs and startups focus on compliance, control and governance from the beginning, and are given the time to grow in a manner feasible for India, there is a lot that can be built meaningfully. While hyperscaling and blitzscaling Silicon Valley style may work to attract billions of dollars at high valuations, these businesses can flameout if fundamentals aren’t strong.
Not that the Silicon Valley model has worked well for the Valley either (See: FTX and Sam Bankman-Fried).
The bottomline: Of 11 entities granted payment bank licences in 2011, five have given them back—and only three have attained profitability. The RBI crackdown hardly gives hope to the others:
It will be viewed as a blow for India’s much acclaimed fintech sector at least in the near term. The RBI action will also be seen as harsh by the industry… navigating the glide path from a payments bank to a small finance bank and finally a full-fledged commercial bank for many potential banking licence aspirants will now be even more of a stiff credibility test.
So what happens to the dream of accessible banking?
Reading list
Mint has an overview of the debacle—while Finshots offers a ‘Paytm for dummies’ explainer. Economic Times and CNBC are best on the long timeline of regulatory breaches by Paytm. Mint has the big picture for the fintech industry—while Economic Times connects Paytm to the cowboy founder phenomenon. Andy Mukherjee’s criticism of the RBI in Bloomberg News (login required) is worth a read. Reuters is best on founder Vijay Shekhar Sharma. Back in 2018, The Wire reported on a Cobrapost sting—which revealed Paytm’s policy of sharing data with the government.
