RBI Cracks Down on Paytm | Banning Banking Services

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The Reserve Bank of India announced a fairly atypical death sentence for Paytm Payments Bank on the evening of January 31. It prohibited the bank from engaging in any kind of banking activity following February 29. This included making deposits, using credit, topping up wallets, paying bills, and anything else.

Although the regulator has already taken action against a number of financial institutions, this particular one felt somewhat definitive. The Reserve Bank of India did not provide a reprieve for the bank from these tough regulations. The brief press release had no information suggesting that Paytm Payments Bank would be given a chance to address its systems or that the RBI would think about loosening limitations in the event that the problems were resolved.

Industry insiders are already doubting the seriousness of the regulatory issues that prompted such an extreme and uncompromising ruling in light of the unusual step.

Observers of the sector to gain insight into the sequence of events that culminated in the bank's eventual shutdown, which appears to have begun less than a year after Paytm Payments Bank (PPBL) was established more than six years ago. These are serious infractions that, at the very least, put the bank's clients at danger of fraud and data breaches. There are even more serious concerns about the promoters' lack of transparency, which includes, but is not limited to, their repeated submission of fraudulent compliance reports to the regulator.

First Strike 

A Sequence of Failures at Paytm Payments Bank, Non-Compliance History, First Strike

The operations that led to the crackdown began when PPBL first obtained a banking license in January 2017. Within a year of operations, the bank saw its first regulatory strike, despite its encouraging start after the demonetisation of 2016. In June 2018, the RBI temporarily stopped accepting new accounts due to violations of licensing requirements, such as failing to maintain day-end balances and failing to follow know-your-customer (KYC) regulations.

The Second Strike

The RBI's discovery that PPBL had filed fraudulent information in October 2021 dealt the second blow, prompting the latter to impose a ₹1 crore fine.

"Upon reviewing PPBL's application for the issuance of the final Certificate of Authorization (CoA), it was noted that certain information provided by PPBL did not accurately reflect the situation as it actually was. In a notification on October 20, 2021, RBI had stated that it had concluded the aforementioned charge was true and justified the imposition of a monetary penalty.

The Third Strike

In the latter half of 2021, further investigations uncovered alarming gaps in cybersecurity, technology, and KYC anti-money laundering compliance. Sources claimed that despite these worries, the RBI's assessment found no physical or server separation between the bank and other One 97 group companies.

Due to this, the RBI placed supervisory restrictions on PPBL in March 2022, ordering the bank to immediately cease accepting new clients and to hire an outside audit company to carry out a thorough system assessment.

"Today, Reserve Bank of India has instructed Paytm Payments Bank Ltd to cease onboarding new customers immediately, in accordance with section 35A of the Banking Regulation Act, 1949, among other powers. Additionally, the bank must designate an IT audit company to carry out a thorough system audit of its IT infrastructure. After examining the IT auditors' findings, the RBI must specifically approve Paytm Payments Bank Ltd.'s onboarding of new clients. This measure stems from specific significant supervisory issues that have been noticed within the bank, the RBI stated in a notification dated March 11, 2022.

Round Four

When the system auditor's report became public in the latter half of 2022, the RBI discovered that the bank had not taken any significant steps to implement the required corrective actions.

By October 2023, PPBL had received a fourth strike against them when the RBI levied a ₹5.39 crore financial penalty for continuing to violate KYC regulations. Among other issues, the regulator pointed to shortcomings in the video-based customer identification procedure (V-CIP), identification of beneficial owners, monitoring of payout transactions, exceeding regulatory ceilings, and delayed reporting of cybersecurity breaches.

Risks of money laundering, digital fraud, and serious KYC AML infractions

According to someone with firsthand knowledge of the situation, "there are major irregularities in KYC, which expose the customers, depositors, and wallet holders to serious risk." According to the source, these included several consumers not having KYC, going into thousands, and PAN validation errors in lakhs of accounts.

The RBI discovered that the same PAN was associated with over 100 consumers in thousands of cases, and with over 1,000 customers in some circumstances. The insider further stated that the overall value of transactions in certain accounts exceeded regulatory thresholds for minimum KYC pre-paid instruments by crores of rupees, raising worries about money laundering.

Promoter lack of transparency

The regulator's worries about the PPBL were heightened by the bank's promoters' record of non-transparency, which made the situation worse. "The compliance that the bank submitted was discovered to be false upon verification on multiple occasions, by both the RBI supervisors and external auditors," the individual with knowledge stated.

The RBI noted that Paytm Payments Bank's sizable payables to its parent company OCL were frequently omitted from the bank's financial filings. The individual who was previously quoted said, "Agreements were often being revised to benefit the OCL or its group companies, and apparently detrimental to the bank and its clients."

Additionally, the regulator discovered a remarkably high quantity of inactive accounts, which are likely to have been exploited as mule accounts. According to a second source with direct knowledge, the RBI discovered that up to 31 crore of the approximately 35 crore wallet accounts that Paytm keeps are inactive.

The bank's absence of a transaction monitoring system and shortcomings in its KYC procedures raised worries about money laundering as well. For example, it was discovered that thousands of cases had their wallets and accounts frozen by different law enforcement agencies nationwide because the accounts were used to perpetrate digital crimes. 

Arm's distance from Promoter Group Entities is not upheld

The RBI's discovery that the group's financial and non-financial operations were being mixed with those of its promoter group companies in violation of RBI guidelines and license requirements only served to exacerbate the problem. Data privacy and sharing concerns were brought up by the PPBL's reliance on the IT infrastructure of One 97 Communications Limited (OCL), its parent company. 

What's Next

"The bigger issue is Paytm has not been on the good books of the regulator and going forward, their lending partners also could possibly re-look at the relationships," as Macquarie put it. Analysts have already been informed by management that the company would not be making any new loan originations for the next few weeks until it addresses the current problem.

Although Paytm cannot make loans to consumers because it is a payments bank, it does collaborate with other financial institutions that can make loans in order to generate income from those loans. These banking relationships, which are frequently built on trust, can suffer if lenders decide to deal with a player who is under regulatory scrutiny more cautiously.

3.93 crore merchants used Paytm as of the end of December 2023. It gives them the option to collect payments via QR codes or to use Paytm Soundboxes, which notify businesses when payments are received and are connected to their bank accounts. Numerous of these retailers have Paytm Payments Bank bank accounts. The deadline for Paytm to transfer all of these QR codes to additional sponsored banks is February 29.