Paytm’s bank is in a state of suspended animation. So, what’s next?

These are meetings where urgent company affairs are debated and voted on. That day, the board recommended and approved a contract with One97 Communications Ltd, the bank’s parent entity—henceforth, One97 would provide the bank with various services it needed to run operations—facilitating know your customer (KYC) norms, customer acquisition, technology support and data analytics services.

In addition, the two entities were to share physical premises, networking systems, software systems, data centre, electrical infrastructure and even power backup systems, the board meeting’s resolution, a copy of which was reviewed by Mint, stated.

While the board stated that the contract “entered into is on an arm’s length basis”, the Reserve Bank of India (RBI), India’s central bank, wasn’t comfortable with the arrangement, which was essentially a related-party transaction. Both the entities had a common director back then—Vijay Shekhar Sharma, the charismatic founder of Paytm.

Among other things, RBI had objected to the bank’s dependence on the parent company’s IT infrastructure and voiced concerns around data privacy.

Paytm Payments Bank started operations six months later, in May 2017, with the services arrangement in place.

“This agreement was before the establishment of the bank. It was in operation for a few months after the payments bank’s launch and later, it was dissolved gradually to meet RBI guidelines,” a One97 spokesperson said.

While Sharma complied with RBI’s wishes at that time, he clearly did not on other occasions. The constant friction with the banking regulator resulted in disastrous consequences for India’s largest fintech company that made digital wallets trendy and mobile payments popular and easy.

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A year after Paytm Payments Bank started operations, RBI found that it did not comply with certain norms—some of its accounts had more funds than permitted by the regulator, Mint had reported on 2 February this year. At that time, customers could keep up to ₹1 lakh in payment bank accounts.

“RBI did not want to take any precipitative action at that time,” a former RBI executive, who didn’t want to be identified, said. Why? “Because it was a new bank and was backed by a startup. There was a belief that getting used to tougher financial regulations takes time,” he said.

But, the regulator ran out of patience last year. In October 2023, it fined the bank ₹5.49 crore, saying that this was due to non-compliance with certain provisions of the KYC norms, besides others. The KYC guidelines act as a vital safeguard against money laundering by mapping each account to a bona fide customer. Banks have to ask customers for their proof of address and identity before they can open bank accounts.

But the worst was yet to come.

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On the eve of the Union budget this year, 31 January, RBI sent a missive that had the shares of One 97 tumbling 20% the next day, in what was one of the biggest daily falls since the company listed in 2021.

RBI barred any addition of funds to Paytm Payments Bank accounts, wallets and Fastags (an electronic toll collection system) after 15 March. In short, it barred the bank from doing any meaningful business, threatening even the overall company’s existence.

The question is what’s next? What can Paytm lean on to survive? Does it have enough crutches to help it see through the next few quarters? And what can it do to assuage the concerns around compliance?

Before we attempt to answer these questions, let’s look at the company’s super-charged rise, and that of its founder Sharma, popularly known as VSS in startup circles.

The rise

One97 was registered in 2000. Sharma, an engineer from the Delhi College of Engineering, launched Paytm—an acronym for pay through mobile—in 2009. The company started off with a payment gateway in 2012, before launching a mobile wallet in 2014.

Over the next couple of years, it started providing QR codes for payments and allowing bill payments on its app. This was even before India sparked off a payments frenzy with the launch of homegrown fast payments platform unified payments interface (UPI) in August 2016.

Then, a day after the Narendra Modi-led government decided to invalidate large value banknotes in circulation on 8 November that year, a move it said was aimed at curbing unaccounted cash, Paytm published front page advertisements in frontline dailies congratulating the prime minister.

As cash fell out of favour, at least temporarily, digital payments became fashionable and Paytm was well positioned to seize the opportunity. There was no turning back for Sharma or the brand he built. Over the next few years, Paytm became a household name and, at times, even a synonym for digital payments. Its first big setback was the initial public offering (IPO), hyped up as one of India’s biggest IPO. It flopped miserably—when the shares of One97 listed on the stock exchanges in November 2021, it did at a discount to its issue price of ₹2,150 apiece.

On 14 March, the company’s stock was valued at ₹353.2 apiece, miles away from the 52-week high of ₹998.3. About ₹78,749 crore in investor wealth has been wiped out since the listing.

The fall

A committee headed by Nachiket Mor, a former board member at RBI, introduced the concept of differentiated banking licences in 2014. It laid the ground for setting up of payments banks and small finance banks.

Payments banks are supposed to reach out to the under-banked and unbanked masses, accepting deposits of up to ₹2 lakh per customer (the amount was doubled in April 2021), but they cannot lend. Access to simplified digital payments through UPI has made it harder for these banks to make money. There are five such banks apart from Paytm Payments Bank today: Airtel Payments Bank, India Post Payments Bank, Fino Payments Bank, Jio Payments Bank and NSDL Payments Bank.

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Paytm Payments Bank, particularly, struggled with issues around KYC. Mint, in a report on 2 February, pointed out that the bank did not conduct KYC for a significant section of its customers. There were instances of a single permanent account number (PAN) being linked to hundreds of customers. Such debacles raise many questions. Clearly, the bank’s board of directors, past and present, sat through multiple RBI warnings and wasn’t able to course-correct.

We pushed for changes that RBI wanted, but our action was perhaps delayed.
—a former board member

“It is not true that we did not act on RBI notices. We pushed for and made changes that RBI wanted the board to do, but our action was perhaps delayed,” said a former board member who spoke on condition of anonymity.

Another former board member said that in 2021, RBI spoke to the board on the need to ensure compliance and build a culture of reporting and governance. “In my experience, over the next two years, we did make many changes,” the board member, who also did not want to be identified, said.

The fallout

The RBI’s latest directive forced Paytm’s management to work out a deal with another private sector bank in record time. Paytm has since shifted its nodal account to Axis Bank. Nodal accounts serve as an intermediary between customers, merchants, and financial entities like payment aggregators and gateways, holding customer payments before settling them with the merchants.

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This shift was important for merchants to continue accepting payments on their Paytm devices. Since many were earlier linked to a nodal account at the Paytm payments bank, they wouldn’t be able to receive payments after 15 March.

Although RBI’s action was against the payments bank and not against the parent entity, analysts expect some erosion in One97’s merchant base—it has 39.3 million merchants.

“We expect 15-20% churn in merchants, customers and devices in Q4 over Q3 levels, along with a 60% QoQ (quarter-on-quarter) decline in loan origination,” analysts at UBS Securities India, a financial services company, said in a note to clients on 28 February. “Paytm will likely experience near-term financial impact on its business along with some permanent loss of business in FY25.” The parent entity’s revenue is generated from three business segments: payment services, financial services, and marketing services.

Paytm will likely experience near-term financial impact along with some permanent loss of business in FY25.
—UBS Securities

A major chunk of the revenue—61% in the third quarter of 2023-24—originated from the payment services business. This segment includes its wallet, buy-now-pay-later service, online and offline payments by consumers. For merchants, the segment includes devices to accept digital payments.

Paytm’s lending operation is bracketed under financial services. Given that Paytm does not have a lending licence, it leverages its relationships with retail users on the app as well as merchants to distribute loans via tie-ups with other lenders. The underwriting of the loan is executed by the lending partner and Paytm keeps a commission. Its lending partners were able to disburse loans of ₹35,378 crore through Paytm in 2022-23, as against ₹7,623 crore the year before, as per its annual report.

Analysts expect the lending business to be hit following RBI’s action. On 12 February, a note from Macquarie Capital, another financial services company, stated that some lending partners were re-evaluating their relationship with Paytm. In case these partners scaled down their business with Paytm, it could lead to a decline in the fintech company’s lending revenue.

₹300-500 crore on its annual Ebitda. ” title=”One97 told the stock exchanges it expects RBI’s action to have a worst-case impact of ₹300-500 crore on its annual Ebitda. “>

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One97 told the stock exchanges in February it expects RBI’s action to have a worst-case impact of ₹300-500 crore on its annual earnings before interest, taxes, depreciation, and amortization (Ebitda), going forward. In 2022-23, the company reported a negative Ebitda (before Esop or employee stock options) of ₹176 crore and net loss of ₹1,776.5 crore. In the third quarter of the current fiscal, it reported an Ebitda before Esop of ₹219 crore and a net loss of ₹222 crore. Interestingly, the parent firm moved the prepaid payment instrument (PPI) licence—which allows it to operate the popular wallet—to Paytm Payments Bank after the lender started operations in 2017. It would require RBI’s permission to move the wallet business back to the parent entity if it has to salvage it. Given how frayed relations are at this point, it doesn’t seem too likely, market watchers said.

“In line with the PPI licensing conditions RBI mentioned to One97, we were required to transfer the PPI license to PPBL (payment’s bank) following the bank’s establishment. Given that PPBL now holds the license, OCL (One97) will not be able to comment on the question of the possibility,” said a spokesperson from One97.

What can save the day

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Even if RBI were to cancel Paytm Payments Bank’s licence, the company would still have its UPI edge. Paytm sought permission from the National Payments Corp. of India (NPCI)—the umbrella entity for retail payments—to act as a third-party application. The application was approved and thus, One97 can continue to facilitate UPI payments even if the payments bank does not exist.

Industry experts believe it is imperative for Paytm to retain as many merchants as possible. “Retail customers might be easier to retain. They might simply move their payments to other apps like GPay or PhonePe without deleting the Paytm app because of some other services the app offers,” said Parijat Garg, a fintech expert. “However, other players are aggressively targeting the merchant ecosystem and if Paytm is able to limit the loss of merchants, they will be able to sail through this crisis,” he said. Garg pointed out that if Paytm loses merchants, it will also lose access to their transaction data. This, in turn, would be detrimental in assessing the eligibility of these businesses for loans. “The loans to merchants would also have a higher ticket size as compared to consumers. Merchant loans are more recurring in nature whereas consumers have significantly more choices to borrow from,” he said.

If Paytm is able to limit the loss of merchants, they will be able to sail through this crisis.
—Parijat Garg

At ₹2 lakh as on 31 December, the average ticket size of Paytm’s merchant loans was ₹30,000 higher than that of personal loans.

Given how closely Paytm’s fortunes are tied to the retention of its merchants, it has tried to placate the fears of these businesses. A week after RBI’s action, the company posted a video on its YouTube channel—Paytm for Business—titled “Paytm’s Merchant community unites! Here’s what they have to say about our uninterrupted services”.

“The decision taken by RBI in the Paytm issue has not impacted us—customers as well as those who accept such payments,” says a man in the video, standing behind a Paytm soundbox and a QR code.

Focus on compliance?

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The RBI order has stirred Paytm into action—the payments bank is communicating it is serious about regulatory compliance. As a first step, it has made changes to its board. Sharma, its largest shareholder with 51% stake, has stepped down. A clutch of independent directors have joined, to bolster the bank’s credibility.

Nonetheless, analysts remain unimpressed.“If the intent is to reform, then why does VSS have both the chairman and managing director positions in the parent listed Paytm?,” Suresh Ganapathy, managing director and head of financial services research at Macquarie Capital, asked, in an email accompanying a note to clients on 27 February. Macquarie did a roadshow in the US and met about 30 investors. A majority of the investors felt that there was no point catching a falling knife, Macquarie stated in the note released on 12 February. These investors want the dust around regulatory uncertainty to settle completely.

For Paytm and Sharma, gaining back trust—the trust of investors, RBI, lending partners, merchants and customers—is likely to be a long haul.