In today’s Finshots, we tell you why the Reserve Bank of India has effectively killed the payments bank business of Paytm and what it could mean for the future of the fintech.

The Story

Paytm’s stock crashed by almost a whopping 40%* this week!!!

And it’s all thanks to the RBI!

On Wednesday evening, the banking regulator issued a circular to the folks at Paytm  Payments Bank— it banned them from accepting any new monies into its Payments Bank accounts, digital wallets, and even FASTags. No deposits, no top-ups, nothing can happen after the 29th of February.

Customers can still withdraw their balances and spend money in their wallets freely, so that’s a relief.

But why did the RBI deliver such a crushing blow to Paytm, you ask?

Well, let’s take it from the top.

Everyone knows the story of Paytm. In 2010, Paytm started as a platform to let people top up their mobile phone balance. By 2014, they had become a digital wallet platform. You could load money into the wallet and make payments to utility companies. And when the RBI announced a new category of banks called Payments Banks in 2015, Paytm applied for a licence. It wouldn’t give them the same permissions as a full-fledged bank. They couldn’t raise massive deposits or lend money, but it was a start. Because if the payments bank ran smoothly for 5 years, it could get converted into a Small Finance Bank. And that would mean Paytm could even get into the lucrative lending game.

But it looks like the RBI was watching things very closely. While auditing the fintech’s Payment Bank operations, the regulator found a problem. A big one.

See, 49% of Paytm Payments Bank is owned by One97 Communications, that runs the Paytm brand. The remaining 51% is held by Paytm’s founder Vijay Shekhar Sharma. And the regulator felt that there was no wall between the two entities — money and data flowed easily even when they shouldn’t.

Now RBI can’t regulate Paytm since it’s not a bank or an NBFC. But, it can regulate Paytm Payments Bank. So over the past couple of years, it gave the company multiple warnings. For instance, here’s something from The Ken.

“The message was [clear:] disentangle from the tight coupling it has with Paytm.”

And the extent of entanglement was extensive.

One can open Paytm Payments Bank only on the Paytm app.

One can access funds from the bank only via the app.

One can register or log in to the bank only through the Paytm app.

The Paytm app drives the promotion and distribution of all of the bank’s services.

And when the regulator found that Paytm Payments Bank didn’t pay enough attention to its concerns, it finally cracked down on the company.

So, what does all this mean for Paytm?

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 bank account where he finally gets the credit.

And there are over 37 million merchants that use Paytm’s services.

That means the Payments Bank rules the roost in the beneficiary bank segment for UPI. Nearly 25% of all UPI transactions end up credited to a Paytm Payments Bank account.

But now, all that will have to change.

As per an article in Moneycontrol,

“….[Paytm will have to] change the QR codes. Now they will have to issue new QR codes, [and] paste the new QR codes on the millions of soundbox devices wherever it is linked to PPB. This is a logistical nightmare,” said a fintech consultant with one of the big four audit firms.

In the meantime, they have to ask all the merchants to move their beneficiary accounts from Paytm Payments Bank to another bank. That’s probably not going to go down too well with a kirana store owner. It’s a hassle for them.

So if they have to migrate anyway, they might even end up trying one of Paytm’s peers such as PhonePe.

Ok. Now what about UPI transactions that you and I make over Paytm?

If you read media reports you’ll see that everyone’s claiming that the segment will take a hit. Whereas research firm Alliance Bernstein says “We expect no immediate impact to their UPI payment business…”.

Who’s right?

Well, probably both.

See, Paytm doesn’t run its show as a third-party application provider (TPAP). Meaning that it’s not simply a user-facing app that offers UPI services while working with a bank in the background. That’s what Google Pay and PhonePe do.

Paytm works directly with its Payments Bank and controls key parts of the UPI journey. But now that tie will be severed. So Paytm needs to get its TPAP credentials in order before the 29th of February and work with a bank for UPI transactions.

It seems doable. But if it faces an unforeseen issue and things go wrong, that’ll be a big hiccup for Paytm.

The next question is if customers panic and try to withdraw all their monies in their wallets and bank accounts, can Paytm meet the requests?

Ideally, yes.

See, whenever there’s a run on a bank, i.e. when lots of customers demand all their cash back, the problem is simple. The bank gets deposits from customers. That’s the bank’s liability. And it takes these deposits and loans out a large chunk of it. That’s the bank’s assets. But the bank can’t run to the doorstep of the borrowers and demand for early repayment. So the bank is left without enough assets to repay all those liabilities.

In Paytm’s case, they weren’t really in the lending business. They simply ‘originated’ the loans for their NBFC partners. And pocketed a ‘finders fee’ for the troubles.

It would have invested the deposits it received in government bonds and with other banks.

So the question of an asset-liability mismatch shouldn’t arise.

And finally, we need to address the elephant in the room — how bad is it looking for Paytm’s bottom line?

The fintech itself says it’s a hit of around ₹300-₹500 crore annually to their EBITDA (the earnings before interest and taxes and stuff).

For context, Paytm was expected to make close to ₹600 crores of adjusted EBITDA (including the cost of shares issued to employees) in FY24. So it could mean a potential wipeout of a significant part of the earnings now.

And when they’ll finally get to being a profitable fintech is anybody’s guess.

Because there could also be a ripple effect.

The thing is that banking and lending partnerships are based on trust. You believe the ones you’re working with are doing appropriate due diligence and their governance practices are robust. But the RBI has pointed out that it’s concerned about governance lapses at the Paytm house. And global investment houses Jefferies and Macquarie are both worried that it could end up spooking some of Paytm’s lending partners — they might even limit the business they do with the fintech.

If that were to happen, it’d be a big blow to Paytm indeed.

So yeah, that’s everything you need to know about RBI’s crackdown on Paytm's Payments Bank. And if you have any thoughts about this, don’t forget to email us or tweet at us.

Until then…

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PS: The RBI hasn’t cancelled the licence yet. But the diktat all but kills the Payments Bank and cancellation of the licence looks like just a formality to be completed at some point in time.

*Paytm's stock hit the lower circuit of 20% on both Thursday and Friday. While this translates to a cumulative drop of ~36%, we wrote 'almost 40%' in the story to convey the approximate extent of the damage.

We do round off numbers in our stories to simplify it. And we typically prefix them with words such as 'almost' and 'nearly' so that our readers know it's an approximate figure. But with the controversy surrounding Paytm this week, we realise that we could've been more specific and we will ensure we do so in the future.