In today’s Finshots, we explain why the fintech firm had a rough Thursday.

The Story

Paytm was having a great year. Its share price had risen by nearly 90%. Foreign investment houses such as BofA and Jefferies were singing praises. Everyone expected the company to hit profitability very soon.

But on Thursday, the stock came crashing down. It fell by a whopping 20%!

The reason?

Paytm announced that it was slamming the brakes on its loan business!!!

Now before we get into why on earth it would do that, we need to understand how Paytm has operated over the past couple of years.

See, at the very basic level, the company’s strategy is quite straightforward. The first step is to lure customers using the payment route. Consumers can top up their mobile phone balance and pay their utility bills conveniently. And for merchants, Paytm offers payment gateway services and offline payments through QR codes.

Once the users are accustomed to the system, step two is to try and attract them more often. That’s where the e-commerce lever kicks in. They offer consumers a chance to book movie tickets and shop for stuff too. And dangle things like soundboxes (that announce when a payment is received) to make the lives of merchants more convenient.

But the third step in this grand plan for dominance is to go where the real money is — financial services. Especially lending.

See, if you were a merchant whose transactions were routed through Paytm’s gateway, the company knows a lot about your business. Also, Paytm rules the roost when it comes to merchant UPI — they have a 24% market share by volume. Think of it this way. When UPI payments are made, money travels from the sender’s bank — called the remitter bank — to the receiver’s bank– called the beneficiary bank. And guess who’s leading the pack on the beneficiary bank front? Paytm’s Payments Bank. All this transactional data could help them gauge the merchant’s creditworthiness. In fact, this could be the only place where the merchant could get a quick loan for their business needs.

And on the consumer side, there’s Paytm PostPaid which is a Buy-Now-Pay-Later (BNPL) scheme and there’s also the good old personal loans in the mix.

Okay, but wait…Paytm doesn’t have a proper banking licence, no? Then how do they lend money out?

Simple. They’ve tied up with other non-banking financial companies (NBCFs) who can do this. At the end of FY23, Paytm worked with 6 different lenders such as Shriram Finance and Aditya Birla Finance. And for facilitating the loan, Paytm takes home a nice commission from them.

Anyway, that’s the business model.

And in the past year, Paytm really doubled down on the third step — the lucrative lending business.

For instance, it doled out just ₹1,400 crores of loans in FY21. But by FY23, this had rocketed to ₹35,000 crores. And the investment house Jefferies expected that it was on track to cross the ₹70,000 crore mark in FY24.

Remember we told you that Paytm’s acquisition funnel was the payments business?

Well, it has around 100 million users who flip open the app every month to indulge in some transaction or the other — maybe to top off the phone or buy movie tickets. So all Paytm has to do is cross-sell loans to them too. And this way, in FY23, Paytm handed out loans to nearly 6 million new-to-credit users. These are people who hadn’t taken a loan before and didn’t really have a credit score. In fact, Paytm became the second-largest acquisition platform for unsecured credit customers.

Guess who’s first? Bajaj Finance, of course!

And since lending isn’t just about giving away money but also collecting it, when it’s time to do so, in FY22, Paytm acquired Creditmate. These folks were a debt collection platform that would send collection reminders and requests, track repayments, and even partner with physical on-ground collection agencies to go knocking at people's doors. Maybe this helped but in the past year, Paytm has been able to recover a larger part of overdue loans as well.

So yeah, Paytm has been dead serious about this side of the business for the past couple of years. And that’s why all these investment research companies turned super positive about Paytm.

But last month, something changed.

At first, the Reserve Bank of India (RBI) sounded the alarm. It said that it was getting worried about the loans in the tiny personal loan category (loans below ₹50,000). And that’s because while overall bad loans in the retail segment were below 1.5%, for this category it has soared to 8.1%.

The worry was that things would get worse before it got better.

So the central bank decided to take action. It decided to tweak something called risk weights. We wrote about it here in detail. But the gist of the matter is that the RBI asks all banks to set aside a certain portion of their own capital before it sanctions loans. But all loans are also not treated equally. The RBI says that home loans are less risky because there’s collateral attached. But personal loans are unsecured so they carry higher risk. That means banks have to set aside more capital if they indulge in riskier loans. It was the RBI’s way of asking banks to slow down.

Suddenly, these tiny personal loans became kryptonite.

And with the RBI tightening the screw, Paytm decided to become a good child too. They voluntarily took a backseat. And in a way, it’s Paytm telling everyone that they’re a prudent lender. That managing risk matters more than anything else.

But of course that didn’t go down well with investors.

And to understand why, take the Postpaid loans business which is basically BNPL. Over 70% of the loans that Paytm hands out in this segment are under the ₹50,000 mark. But the bigger problem is that nearly half of all loans Paytm disburses fall into the BNPL category. So this effectively means that Paytm’s biggest lending division will shudder to a halt now. It’s no wonder that analysts at Goldman Sachs believe that scaling back these smaller loans will have an outsized impact on the firm.

Also, 40% of Paytm’s personal loan customers are first vetted through BNPL. They might buy something in instalments and that gives Paytm confidence to lend them higher sums of money later. But now, that ‘test’ funnel will disappear too. And even though Paytm says they will increase lending in the segment, things could first slow down before it picks up.

So with 30% of the company’s revenue coming from financial services, you can see why investors panicked and dragged the stock price lower by 20% yesterday.

Now the question is — what’s next for Paytm?

Well, we don’t know yet. The consensus seems to be that turning off the BNPL tap will hurt the near-term outlook.

But the bigger picture is that only 1% of Paytm’s users have actually availed of personal loans (not including BNPL) on the platform so far. And that means the opportunity to nudge people in this segment into higher ticket loans is immense too. It’s the same thing in the merchant loans category — the penetration levels are at a puny 1.2%.

Also, credit cycles turn. People might slow down on borrowing money. Maybe the bad loans won’t rise. And if that happens, the RBI could reevaluate its risk-weighting decision in the future. Personal loans won’t be a kryptonite for the industry anymore. And maybe Paytm will step on the gas again.

It’s going to be an interesting 2024 for Paytm for sure.

Until then…

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