SUM AND SUBSTANCE | What broke Paytm? (2024)

It was a picture of contrasts. At the Davos World Economic Forum in 2023, Paytm CEO and founder Vijay Shekhar Sharma was asked by the business channel CNBC TV18 about the mood in the “new-economy contingent” he was representing. VSS, as he is commonly known, was asked about the frequent “accounting issues” among them and what advice he, as a start-up icon, would share. “You make choices,” said Sharma. “If you want to build long, you build an institution which sits on a strong foundation; if you want to build an institution that can be executed and flipped, you do it like that.”

In February 2024, at a virtual town hall held a few days after the Reserve Bank of India prohibited Paytm Payments Bank from almost all its major banking services, it was a visibly different Sharma who told the gathered Paytm employees: “We are not completely sure of things… like what exactly went wrong. But we will figure out everything soon. We will reach out to the RBI to see what can be done.” He also told employees that the “company will focus on being extremely compliant moving forward”.

It has been a story with many twists and turns. On November 8, 2016, Prime Minister Narendra Modi announced a demonetisation drive that would throw India’s cash-reliant economy into a tailspin. There was one clear winner though. Paytm, a company that had been working on payment solutions for offline merchants since 2015, dove right in. If a cash-haemorrhaged economy was the problem, then Paytm with its mobile wallet platform was the solution. Sharma commissioned front-page advertisem*nts by Paytm in major newspapers: the Prime Minister’s photograph was emblazoned across the page along with the company hailing demonetisation as the “boldest decision in the financial history of independent India”.

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By the end of that month, Paytm, owned by One97 Communications Ltd, claimed to have added 1.5 lakh merchants to an existing network of 10 lakh merchants across India thatwere now accepting digital wallet payments. The company said it had served over 45 million users and signed up over five million new users. As its famous tagline went, “Ab ATM nahin, Paytm karo” (Don’t use the ATM, use Paytm).

Clashing with the RBI

The timeline on Paytm’s web page details its many offferings: payment gateway, mobile wallet, movie and flight ticket payments, Paytm Gold, equity trading, and the big one: Paytm Payments Bank Ltd (PPBL).

In 2014, RBI released draft guidelines for “Licensing of Payments Banks” and “Licensing of Small Banks”. For the central bank, these banks would fulfil a common objective of furthering financial inclusion. Payments banks specifically would provide a limited range of products but have a widespread network of access points, particularly to remote areas, either through their own branch network or through Business Correspondents or through networks provided by others.

The underlying presumption was that there would be value addition by adapting technological solutions to lower costs. The remit for the companies that were eligible for a payments bank licence ranged from non-banking financial companies, mobile telephone companies, and supermarket chains to real sector cooperatives and public sector entities. According to the rules for payments banks, they cannot lend money and can accept deposits only up to Rs.2 lakh, essentially targeting households and individuals with modest incomes.

Paytm Payments Bank was among those awarded a licence, and the bank started its operations in May 2017 with services that included digital banking, savings accounts, current accounts, fixed deposits with partner banks, Paytm wallet, UPI, and FASTag, among other offerings. It was an almost natural turn in the ambition of taking on the banking universe, something that has always been a running thread in Paytm and its founder’s story.

But the frequency of run-ins with the central bank should have had everyone concerned. In June 2018, RBI prohibited Paytm Payments Bank from opening any new account and wallet on account of supervisory concerns. Those prohibitions were lifted in December 2018. The next year, the Office of Banking Ombudsman issued a show-cause notice for Paytm Payments Bank’s failure to monitor a certain account maintained with it that had shown a sudden increase in the velocity of daily transactions involving immediate transfer to other banks.

These actions were found to be in violation of RBI’s provisions on KYC (know your customer) norms. In July 2021, the central bank issued a show-cause notice to PPBL for submitting false information about the transfer of an operating unit from One97 Communications to PPBL. In October the same year, PPBL was charged a Rs.1 crore penalty for contravention of the Payment and Settlement Systems Act, 2007.

From RBI’s point of view, a row of red flags was popping up: PPBL did not monitor payout transactions or carry out risk profiling of entities availing those services. In several cases, the regulatory ceiling of end-of-day balance in customer advance accounts was breached. The banking regulator also found that Paytm Payments Bank had reported a cybersecurity incident late, and had failed to implement device-binding control measures related to “SMS delivery receipt check”. The video-based customer identification by the bank also failed to prevent connections from IP addresses outside India.

In October 2023, another penalty, of Rs.5.93 crore, was imposed on the payments bank after RBI found several instances of non-compliance, once again highlighting the bank’s failures around the identification of account owners. While reports have pointed to money laundering concerns, Paytm and its management vociferously deny any such violation.

For a multifaceted platform like Paytm, could this impact all of its businesses? Paytm Payments Bank is an associate of One97 Communications Ltd that holds 49 per cent of the paid-up share capital while Sharma has a 51 per cent stake in the bank in his personal capacity. Paytm Payments Bank is also a key banking partner for Paytm. This means funds deposited in Paytm’s popular digital wallets are held with Paytm Payments Bank. The bank houses all of the parent’s 330 million wallet accounts. According to Macquarie Capital, that implies money held in them is deposited with the payments bank.

s“The bigger issue is that Paytm has not been on the good books of the regulator and going forward, their lending partners also could possibly relook at the relationships,” wrote Macquarie analysts after RBI’s action against Paytm Payments Bank.

A controversial journey

In breathtaking fashion, Sharma has leapt from one controversy to another—while continuing to get both support and funding along the way from blue-blooded financial institutions like the Ant Group, SoftBank (which has been consistently paring down its stake), Elevation Capital, and until last year, Berkshire Hathaway. Of course, after its initial public offering (IPO), scores of mutual funds hold One97 Communications in their kitty. For the December 2023 quarter, the share of foreign direct investment in the stock also increased by 5.56 per cent to 45.08 per cent.

From an alleged case of extortion and blackmail by his long-time personal secretary Sonia Dhawan to reports of a massive data breach, something Paytm denied, Sharma is no stranger to bad press. But his biggest test was the much-awaited Paytm IPOinNovember 2021. In a “code of silence”, many bankers and stock market experts agreed that the IPO was valued and priced extremely aggressively: Paytm raised $2.5 billion from the IPO, valuing it at about $20 billion. The bravado of Madhur Deora, group CFO at Paytm, saying “A higher valuation could have been achieved but we decided to price it at a level where everyone makes money” changed quickly in a post-listing debacle to “obviously the way the stock behaved...was unexpected”.

The stock was issued at Rs.2,150, got listed at Rs.1,950, then went into a relentless decline, hitting a lower circuit after recording a 20 per cent decline during trading hours. It finally closed down by about 27 per cent from its issue price. It recorded the worst first-year share plunge among large IPOs over the past decade, according to Bloomberg.

Since news of RBI’s intervention, the stock has moved in manic fashion, alternately crashing 20 per cent on a day and rising 10 per cent on scraps of potentially good news, such as a potential buyer or a sympathetic ear from the Finance Ministry. While much has been reported on the nature of the crackdown on the bank and the possible consequences, the episode is a good point to examine the role of protagonists.

In its zeal to push financial inclusion with the magic wand of technological solutions, did the central bank fail to set up enough checks and balances for such payments banks? How would depositors and users be safeguarded? Were there clear stipulations on what constituted unacceptable behaviour by payments banks? Where is the PPBL board in all of this?

Reflecting a larger problem

The other protagonist is the Securities and Exchange Board of India (SEBI). In this case, it seems to have been reduced to wringing its hands as an ineffective bystander. It has had no role to play in either the IPO pricing or in the hammering the stock has taken. This, even as venture capital firms run amok with how they value businesses in which they invest. Paytm was offered in the primary market at an eye-watering 27 times enterprise value or gross profit for fiscal 2024.

The government seems to have taken the moral high ground with thePaytm debacle. A strategic leak of a meeting between Paytm and the Finance Minister indicated that the Minister made no commitments.

Union Minister Rajeev Chandrasekhar said that being a fintech or technology company “does not exempt any entity from regulatoryoversight”. The Enforcement Directorate has said it will probe Paytm Payments Bank if any fresh charges of fund siphoning are found, but there seems to be far less alacrity to move on this than there has been to raid the homes and offices of State Chief Ministers or journalists in the recent past.

But the most important constituent in this worrying and damaging string of events is India’s entrepreneurial ecosystem. Following the RBI’s regulatory action, a group of start-up founders wrote to both RBI Governor Shaktikanta Das and Finance Minister Nirmala Sitharaman asking them to reconsider the regulatory action against Paytm’s payments bank unit. The group of founders reportedly urged RBI to reassess the “proportionality of restrictions” on Paytm considering the potential impact on the payments bank, the fintech ecosystem, and the broader economy.

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The recent string of entrepreneur-led blow-ups in the start-up community—from Ashneer Grover’s BharatPe to Byju Raveendran’s Byju’s—shows that there is much blame to be placed at the doorstep of the petulant and, in many cases, downright dishonest behaviour of many of these new-age entrepreneurs, who seem to be demanding that regulations treat them kindly since they are emerging businesses. In all fairness, RBI is a central bank with more teeth than many of its global peers, and while it is reactive in nature, protecting depositors is and should be paramount for it while addressing any financial industry anomalies.

Fond of wearing his national pride on his sleeve and posting inspirational quotes on social media feeds, Sharma has long been the poster boy for fintech entrepreneurship. A space that has been the crown jewel of “India Shining” for both the government and funders. He is a small-town boy who has admittedly built a business from scratch, with no intergenerational wealth supporting him and no friends in high places to vouch for him, particularly in the early days of Paytm. A few days after the incident came to light, Sharma re-upped an old post on his social media feed: “A hero is no braver than an ordinary man, but he is brave five minutes longer.” One hopes, for the sake of Paytm’s depositors, investors, and users, that it is now time to do what is right rather than what is brave.

Mitali Mukherjee is Director of the Journalist Programmes at the Reuters Institute for the Study of Journalism, University of Oxford.