Payments bank model flawed, prone to risk

The recent fallout of the Paytm crisis exposes some inherent flaws in India’s evolving fintech industry, which needs an urgent course correction for maintaining stability in the sector. Dichotomous as it may sound, while UPI has remained insulated from headwinds, Paytm as one of the main user platforms has found itself in troubled waters with a significant erosion in market value.

Unlike VISA, which also acts as a payment gateway, Paytm’s unusual and perhaps controversial structure as “payment bank” exposes it to several governance risks not oblivious to conventional banks.

As India achieves a rising economic stature, it is inevitable to see zealous individuals and vested institutions using a new route in payments bank as a novel way to allegedly launder money on the assumption of low risk attributable to less stringent regulatory oversight.

The combination of technology and governance holds the key in instilling confidence in India’s fledgling fintech sector.

As UPI continues to capture new markets including France, Mauritius, Sri Lanka and the UAE, the world at large will be keenly monitoring the resilience of India’s payment infrastructure with episodes like Paytm fiasco unlikely to boost confidence.

In an era where sanctions have become a norm, there has been a jostling of sorts in rolling out alternative payment infrastructures from the likes of UnionPay from China to UPI from India with a dual objective: first, to challenge dollar’s hegemony by pushing a payment system far and beyond domestic frontiers; and second, to subtly subvert international coalition’s ability in the foreseeable future to impose sanctions aimed at choking the domestic economy by cutting access to international financial markets; largely dominated by the dollar.

Exogenous shocks

It doesn’t come as a surprise in the post-sanctions era that both Iran and Russia, despite inevitable economic headwinds in the immediate aftermath of imposition of sanctions, have now gained a large degree of insulation from the exogenous shocks imposed by the West.

The complexity of international payment infrastructure gets further blurred as China is still viewed as a neutral actor with an active trade both with the West as well as its ideological partners operating under the shadow of international sanctions.

Even as UPI remains unscathed, the Paytm crisis should prompt policymakers to initiate necessary course corrections.

First, the entire concept of payments bank initiated during the tenure of former RBI Governor Raghuram Rajan needs to be revisited as it simply doesn’t provide sufficient rationale for payment providers to double-up as banks by accepting deposits without the mandate for lending. The model is prone to significant risk in the absence of recovering the cost of deposit, skewing the balance sheet negatively.

As a consequence, from an asset-liability management (ALM) perspective, it is too risky a business model with significant scope for dubious players and vested interests to conveniently park unaccounted wealth as deposits. There is no international precedent for payments bank, and much to the chagrin of the regulators, the model has simply failed to live up to its expectations.

It may not come as a shock if Paytm presents only the tip of the melting iceberg of payments banks, mandating an imminent forensic audit of all the players in the scene.

The international competitor of Paytm, Paypal, continues to play its bread and butter role as a payment provider without engaging in any exotic banking product.

It would take some time before UPI can compete with the likes of VISA. In such a scenario, policymakers would do well to further popularise the usage of UPI within the domestic frontiers and rescind the concept of payments bank. India may well have emerged, but there is still some time before it has finally arrived. Until then, let’s set our own house in order.

The writer is Assistant Professor of Finance, EBS Dubai. Views are personal

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