On January 31, 2024, the RBI issued a press release which raised many eyebrows. Not only did the central bank order intend to bring almost all activities of Paytm Payments Bank (PPB) to a standstill after a month, it also made it impossible for the bank to function. The question this raised was: why did the RBI take a circuitous route to make PPB down its shutters instead of cancelling its banking licence outright?

The central bank clearly did not have sufficient grounds to cancel the banking licence of PPB. According to rules, a banking licence can be cancelled only if “the company ceases to carry on banking business; or is unable to pay its present or/and future depositors; or carrying on banking business by the company is detrimental to the public interest or to the interest of its depositors.” None of these seem to apply to PPB.

But why did it become imperative for the central bank to make PPB stop its operations? The RBI press release did not state the exact reason for this action and stopped with stating that the systems audit and compliance validation report had found, “persistent non-compliances and continued material supervisory concerns.”

There have been a bevy of news reports over the past week about possible reasons behind the action including – improper KYC, fake IDs and mule accounts created to do money laundering, large number of inoperative wallets, and so on.

But though the recent release was silent on the transgressions of Paytm Payments Bank, other RBI orders directed at the bank have spelt out its misdoings quite plainly.

Past offences

PPB has been a repeat offender and has faced RBI’s wrath several times since its inception in 2017. It needs to be accepted that the central bank has given PPB a long rope so far, given the nature of its wrongdoings.

At the heart of the matter is on-boarding new clients without proper KYC checks. Now, there could be two reasons for not collecting proper documents while on-boarding clients. One, it could be done with a view to show a large accretion in customers. There was a mad rush in the first year with all major payment banks bending the rules to add customers. It may be recalled that in March 2018, Airtel Payments Bank had been slapped with a penalty of ₹5 crore for opening customer accounts without their consent. Fino Payments Bank and Paytm Payments Bank had been similarly told to stop on-boarding new clients in 2018, though the order was revoked subsequently.

The other reason for inadequate KYC checks can be more serious — to facilitate creation of fake accounts and IDs through which money trail can be hidden or money laundering can be done. There are indications that Paytm Payments Bank accounts and wallets were being used for these illegal purposes.

Why digital wallets?

Digital wallets may have helped in speeding digitisation of payments in the initial years, but as UPI based payments gained ground, usage of wallets has been declining. But Paytm wallets have continued to increase in number and usage.

One97 Communications, the parent of Paytm Payments Bank, was among the first movers in the digital wallet space, garnering a lion’s share in the wallet space. It transferred the entire wallet portfolio to PPB. The bank was also used by One97 Communications to house the deposits linked to the wallet and the nodal account used for merchant transactions.

According to RBI, as of December 2023, there were 142.9 crore wallets issued. Paytm Payments Bank had 62.8 crore of these wallets, accounting for 43 per cent share. What’s more, PPB added 11 crore new wallets between March 2022 and December 2023, which amounted to 76 per cent of the incremental growth in mobile wallets in this period. In other words, Paytm Payments Bank was driving the growth in digital wallets in recent years.

The sterling growth in UPI QR code based transactions has made usage of mobile wallets less popular in recent years. But one area where wallets can be particularly useful is when money trail needs to be hidden. This is possible in wallet-to-wallet transactions. As far as share of PPB in fund transfers using wallets go, it had 78 per cent share in December 2023.

Misuse of payout

Paytm Payments Bank also appears to have facilitated creation of accounts where the beneficial owner was intentionally hidden and these accounts were being used to move funds overseas. This is obvious in RBI’s order to PPB in October 2023, when the bank was fined ₹5.39 crore.

The reasons given by the RBI then were — “(i) it failed to identify beneficial owner in respect of entities on-boarded by it for providing payout services, (ii) it did not monitor payout transactions and carry out risk profiling of entities availing payout services, (iii) it breached the regulatory ceiling of end of the day balance in certain customer advance accounts availing payout services, (iv) it reported a cyber security incident with delay, (v) it failed to implement device binding control measure related to ‘SMS delivery receipt check’ and (vi) its Video Based Customer Identification Process (V-CIP) infrastructure failed to prevent connections from IP addresses outside India.”

Payout services are used by businesses to make large payments to their vendors, customers or employees through a digital payment gateway. These payments can also be across the border. As the RBI’s order above says, entities which Paytm Payments Bank on-boarded for using payout service could have been shell companies or mule accounts for laundering money and sending it overseas.

There seem to have been serious concerns in the operations of Paytm Payment Bank and the RBI seems to have taken the right step in restraining its operations.