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The recent RBI action against Paytm Payments Bank has sparked widespread discussion and speculation on the reasons for regulatory action, Paytm share price and Paytm’s future strategy to deal with the restrictions. In a sense, this action is not appalling considering the previously issued regulatory warnings to the Paytm Payments Bank, triggered by the ‘inconsistencies’ in compliance. The banking regulator in India is often commended for its timely actions against delinquent institutions. However, in Paytm’s case, this action has scandalized the public due to their familiarity with the Paytm mobile wallet and because of Paytm’s large market share in the digital banking segment.

The on going discussion neglects the fundamental issues— a larger concern about the raison d’être of payments banks and whether Paytm and counterparts meet the goals that led to their establishment.

The Paytm Mobile Wallet is widely used in India for all types of transactions. It is not clear whether the regulatory ban is on activities of payments bank or also on the mobile wallet. Paytm mobile wallet is different than the Paytm Payment Bank. Mobile wallet needs to be linked to a bank account for transactions. It doesn’t accept deposits and isn’t a ‘bank’ but serves as a digital link between bank accounts.

Contrary to the Paytm mobile wallet, Paytm Payment Bank accepts small deposits, and offers payment services to the public. A Paytm wallet user may not have a Paytm Payment Bank account. Payments Banks, is  a relatively recent addition to India’s banking sector. Unlike commercial banks, Payments banks are restricted in their banking operations and have limited functions, including deposit acceptance, payments, and remittance.

The raison d’être Payments Banks:

The concept of Payment Banks were proposed by the Nachiket Mor committee, specifically the “Committee on Comprehensive Financial Services for Small Businesses and Low-Income Households(2014).” It aimed to offer inclusive financial services to marginalized segments without compromising financial stability or commercial banks’ profitability. The committee emphasized the often overlooked risk and cost-to-serve aspects in financial inclusion strategies.

To mitigate the over-reliance of the financial inclusion policy on scheduled commercial banks, which led to high-risk portfolios and costly infrastructure, a conceptual separation between lending and payments activities was introduced. However, payments banks in India have sparked controversy since their establishment, with various issues undermining their original envisioned purpose.

Skewed market structure:

Out of the 11 entities approved by the RBI, five surrendered their licenses, leaving six surviving companies—Airtel, Paytm, Fino, India Post, Jio, and NSDL Payments Bank. Among them, the Indian Postal Payments Bank is state-owned, while the remaining five are private entities. All private payment banks are owned by telecomm giants, except for Fino, which has evolved from Fino Paytech, with a track record of providing  banking services for the micro-segment. As of December 2023, NSDL and Fino are the top performers in the Micro ATMs sector. On the other hand, Paytm dominates the PoS and e-commerce transactions market, with a market share higher than the combined total of the remaining five competitors. Recently Payments Banks are allowed to act as the  small finance banks. The speculation about Jio Payment Bank  marching ahead with Paytm’s fall is making rounds. However, the question remains: with only six banks and a negligible market share in payment transactions, will the payment banks be successful in meeting their purpose and achieving financial inclusion goals?

Limited success: The Payment Banks business model presumes a high-volume, small-size, low-cost business, relying on digital technology and leveraging ‘business correspondent’ networks. These banks are permitted to invest and borrow in the money market for liquidity and returns. However, the segment has booked consistent net losses since its establishment. For instance, according to the RBI data the net loss of payment bank sector was  Rs 517 Cr in 2018, increased to 932 Cr in 2019. Though the losses reduced in 2022 to  132 Cr in 2022, the Payment banks still face sustainability concerns due to lending restrictions and fee-based revenue with stagnant deposit base. In December 2023, the Micro ATMs by the Payments Banks together were 43% of the total Micro ATMS by the banking sector. The debit cards issued by the Payment Banks were just 6% of the total debit cards, online-ecomm transactions are just 3% of the total, while PoS transactions are less than 1% of the total. Studies show that payment banking service adoption among non-tech-savvy customers is miniscule. Due to the outreach of Jan Dhan, Aadhaar enabled payments system and mobile wallets, the payments banks have lost their appeal.

Broader concerns and profound effect:  The regulatory action against Paytm Payments Bank prompts broader concerns regarding the efficacy of the Payment Banks segment. Back in 2014, the report envisioning these banks states that the “very energy driving financial inclusion policy has been a weakness, as regulators shift from one idea to another, whether it be cooperative banks, nationalization of banks, self-help groups, regional rural banks, or business correspondents.” Ironically, the payments banks are now at risk of being just another evasive idea included in this series of institutions for financial inclusion.

As new types of institutions and unconventional banking practices emerge due to the rise of digitalization and fintech, the role of the regulator becomes increasingly complex. In this scenario, the regulatory action, incidentally well-publicized, serves to instil confidence among the public. It can be seen as a regulatory ‘announcement effect,’ cautioning the fintech sector against complacency. Additionally, it assures the public of the regulator’s commitment to safeguarding their interests, encouraging use of digital financial services and financial inclusion. the use of digital financial services, and promoting financial inclusion.

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