By Indrajit Gupta and NS Ramnath
For more than three weeks now, the indignation and the diatribe launched against the Reserve Bank of India for its action against Paytm Payments Bank, has beggared belief. The primary arguments trotted out—all of it remarkably specious—is that the regulator doesn’t understand the fintech sector (and insists on unnecessarily stringent KYC norms), isn’t willing to create space for innovation in the banking sector and it tends to favour the incumbent banks.
None of this is new. In the past too, Vijay Shekhar Sharma, the high profile and maverick poster boy of India’s startup world, has made it a habit of publicly cocking a snook at the regulator. This time, the most breathtaking attack—calling the 60-year-old regulators fuddy-duddy and biassed against fintechs—was from none other than Ashneer Grover, a startup founder with a terrible reputation himself.
The gyrations in the Paytm stock have been equally intriguing. It crashed from a high of around Rs 761 before the RBI directive to Rs 325 by Feb 15, only to recover to around Rs 428 on February 26. Analysts covering the stock are a divided house. Macquarie downgraded the stock, citing low revenue, and fixed the target price at Rs 275. Jefferies stopped its coverage entirely. Goldman Sachs maintained a neutral position and set a target price of Rs 450. Bernstein, on the other hand, rated Paytm as an outperformer and fixed the target price at Rs 600.
So what explains this wide divergence?
We’d urge you to read, as we did, Paytm’s earnings call transcript from January 20, about ten days before the RBI released its directive. You’d get absolutely no hint of the impending regulatory trouble—and are likely to leave with the impression that Paytm was in the pink of health, recording eye-popping growth rates. So much so, before each of the analysts from storied global and local brokerages asked a question to the Paytm leadership, they faithfully congratulated Sharma for the company’s “great results”.
A case of wilful blindness, did you say?
[Curated and designed by NS Ramnath]
The root causes
Let’s deconstruct what’s really going on, starting with Paytm’s business model. Paytm’s secret sauce, it claimed, was its Super App strategy. It had amassed millions of users—customers and merchants. All it had to do was create a flywheel effect—a favourite startup term—through a plethora of services, ranging from ecommerce, travel, store money in the wallet, open a deposit account, pay for mobile recharge, electricity, gas, FASTag, etc.
Paytm established an early lead with the introduction of its wallet in 2014. Many of the public sector banks like SBI and private sector banks like ICICI Bank had their own wallets, but they didn’t see any value in promoting it beyond their existing customer base. However, it wasn’t until the fateful day in November 2016—when Prime Minister Narendra Modi announced demonetisation—that Paytm saw a massive jump in wallet downloads. In less than a year, Paytm doubled its customer base and set a target of 500 million by 2020 (see How Paytm went big on Indian demonetisation).
In 2017, however, the introduction of UPI turned out to be a blindspot for Sharma. UPI obviates the need for a wallet at one end. And the sizeable sum of money he had paid for the payments bank licence prompted him to pause. Besides, back then, no one knew how UPI would fare, especially since it was run by a public sector entity and people were sceptical about its ability to innovate and disrupt the fintech space. Not only did UPI grow by leaps and bounds, Paytm’s key rivals PhonePe and Google Pay cornered much of the growth.
After almost 18 months, Paytm belatedly decided to join the UPI bandwagon. Today, it has about 23% of the UPI payments space, but makes negligible money from it.
The pressure to perform was starting to take its toll on Sharma. Despite strong opposition from his key investors, he insisted on pushing through Paytm’s IPO.
On the listing day in November 2021, the stock slid from its IPO valuation of a stupendous $20 billion to $13.5 billion, making it one of the worst performing IPOs in the world.
None of its bouquet of services have set its cash registers on fire.
By February 2024, its market cap had shrunk to $3.12 billion. Here’s the upshot: none of its bouquet of services have set its cash registers on fire. Neither its wallet business nor its payments bank licence offer even an iota of margin that would offer any cheer to its investors. Plus, a digital public infrastructure like UPI made it free for users to transfer small ticket funds digitally. And it looks unlikely that users will be charged a fee for using UPI anytime soon.
For each of the services, there were already incumbents who were strongly placed. Like Amazon, which set the standard for ecommerce with its range of merchandise across categories and nation wide last mile delivery capacity. MakeMyTrip and Booking.com led the way on travel and the banks and other existing payment platforms made it easy to pay bills.
Paytm still has over Rs 8,500 crore of cash from the money it scooped up from marquee investors like SoftBank, Ant Financial and Berkshire Hathaway, all of whom have exited the company. (Its cash hoard means, said an analyst, that Paytm stock will have a floor of Rs 170.)
Starting sometime in 2022, Paytm did find a ray of hope though: to sell large volumes of small ticket personal loans to its customers and merchants in a jiffy. It signed partnerships with NBFCs and banks like Aditya Birla Finance, Hero Fincorp, Shriram Finance, Poonawala Finance and Piramal Finance. Most of these NBFCs do not have any real competence in digital lending or a digital platform of their own. On the other hand, Paytm had a robust app and technology and a wide customer base. It could therefore cross-sell loans to its Paytm Payments Bank customers and merchants. And it was able to wrangle mouthwatering spreads of 15-20% for sourcing loans for its lending partners and helping with collections. It seemed like a veritable gold mine. Except for a fly in the ointment: its lax know-your-customer (KYC) norms.
On the surface, Paytm seemed to make the right decisions. Its Payments Bank used Finacle, a banking product from Infosys, which counts State Bank of India among its customers. However, in the back end, one of its former tech partners from Infosys who worked on Finacle for Paytm affirms that the firm asked them to remove several key filters so that Paytm wouldn’t face any constraints in onboarding customers digitally and demonstrating scale.
Establishing the identity of the customer and his current location was a tricky issue. While Aadhaar could validate identity, it wasn’t useful as address proof. And there were enough instances of PAN being blatantly misused to open Paytm Payments Bank accounts, leading to several cases of online fraud.
There were two obvious fall-outs of a lack of a rigorous KYC system. Around early December 2021, a senior executive at a leading global online payment platform says, they witnessed a set of merchants gaming their system by registering fictitious accounts and using them to dupe customers. When they began studying the patterns, they found that in 90% of the cases, merchants had a Paytm Payments Bank account. After observing the pattern for a few weeks, they decided to stop onboarding any merchant with a Paytm Payments Bank account. The rationale: given the plethora of banking options, no merchant would willingly sign up with Paytm Payments Bank, unless they did so because of the lower KYC norms. In the end, it made no difference to their volumes, but helped eliminate the risk of fraud.
Similarly, at SBI, a former deputy managing director says she saw umpteen cases of frauds live at the bank’s fraud detection cell in 2019. Again, almost 90% of the cases were linked to Paytm Payments Bank accounts. “We couldn’t do much to stop it either. The customer would not believe us when our agents said they were calling from SBI. We could literally helplessly watch money being withdrawn from our customer accounts and not be able to do anything about it,” said the same executive.
While a RBI report last year says that overall digital frauds may have come down from Rs 59,816 crore to Rs 30,252 crore, this could well be a gross underestimate, since many such cases go unreported by both customers and banks, avers the same senior banker from SBI. Hence the RBI has asked banks to report all frauds, not just those above Rs 1 lakh.
Now, while there is enough hoopla about using algorithms to determine credit worthiness, the fact is that managing collections is a real challenge in the Indian environment.
There were initial concerns that the digital lending process was opaque. Since approvals were often done in a few minutes, customers often did not know the identity of the lender—and believed it was a loan provided by Paytm. Plus, the fact that the interest rates on the Paytm enabled loan was significantly more expensive as well. All along, in its engagements with the regulators and its lending partners, Paytm insisted that the KYC norms had to be whittled down, keeping in mind the customer expectations of speedy approvals in the digital lending space.
On its part, RBI tightened the norms—but it was a cat-and-mouse game. Paytm and its lending partners would figure out new ways to pad the pricing of the loans, use the digital lending default loss guarantees and huge growth in new loans to mask delinquencies.
The small ticket size, coupled with lack of proper address proof, also makes it tough to recover bad loans. Besides, the credit market began to overheat, with the same customers getting access to multiple fast, easy loans, often using fake PAN cards. The RBI sensed this growing stress and clamped down on personal, unsecured loans by increasing the risk weight ratios and unveiling digital lending guidelines that would curb unchecked growth in digital lending. By the end of last year, Paytm’s one trick pony had almost come to a halt. And immediately after the January 31 RBI directive, its major lenders like Aditya Birla Finance simply stopped funnelling small loans through Paytm, citing reputational risk.
Given the heat from RBI, it is unlikely that these NBFCs will muster up courage to lend through Paytm for a while. In any case, the spreads for a direct sales associate in the digital lending space will continue to narrow. As a marketplace, Paytm will be expected to offer its customers the option of choosing from a selection of lenders, not an opaque, exclusive deal with a lender. That will eat away all the super normal margins that had the analysts salivating.
What the future holds
Two developments took place on February 26. One, RBI asked NPCI to allow Paytm to partner with 3-4 nodal banks and thereby facilitate payments for its merchants and customers. While that might help restore its operations, the regulator is unlikely to offer much more wriggle room for the fintech venture.
Two, Sharma resigned from the board of Paytm Payments Bank.
Whether that opens up room for an amicable resolution between RBI and the payments bank remains to be seen, especially given the history of Sharma’s run-ins with the regulator.
“We weren’t sure he understood what regulation meant—and how to engage with us in a serious manner.”
Sharma has repeatedly misled the regulator and flouted rules. A former senior general manager at RBI puts it down to Paytm’s founder’s excessive reliance on brinkmanship. “It is hard to believe anything he says. He would agree to do a few things that we would point out to him. But by the next meeting, none of those changes would be made,” he said. On occasion, he would even shed crocodile tears in the meeting with RBI, with tears running down his cheeks. And just five minutes later, he would be laughing loudly and smiling outside the room. “We weren’t sure he understood what regulation meant—and how to engage with us in a serious manner.” Sharma believed he was fully capable of saving the day, even when he was on the precipice. In many ways, he became his own biggest enemy.
Now, even the regulators themselves and his own employees say Sharma was always buzzing with ideas. He was passionate about problem-solving and loved to encourage his people to remove friction for customers. He clearly understood business risk and was willing to throw money to find technological solutions. The Sound Box designed to cut out fraud, was one such solution. Yet he was also a bit like an errant school boy, straining at the leash, unable or even unwilling to understand compliance risk. “So if he eventually decides to shoot himself in the head, there’s very little we can do,” says the same former director on the RBI board.
After multiple warnings and penalties, RBI’s patience finally snapped. They had had enough.
Strangely, another top banker at RBI said that during their run-ins with Paytm Payments Bank, no one from the bank, other than Sharma would visit the RBI. The trouble was that Sharma claimed he had an arm’s length distance from the bank and did not have a fiduciary role at the RBI regulated entity, other than being the single largest shareholder—with 51% stake—through his ownership of One97. As a result, RBI was unwilling to discuss any specifics with Sharma. Why Sharma would do this is unclear. In fact, even at the hurriedly convened analyst call the next day after the RBI announcement, Sharma, who joined from London, claimed he did not know the specifics of the momentous RBI directive since he wasn’t involved with the functioning of the bank.
Yet, insiders say that the concept of an arm’s length distance is far from the reality. No decision inside Paytm can be taken without Sharma’s approval. He is as hands-on as it gets, they say. He likes to get into every decision, including even the colour of a button on the Paytm app. He is CEO and CTO, all rolled into one.
There were initial efforts to slow down this mad scramble to ramp up customers and merchants when Shinjini Kumar joined as CEO of the Paytm Payments Bank in March, 2016. Kumar had three decades of experience at BankAm, Citi and RBI. She advised Sharma to take a more measured approach to growth. “At that meeting, when Sharma heard such advice from Kumar, he would turn around and tell her to step aside if she was unable to get things done. And that he would handle it himself,” said a former Paytm insider, who worked there from 2016 to 2022.
Bringing in bankers like Shinjini Kumar would have helped bring discipline and a method to the madness inside Paytm. Kumar lasted for a year and four months.
Next in line was Sharma’s trusted HR colleague Renu Satti, She had worked with him from the get go. The decision sent shockwaves across the organisation. “She had no banking experience whatsoever. She was efficient. And trained by Vijay and handpicked by him,” said the same insider.
During that time, the pressure to ramp up and scale began to tell on Satti. She clinically set up a huge network of feet-on-the-street executives to activate the merchant network. Before the close of every quarter, these executives would get merchants to make a large number of transactions of Re 1 to show that the merchants were active. “I would see this long list of Re 1 transactions. I soon figured out what was going on to game the system and share metrics with the board and investors,” said the insider.
The same scenario played out in compliance as well. A senior compliance officer said he prepared a set of slides on compliance before the board meeting, but was told to take them out from the deck before the meeting. There was no need to share data with the board on compliance, he was told. Strangely, while Shinjini Kumar quit the bank in 2017, she later joined the board in October 2021 as an independent director, before resigning earlier this month.
Of course, there’s been considerable chatter about Sharma’s run-in with the RBI. What’s not fully understood is that RBI has a sharp sense of what causes systemic risk. Its periodic audit reports are often able to identify patterns before things actually blow out. Even at the best of times, the decision to exercise regulatory action is based on judgement, said a former director in the RBI board. “Even in the Yes Bank case, when we did a post mortem, we felt we were late in acting to replace the existing management,” he said. Unlike the Yes Bank case, once they realised that their directives were repeatedly falling on deaf ears, RBI took a calibrated approach. While suspending Paytm’s operations and disallowing any further onboarding and activation of customers, RBI made sure Paytm customers and merchants would be given adequate time to move to another wallet, in case they so wished. Paytm has also been allowed access to another nodal account from a bank or a set of banks, other than Paytm Payments Bank, whose licence stands terminated.
The conflict between regulation and technology
There are two main arguments that have been put forward in the public domain to challenge RBI’s strong actions. One, that this RBI move will stymie inflow of venture capital funding into the country—and impact the startup space in India. Shortly after RBI’s strictures, a story in Moneycontrol said a group of startup founders, including Murugavel Janakiraman of Bharat Matrimony, Deepak Shenoy of CapitalMind, Ritesh Malik of Innov8, Vishal Gondal of GOQii, Yashish Dahiya of PB Fintech and Rajesh Magow of MakeMyTrip, wrote to Prime Minister Narendra Modi, FM Nirmala Sitharaman and the RBI governor asking for RBI sanctions against Paytm to be rolled back.
On its part, RBI has seen this tussle between private capital and public good play out in the previous decade.
More than a decade ago, RBI had seen a similar blowout in the microfinance space. Sensing an opportunity to build up enormous valuations and an humongous IPO, a clutch of private equity investors ploughed in sizeable funds into SKS Microfinance. SKS used modern retail banking techniques to scale up doorstep credit to poor families in rural India, leading to accusations of over-stretching, rural indebtedness and mission drift, in favour of profitability and investor targets.
Digital lending is the next big thing for investors. And Paytm’s sheer scale has potential lending partners all excited. Unless properly regulated and a clear focus on consumer protection, there’s another chance of an MFI-like blowout in the works.
“RBI keeps two core values close to its heart. One is consumer protection, and the other is managing systemic risk. Their priority is not fostering innovation."
Two, there’s a persistent argument that RBI has been heavy-handed in its dealing towards fintechs and ended up throttling innovation in the sector. Nothing can be further from the truth. As a regulator, RBI has laid down clear rules for players to follow. “RBI keeps two core values close to its heart. One is consumer protection, and the other is managing systemic risk. That's what they do. Their priority is not growing the fintech ecosystem, or fostering innovation. They still do it because if the innovation happens in the right way, it'll help both core values—it will reduce systemic risk and benefit the end customer. But, protecting the two is, to them, a higher priority,” Sahil Kini, co-founder and CEO of Setu, a fintech venture (currently a part of Pine Labs), told us for an earlier special report on fintech.
And when there is ambiguity about rules, the regulator is often available to informally guide players on how to navigate the new terrain. Other responsible fintech players, who don’t believe in playing fast and loose, aver to this. They say RBI is patient and thoughtful at most times.
So why should Paytm expect to be treated differently?
Interestingly, the same Moneycontrol story quoted above, said:
“The letter has garnered a lukewarm response from the wider Indian fintech and startup ecosystem. At least four founders Moneycontrol spoke to said they opted to stay away as they saw this as a Paytm-specific issue and didn't want to rub the regulator the wrong way.”
Founding Fuel also heard the same refrain from The Indus Entrepreneurs (TiE). A senior functionary there said they refused to join hands for more or less the same reasons. “We are committed to supporting startups. Paytm is no longer a startup. And this isn’t an industry-wide issue. Just one errant player that failed to abide by the rules.”
(Our message to Vijay Shekhar Sharma went unanswered.)
(A shorter version of this column was first published in Business Standard)
Dig Deeper
A Fine Balance (By NS Ramnath. Founding Fuel FinTech Special Report, August 2023)
