Explained | RBI orders Paytm’s banking arm to stop fresh business. What happens next?

India's central bank - the Reserve Bank of India (RBI) - on Wednesday (Jan 31) ordered Paytm Payments Bank (the banking arm of Paytm) to stop accepting fresh deposits in its accounts or popular wallets from March. In a statement, the RBI said that Paytm Payments Bank will not be allowed to take further deposits in any customer accounts after Feb 29, and no credit transactions will be allowed either, including via wallets.

Paytm Payments Bank is an associate of One 97 Communications. On Thursday, Paytm said in a statement that it will take steps immediately to comply with the central bank's directions. One 97 will cease working with Paytm Payments Bank and start working only with other banks, it said.

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The RBI's decision is a major blow to Paytm - which is one of India's largest payment firms.

What is Paytm Payments Bank?

Founded in 2017, Paytm Payments Bank is 49 per cent owned by Paytm and 51 per cent owned by Paytm's Chief Executive Officer (CEO) and founder Vijay Shekhar Sharma. The payments bank acts as a key banking partner for Paytm. For example, funds deposited in Paytm's popular digital wallets are held with Paytm Payments Bank.

The payments bank may accept small deposits of up to $2,400 (around Rs 2,00,000) but is not allowed to lend. Deposits must be parked in government securities or deposits at other banks.

Citing Macquarie Capital, the news agency Reuters reported that the bank houses all of the parent's 330 million wallet accounts, meaning money held in them is deposited with the payments bank.

The actions taken by the RBI are under a provision of banking regulations that allow the regulator to give directions to a bank in the interest of depositors.

What led to the RBI's action?

In its statement, the RBI said on Wednesday, "The Comprehensive System Audit report and subsequent compliance validation report of the external auditors revealed persistent non-compliances and continued material supervisory concerns in the bank, warranting further supervisory action."

Issuing directions to the bank, the RBI said, "No further deposits or credit transactions or top-ups shall be allowed in any customer accounts, prepaid instruments, wallets, FASTags, NCMC cards, etc. after Feb29, 2024, other than any interest, cashback, or refunds which may be credited anytime."

"Withdrawal or utilisation of balances by its customers from their accounts including savings bank accounts, current accounts, prepaid instruments, FASTags, National Common Mobility Cards, etc. are to be permitted without any restrictions, up to their available balance," it added.

In March last year too, Paytm Payments Bank was restricted from adding customers but continued doing business with existing customers. However, it has now been told to wind down most of its businesses this month.

Paytm shares plunge post RBI's action

Agreeing to comply with the RBI's directions, Paytm said on Thursday it expected a worse-case impact of Rs 3 billionto Rs 5 billion to its annual earnings before interest, tax, depreciation, and amortisation (EBITDA).

Following the central bank's move, Paytm shares plunged the daily limit of 20 per cent on Thursday which could be a precursor to its license being cancelled, a source told Reuters.

The source said that RBI's action (against Paytm) followed years of non-compliance with central bank rules, including on customer due diligence, use of funds, and technology infrastructure.

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Paytm's stock is trading at less than one-third of its listing price of Rs 1,950, despite having climbed 20 per cent last year. With Thursday's plunge, the shares are down more than 4 per cent this year, Reuters reported.

Shekhar Sharma lost about $233 million on Thursday as the shares cratered.

Paytm was founded by Sharma in 2010 and rose to fame after Uber made it a quick payment option in India. Paytm saw an unprecedented demand in 2016 after the Modi government introduced demonetisation, which led to a major shift from cash to digital payments.

The impact

So what would be the impact of RBI's decision? According to Jefferies, Paytm's business impact will largely come from reputation concerns arising from governance or compliance, and the path to resolution will be from better compliance with regulations.

Jefferies further downgraded Paytm's stock to "underperform" from "buy", slashing its target price to Rs 500 from Rs 1,050 and saying regulatory and reputational issues could affect profitability.

Meanwhile, JPMorgan cut Paytm's rating to "underweight" from "neutral", lowering its target price by one-third to Rs 600.

"While we don't believe that the order is an end of the road for Paytm, it materially impacts near-term growth, profitability forces another pivot and necessitates it to restore the credibility of the durability of the business," JPMorgan analysts said.

(With inputs from agencies)