[By Manav Pamnani & Teesha Arora]
The authors are students of NALSAR University of Law, Hyderabad and Symbiosis Law School, Pune respectively.
Introduction and Background
In a recent move, the Reserve Bank of India (RBI) has imposed restrictions on Paytm Payments Bank, prohibiting it from accepting fresh deposits in its accounts, facilitating credit transactions, and offering fund transfers, including the Unified Payment Interface (UPI) facility, after March 15, 2024. This has emerged in light of the multiple violations on the part of the bank to meet the regulatory requirements and directions given by the RBI.
Paytm Payments Bank, an associate of One 97 Communications Limited (OCL), is an Indian Payments Bank founded in 2017. It is a part of the financial network of one of India’s largest payment companies, Paytm. In fact, on October 7, 2021, it was officially added to the second schedule of the RBI Act of 1934. In its press release on March 11, 2022, the RBI directed the Paytm Payments Bank to stop onboarding new customers. It further added a condition that such onboarding would only be permissible if the bank appointed an Information Technology (IT) audit firm to conduct a comprehensive system audit of its IT system and if, after a thorough review, the audit report seemed satisfactory. This audit report would comprise compliance checks with reference to Section 43A and Section 79 of the IT Act. The reason for ensuring compliance with the aforementioned provisions of the IT Act can be inferred from the preamble of the Act itself which lays down its objective, which is to facilitate lawful digital transactions while mitigating cybercrimes and other potential non-compliances. Since the operations of Paytm involve digital transactions and storage of data, these provisions become relevant. In this regard, Section 43A deals with compensation for failure to protect data. It requires a body corporate to uphold acceptable security standards and procedures while managing, dealing with, or having any sensitive personal data or information on a computer resource that it owns, controls, or manages, failing which, it would have to compensate the affected people who have incurred wrongful loss. On the other hand, Section 79 encompasses an exception, according to which, intermediaries may be immune from liability if they operate as mere middlemen in the transmission, storage, or exchange of third-party information or data.
The audit report, however, indicated persistent non-compliance on the part of the bank coupled with material supervisory concerns. It reflected that lakhs of accounts had not followed the mandatory Know Your Customer (KYC) procedure. Adhering to KYC guidelines is non-negotiable due to the significant purpose it serves which mainly includes verifying the identities of customers in order to prevent money laundering activities. The omission on part of Paytm thus violated Section 12 of the Prevention of Money Laundering Act, 2002 which mandates the verification of the identities of clients before entering into financial transactions. The importance of the KYC procedure leads financial institutions and conventional banks to strictly follow it. In the given case, since Paytm has repeatedly violated this crucial norm, RBI’s clampdown is justified. The exacerbating factor in this case is that the transactions in the non-KYC accounts exceeded millions of rupees, far beyond the prescribed regulatory limits, as specified in the Reserve Bank of India (Know Your Customer) Directions, 2016.
Moreover, over a thousand users had the same Permanent Account Number (PAN) linked to their accounts which further raised money laundering concerns. This led the RBI to utilise its power under Section 35A of the Banking Regulation Act, 1949 and issue the aforementioned directions. It also passed an order on October 10, 2023, imposing a monetary penalty of rupees 5.39 crore on Paytm Payments Bank for breaching the several regulatory requirements.
Justification of the Action in light of Section 35A of the Banking Regulation Act, 1949
Section 35A of the Banking Regulation Act provides for the power of the RBI to give directions. This power extends not only to specific banking companies in cases of non-compliance but also to general guidelines or circulars issued in interest of the overarching banking framework. For example, in 2016, the RBI issued the Master Directions on Fraud to consolidate and update seven earlier circulars on the classification, reporting and monitoring of fraud. Thus, the power enshrined under this section has a wide ambit and can be utilised in any scenario right from breaches pertaining to banking norms to introducing guidelines or amendments to upkeep the integrity of the banking sector. In this regard, Section 35A states, “(1) Where the Reserve Bank is satisfied that – (a) in the public interest; or (aa) in the interest of banking policy; or (b) to prevent the affairs of any banking company being conducted in a manner detrimental to the interests of the depositors or in a manner prejudicial to the interests of the banking company; or (c) to secure the proper management of any banking company generally, it is necessary to issue directions to banking companies generally or to any banking company in particular, it may, from time to time, issue such directions as it deems fit, and the banking companies or the banking company, as the case may be, shall be bound to comply with such directions.” This implies that the RBI has the power to issue such directions if any of the three conditions specified in this Section are met. These conditions are disjunctive, and even if only one among them is fulfilled, the RBI can utilise this power. The present situation entails an overlap of all the stated requirements. Adherence to the regulatory requirements and guidelines is paramount to the effective functioning of the financial ecosystem, and any form of deviance affects the confidence of the investors and affiliated business entities, thus negatively affecting the public interest. Non-compliance also indicates that the management of the banking company is not being conducted properly. Therefore, since the conditions mentioned in this Section (at least one) are fulfilled, the utilisation of the power prescribed is justified.
However, Clause 2 of this Section further states, “The Reserve Bank may, on representation made to it or on its own motion, modify or cancel any direction issued under sub-section (1), and in so modifying or cancelling any direction may impose such conditions as it thinks fit, subject to which the modification or cancellation shall have effect.” This implies that the decision taken by the RBI has not attained finality and might be altered, especially in light of the recent representations made by Paytm Payments Bank, contesting the direction by stating that the regulatory compliances had been followed. However, even if these representations are accepted, the RBI can impose any conditions it deems fit. The powers granted under Section 35A are not arbitrary because of the significant role of the RBI in acting as the financial regulator of the economy. The correct utilisation of these powers is necessary to ensure a healthy financial ecosystem with sufficient safeguards, minimum non-compliances, and reduced misuse of any potential loopholes in legislations with an effective regulatory mechanism in place.
Potential Impact of the Decision
The sudden changes brought about by this decision will impact a large number of people but not to their disadvantage. The RBI had meticulously fixed the time frame within which transactions had to be settled. It had given a buffer period of around a month, within which Paytm Payments Bank had to make adequate preparations not to accept deposits and undertake ancillary activities. It had further allowed a period of around fifteen days, up to March 15, 2024, to settle all the transactions executed before the end of February. This meant that interests, cashback, and refunds could be processed until this extended period, thus ensuring that the account holders get their respective share of proceeds without depriving them of any benefits. The reason behind introducing such a flexible schedule is to ensure that no prejudice is caused to any customer. However, despite the organised planning, inevitable drawbacks are bound to occur. Paytm Payments Bank has several associated services, most of which have ceased to operate after the end of February. These include Fastags, fund transfers, Bharat Bill Payment Operating Unity (BBPOU), and National Common Mobility Cards (NCMC). These services alongside the loans offered by the bank formed its core operating and income-generating activities, the prohibition of which is a major blow to the bank’s key revenue streams. Additionally, although the withdrawal facility had been permitted up to February 29 to enable customers to withdraw funds safely, the sudden disruption in several services has caused inconvenience and uncertainty. This is because the accounts will have to be deactivated, forcing customers to seek another bank to deposit their funds. This will require a completely new verification procedure, with customers being mandated to initiate and complete the KYC requirements all over again. These processes will also include convenience charges, which have to be borne by the depositors themselves. These monetary charges exclude the efforts that the account holders would have to invest and the time that they would have to spend. It is not only the beneficiaries who will be prejudiced by this RBI decision but also the investors who have suffered an estimated loss of rupees 17,500 crore. This is because the listed equity shares of Paytm and its associates have plunged drastically, forcing investors to withdraw their money.
On a larger scale, this non-compliance will result in the escalation in vigilance from regulatory bodies, including tax authorities which will aim at ensuring robustness in financial transaction monitoring and reporting mechanisms enshrined under Sections 139(1), 271, 272A of the Income Tax Act, 1961 which deal with filing income tax returns, non-compliance with mandatory provisions like filing returns, adherence to notices, and concealment of income, and penalties for related offences like failure to furnish information, allow inspections, answer questions and so on, respectively. The resultant disruption in digital payment services may also necessitate recalibrations in tax policies to accommodate evolving payment modalities. Tax authorities may increase their efforts to ensure transparency in financial transactions and reporting, including cross-referencing banking data with tax filings to identify discrepancies. The benefits accrued to public interest and the financial ecosystem as a whole will thus eventually outweigh the drawbacks suffered by depositors and investors. The strict enforcement of financial norms by the RBI will serve as a precedent for future lapses, strong enough to deter potential defaulters from indulging in such fraudulent and negligent activities. This will help preserve integrity and fairness and uphold the idea of a strong financial system as one ensuring adherence to all regulatory and supervisory mechanisms.
Future Prospects and Conclusion
The penalty collected from Paytm Payments Bank can be effectively utilised by the RBI to minimize the difficulty faced by the account holders and the losses incurred by the investors. Although this is impractical and has its own administrative and technical challenges, a sincere attempt on the part of the RBI could mitigate the hardships caused to several people. This amount collected can also be utilised for spreading awareness and educating people about the intricacies associated with regulatory compliances and the importance of adhering to statutory norms. While the future prospects of Paytm seem grim, OCL, on February 1, 2024, informed stock exchanges that such a direction would not affect the operations of Paytm. It will, at most, cause a loss of around 300-500 crore rupees to Paytm without hampering the interests of the stakeholders. This is because Paytm will move to other banks to continue providing services with loans, insurance and broking remaining unaffected. Such an optimistic approach predicts a positive outcome, which is unlikely. The reason for this is that the financial statement of OCL presents a very different picture. Despite gradually moving towards profitability, OCL in the latest quarter reached an increased Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) profitability of merely 31 crore rupees as compared to the 2023-24 financial year. This indicates that the annualised loss of 300-500 crore rupees is a significant setback towards shareholder value creation. Moreover, the violations on the part of Paytm Payments Bank are serious in nature, and dealing with such gross defaults leniently can serve as a bad precedent. It is only if strict action is taken today that the financial ecosystem of tomorrow will be secure with minimal lapses, efficient regulatory mechanisms, and a stakeholder-friendly business environment.