Syllabus
GS Paper 3 – Indian Economy and issues relating to Planning, Mobilization of Resources, Growth, Development and Employment. Inclusive Growth and issues arising from it.
Context
Recently, Reserve Bank of India has issued an order to Paytm Payments Bank Ltd, a limited service bank that is permitted to accept deposits but is prohibited from issuing loans.
Paytm Payments Bank Crisis
Introduction
The recent actions taken by the Reserve Bank of India (RBI) against Paytm Payments Bank Ltd (PPBL) have drawn attention to the functioning of Payment Banks in India. The RBI has directed PPBL to cease the majority of its operations, which include accepting additional deposits, facilitating credit transactions, and topping up customer accounts, prepaid instruments, wallets, and cards used for road toll payments, effective from February 29, 2024.
Payment Banks
- Establishment: Payment Banks in India were instituted in 2014, following the recommendations of the Nachiket Mor Committee. They were designed to function on a smaller scale, carrying minimal credit risk.
- Objective: The primary goal of these banks is to promote financial inclusion by providing banking and financial services to areas that are unbanked or under-banked. They also serve the banking needs of overlooked populations such as the migrant labour force, low-income households, and small entrepreneurs.
- Legal Provisions: The legal guidelines that govern the operations of payment banks in India are as follows:
- Registration and Licensing: These banks must register as a Public Limited Company under the Companies Act 2013 and secure a license in accordance with the Banking Regulation Act 1949. They are also regulated by the RBI Act 1934, Foreign Exchange Management Act 1999, and Payment and Settlement Systems Act, 2007.
- Capital Requirement: The minimum capital requirement for these banks is 100 crores. For the first five years, the stake of the promoters should not be less than 40%. Foreign shareholdings are also permitted as per FDI rules for private banks in India.
- Voting Rights: The voting right of a shareholder is capped at 10%, which can be increased to 26% with the approval of the Reserve Bank of India. The banks should be fully networked from the beginning.
Features of Payment Banks
- Account Types: Payment banks can only open Savings and Current Accounts. The maximum deposit balance is capped at Rs 2,00,000. However, they cannot accept deposits from Non-resident Indians.
- No Lending: These banks are not permitted to offer lending services. They can issue ATM or Debit cards, but not credit cards.
- CRR Obligations: Like other commercial banks, payment banks are required to deposit a Cash Reserve Ratio (CRR) with the RBI.
- SLR Requirements: Payment banks must invest at least 75% of their demand deposit balances in Statutory Liquidity Ratio (SLR) eligible Government securities/treasury bills with maturity up to one year. They can hold a maximum of 25% of their demand deposit balances in current and fixed deposits with other commercial banks for operational purposes.
- No NBFC Functions: Payment banks are not allowed to open subsidiaries to undertake Non-Banking Financial Services activities. However, with RBI’s approval, they can partner with other commercial banks to sell mutual funds, pension products, and insurance products.
- Additional Services: Payment banks can offer internet banking and mobile banking facilities. They can also facilitate utility bill payments and accept remittances to be sent to or received from multiple banks through RBI-approved payment mechanisms like RTGS, NEFT, and IMPS.
Regulation of Payment Banks
- Scheduled Banks Status: Payment banks are recognized as scheduled banks under the Reserve Bank of India Act, 1934. However, to distinguish themselves from other banks, these institutions must include the term “Payments Bank” in their name.
- Registration: Payment banks are registered as public limited companies under the Companies Act, 2013.
- Licensing: These banks are licensed under the Banking Regulation Act, 1949.
- Regulatory Oversight: Payment banks are governed by several laws and regulations, including the Banking Regulation Act, 1949, Reserve Bank of India Act, 1934, Foreign Exchange Management Act, 1999, Payment and Settlement Systems Act, 2007, Deposit Insurance and Credit Guarantee Corporation Act, 1961, and other relevant statutes and directives.
- RBI Guidelines: The RBI issues specific guidelines that define the eligibility criteria, permissible activities, capital requirements, and other operational aspects for entities seeking to operate as payment banks.
- Ownership and Capital Requirements: Entities intending to establish a payment bank must comply with these regulations to ensure financial stability and the effective execution of banking operations.
- Customer Protection: Payment banks are required to implement robust KYC procedures to verify the identity of their customers and prevent money laundering and fraudulent activities.
- Security Standards: Payment banks are expected to adhere to high technology and security standards to ensure the safety and integrity of financial transactions.
- Reporting Requirements: Payment banks are required to submit periodic reports to the RBI, providing details about their financial health, operations, and compliance with regulatory norms.
- RBI Review: The RBI conducts regular inspections, audits, and assessments to ensure that these entities comply with regulatory guidelines and maintain financial stability.
Importance of Payment Banks
- Financial Inclusion: Payment banks have fostered financial inclusion by providing financial services to the unbanked sections of society, including migrant workers, low-income households, and small-scale entrepreneurs.
- Geographical Reach: Thanks to their technology-oriented services, these banks have a broader geographical reach compared to traditional banks, whose reach is limited by the need for physical infrastructure.
- Account Features: Payment banks offer zero balance accounts or no minimum balance accounts without any extra or hidden charges, unlike commercial banks that impose fees if customers don’t maintain a minimum balance.
- Complementary Services: Payment banks enhance the financial efforts of traditional banks by partnering with them to sell products like mutual funds, pension products, and insurance products. For example, SBI Life Insurance products are available through Paytm.
- Transaction Capabilities: These banks have established an effective infrastructure for handling low value, high volume transactions. For instance, Paytm QR codes are used by everyone from vegetable vendors to grocery shop owners.
- Interest Rates: Payment banks offer higher interest rates compared to traditional banks. For example, the Return on Investment (ROI) of a Payment Bank is generally around 7%, whereas the ROI of a commercial bank is typically between 3.5% and 6%.
Recent Issues with Paytm Payments Bank
The necessity for regulation has been highlighted by the Reserve Bank of India’s (RBI) findings that Paytm Payments Bank Ltd (PPB) has breached several of its rules and regulations. These violations include exceeding the limit on customer deposits, failing to report suspicious transactions, and non-compliance with the Foreign Exchange Management Act. Furthermore, the RBI has reportedly leveled accusations of financial crimes against Paytm, including the falsification of customer information and involvement in money laundering activities.
- Non-KYC Accounts: There are lakhs of accounts that are not compliant with the Know Your Customer (KYC) norms.
- Single PAN Card Usage: A single PAN card has been used to open multiple accounts in thousands of instances.
- Money Laundering Concerns: Some accounts have transaction values running into crores of rupees, exceeding the regulatory limits for minimum KYC pre-paid instruments.
- Dormant Accounts: Out of the 35 crore Paytm wallet accounts, 31 crores were found to be dormant. These dormant accounts were used as mule accounts and for committing digital frauds.
- Data Privacy Issues: Paytm bank’s reliance on its parent company, One97 Communications Limited (OCL), for IT infrastructure has raised concerns about data privacy.
- False Compliance Submissions: The compliances submitted by Paytm to the RBI were found to be incomplete and false on several occasions.
Consequences of the RBI’s Actions Against Paytm Payments Bank
- Reputation Impact: The Reserve Bank of India’s actions in response to Paytm Payments Bank’s repeated compliance issues can significantly harm the bank’s reputation. This could undermine public trust and confidence in its services, potentially affecting its credibility and customer loyalty.
- Service Disruption: The RBI’s directive has put a halt to Paytm Payments Bank’s basic banking functions, impacting transactions through UPI, IMPS, and Aadhaar-enabled payments.
- Influence on Other Businesses: Paytm’s involvement extends beyond banking. Issues in the payment bank could have a negative impact on its other digital payment services.
Challenges with Payment Banks
- Digital Divide: Payment banks, which operate solely online and have no physical presence, are affected by the rural-urban divide in internet connectivity. This has hindered their expansion and penetration.
- Profitability Challenges: Payment banks are not allowed to lend money and earn interest income like traditional banks. Additionally, the stringent requirement to invest 75% of demand liabilities in Government securities has limited their profitability. For instance, operational payment banks reported net losses of Rs 516.5 crore for the financial year 2018.
- Dormant Accounts: A large number of dormant zero balance accounts have affected the operations of payment banks in India. These dormant accounts have also been misused for personal loan scams and money laundering. For example, out of the 35 crore Paytm payment bank accounts, 31 crore remained dormant and were misused.
- Intense Competition: Payment banks face fierce competition from payment wallets like Phone Pe, Bharat Pe, and conventional commercial banks’ payment services like SBI Yono and ICICI i Mobile Pay.
- Low Return on Equity: The cap on the amount of demand deposits at Rs 2,00,000 and the 15% capital to Risk Weighted Assets ratio has severely impacted the returns on equities of payment banks in India. Their return on equity is less than 5%.
- Defunct Payment Banks: The over-regulated functioning and significant losses have led to an increase in the number of banks surrendering their licences and ceasing their operations. For example, Cholamandalam Distribution Services, Sun Pharmaceuticals, Tech Mahindra, and Aditya Birla Payment Bank have surrendered their licences.
Way forward
- Profit Generation: The RBI should consider increasing the deposit limits of payment banks. Additionally, a mechanism should be established to allow these banks to transfer surplus money from demand deposit accounts to universal banks.
- Infrastructure Sharing: Measures should be taken by the RBI to facilitate infrastructure sharing between traditional banks and Payment Banks. For instance, Payment Bank desks could be set up in traditional bank branches.
- Internet Connectivity: To allow new players to enter the payment bank market, internet connectivity in rural areas needs to be improved. This is particularly important as the payment bank sector is currently dominated by telecom giants like Airtel and Jio.
- Scope of Operations: Payment banks should be permitted to offer their own mutual fund and insurance products. This would enhance their revenue generation and profitability.
- Regulatory Vigilance: The RBI must regularly undertake the compliance of e-KYC and no frill accounts to prevent future crises like the Paytm crisis. The recommendations of the Anand Sinha committee should be implemented to separate the banking operations of the payment bank from the ownership structure.
Conclusion
The Paytm Payments Bank crisis underscores the challenges faced by payment banks in India. Regulatory issues, operational constraints, and reputational damage have highlighted the need for robust compliance and oversight. Despite these hurdles, payment banks play a crucial role in promoting financial inclusion, especially in underserved areas. The crisis serves as a reminder for the need for stronger regulatory vigilance, infrastructure sharing, and expanded internet connectivity to ensure the sustainable growth of this sector.
Source: The Hindu
Practice Question
Discuss the role of payment banks in promoting financial inclusion in India. In light of the recent Paytm Payments Bank crisis, critically examine the challenges faced by payment banks and suggest measures to ensure their sustainable growth. [250 words]
How to approach this question?
Introduction:
- Begin by briefly explaining what payment banks are and their purpose.
- Mention the objective of financial inclusion and how payment banks contribute to this goal.
- Introduce the Paytm Payments Bank crisis as a case study for the discussion.
Body:
- Role of Payment Banks: Discuss the role of payment banks in promoting financial inclusion. Highlight their services, reach, and impact on unbanked and under-banked populations.
- Paytm Crisis: Provide a brief overview of the Paytm Payments Bank crisis. Discuss the regulatory issues and operational constraints that led to the crisis.
- Challenges: Critically examine the challenges faced by payment banks in India, using the Paytm crisis as a reference. Discuss issues like regulatory compliance, profitability, competition, and customer trust.
- Solutions: Suggest measures to address these challenges. These could include regulatory reforms, infrastructure sharing, increased internet connectivity, expanded scope of operations, and enhanced customer protection measures.
Conclusion:
- Summarize the key points discussed in the body of the answer.
- Conclude by emphasizing the importance of payment banks in achieving financial inclusion and the need for effective regulation and oversight to ensure their sustainable growth.
Remember to provide a balanced answer, incorporating relevant facts and figures, and propose feasible solutions. Structure your answer well, with a clear introduction, body, and conclusion. Also, ensure that your answer is within the word limit specified for the exam. Good luck!