By Srinath Sridharan,
The “smell test” serves as a tool for financial regulators to extract market intelligence on entities. Employing a blend of common sense and seasoned experience, this seeks to identify any unusual activities or deviations from regulatory norms. In a crisis, the scrutiny of the smell test becomes notably more rigorous. Paytm has just proved a fundamental principle: no entity, regardless of size or prominence, is immune to regulatory oversight.
Fintech giants like Paytm must recognise that equity strength and market dominance do not exempt them from the stringent rules that govern financial operations, nor does claiming regulatory ignorance. Innovation should not come at the cost of compromising the regulatory system that upholds the integrity of the financial system. A notable portion of Paytm’s top management wears dual hats, serving roles both at the parent entity and the bank—undoubtedly a conflict of interest.
Surprisingly for such severe RBI action on a bank, its MD & CEO has been silent, while the parent entity’s KMPs have been speaking publicly. Does this indicate the control and sway of the promoter over the two entities and serve as an barometer of the entity’s governance? A genuine commitment to governance, however, demands more than just recognition. Can a truly independent director assume its chair’s role? This lesson finds inspiration in the governance model exemplified in Kotak Mahindra bank, where the promoter functioned as the managing director under the guidance of an independent director as chairman.
The RBI’s intervention against Paytm supposedly materialised after repeated warnings over the past two years regarding the interconnectedness between its payments app and its banking arm. According to media reports, RBI inspections showed discomfort on the money and data traffic flows between the tightly regulated bank and the broader Paytm ecosystem, leading to supervisory challenges. If proven, such breaches would mean significant concerns regarding overall financial stability as well as issues of national security.
Earlier, the concerns were regarding whether Paytm shared consumer data with its China-based shareholders. Admittedly, if this were true, only Paytm’s core team and the RBI would have been privy to such information through the supervisory inspection discussions. Probably, during the pandemic, one assumes that the regulatory system would not have wanted to act against a large payments entity, considering the then-need for continuity of payments flow.
Media reports also indicate the co-mingling of the Paytm group’s financial and non-financial businesses with its promoter group companies, violating its licensing conditions and RBI directives. If most of media reports about repeated and multiple compliance issues of Paytm since its inception are true, then one wonders how the RBI gave it approval to become a scheduled commercial bank.
In October 2023, the RBI penalised Paytm for severe lapses across its banking operations. This warranted a more proactive and immediate response for rectification, but not showcasing intent and improvement in regulatory behaviour seems to have triggered regulatory action this time. Despite no steady profitability, Paytm listed in public markets with exuberance, led by its publicly-adored poster boy founder-CEO.
Since then, every once in a while, there seemed to be a new business pivot announced—from lending to insurance to wealth management to AI—to keep optics high. Yet, the very core of a financial entity seems to be broken—compliance.
The fundamental concept behind fintechs disrupting traditional business models lies in identifying frictions within the products and processes of existing incumbents and leveraging technology to eliminate them. However, when fintechs perceive regulation itself as friction, it is all over. Regulators exist not to stifle innovation, but to ensure stability, protect consumers, and maintain the overall health of the financial ecosystem.
Effective communication is imperative, especially during crises. Paytm’s response the day after the RBI action was lacklustre, bordering on ignorance or arrogance. They claimed that the payments bank as a separate entity was technically correct. However, it sounded like they were almost mansplaining to the market analysts, given the shared ownership between the parent entity and the founder.
Moreover, the board members were from the parent entity. Attempts to leverage social media influence or call in favours from fellow fintech founders may not resonate with regulators. Paytm has just hurt the reputation of the wider fintech community. With the financial regulators, the fintechs will have to work twice as harder.
The failure of a bank to adhere to fundamental cybersecurity and KYC norms signifies a glaring lapse in its core functions. Why should the financial regulator repose trust in the current leadership considering these repeated regulatory lapses? Even if the founder did not personally benefit from any of the lapses, it shows failed operational leadership, considering that he sits on both the parent entity and bank entity boards.
From the tone of the RBI’s public communication about its action on Paytm, it looks that it is not done yet. Unlike earlier instances with other regulated entities, it has not indicated that it will allow operations to commence after regulatory breeches are solved. If the regulator has lost trust, the message to the founder and KMPs is to simply step down to let the entity be governed by an independent Board and run by management teams the regulator has confidence in, assuming that the entity will have a regulatory licence in the coming days. For an entity that rose to fame during demonetisation, it forgot that trust has the highest monetary value in the financial space.
(The author is Policy researcher and corporate advisor)