RBI’s action on Paytm Payments Bank raises important questions

Media reports suggest that RBI was unhappy about related-party transactions between PPB and other Paytm group companies, and that Paytm has put its wallet business on the block.  (Bloomberg)
Media reports suggest that RBI was unhappy about related-party transactions between PPB and other Paytm group companies, and that Paytm has put its wallet business on the block. (Bloomberg)

Summary

  • We should ask if risks are being properly assessed and whether retail investors need to be protected.

The Reserve Bank of India (RBI) last week took action that put a question mark on Paytm Payments Bank’s (PPB) future. It directed PPB to accept “no further deposits or credit transactions or top ups… in any customer accounts, prepaid instruments, wallets, FASTags, National Common Mobility Cards, etc" after 29 February.

RBI explained its action by saying that audit reports revealed persistent non-compliances by the bank and continued material supervisory concerns over it. So, RBI believes that PPB hasn’t been following regulations.

Subsequent media reports have noted that PPB did not follow know-your-customer norms in many cases. Further, reports suggest that RBI was unhappy about related-party transactions between PPB and other Paytm group companies, and that Paytm has put its wallet business on the block. All these reports are source-based and RBI hasn’t offered detailed reasons. Nonetheless, RBI’s action and other previous developments do raise a few points.

First, many venture capitalist-funded new-age startups in the digital space have ended up under-estimating their regulatory risk. Companies operating in the games/gambling space and in the crypto space are good examples. Maybe they did not under-estimate the regulatory risk, but just thought that they’ll be able to scale up their businesses quickly, and then get the regulator to talk to them on equal terms. Their investors also probably thought so and bought stakes in them at extremely high valuations, hoping to sell their stakes at even higher prices to retail investors.

At some level, entrepreneurs do tend to think they can brazen out allegations of rule-breaking. Entrepreneurship has an element of hurdle leaping and being optimistic is the name of the game. But the line between optimism and over-optimism is a thin one and the latter can lead to under-estimation of risk, which seems to have happened here.

Further, the inspiration for several of India’s new-age entrepreneurs seems to come from something that Mark Zuckerberg, CEO of Meta Platforms, once said: “Move fast and break things. Unless you are breaking stuff, you aren’t moving fast enough."

Indeed, regulations hamper the ability to break things and move fast. Further, one may not like the laws of the land because they hamper the capacity to be agile, but the laws of the land are the laws of the land, and they need to be taken into account in any new and evolving business. Also, in 2014, Facebook (now Meta) changed its internal motto to: “Move fast with stable infrastructure". Guess it’s time Indian startup entrepreneurs got this memo.

Second, quite a few new-age entrepreneurs in the digital space and others who have incentives in that space came out in support of PPB on social media. What they were trying to say without really saying so directly was that startups need light-touch regulation to become tomorrow’s big businesses.

This argument does not take into account the fact that PPB operates in the financial space. And whenever the financial system has seen light-touch regulation, things haven’t typically ended well. The cases can vary from the dotcom mania of the 1990s, the financial crisis that started in 2008 and the rise of Sahara India through the 1990s and early 2000s to the bad-loan crisis in the 2010s, when RBI turned a blind eye to the mounting bad loans of public sector banks for quite a few years.

Of course, PPB isn’t anywhere as big as any of those financial institutions, but it is integrated closely with India’s financial system, especially with a network space where individuals and businesses carry out small financial transactions, and that in itself is a very good reason for strong regulatory oversight.

Third, RBI’s decision has had a huge impact on the stock price of One97 Communications, which owns 49% of PPB. It is down by more than 40% since 31 January. More importantly, it is down almost 79% from its issue price of 2,150 in November 2021.

In fact, through the initial public offering (IPO) of One 97 Communications, 10,000 crore worth of shares were sold by existing investors. Since then, a huge amount of value has been destroyed. Interestingly, retail investors as of December-end owned 12.85% of the company, while mutual funds and insurance companies owned another 5.39% of One97.

So, should companies like One97 Communications, with business models that haven’t really evolved and made a consistent profit for a few years, be allowed to list on stock exchanges, letting existing large investors unload their stakes at excessive valuations on to gullible retail investors? In fact, the first risk stated in the draft red herring prospectus of the company published before its IPO was: “We have a history of net losses and we may not be able to achieve profitability."

Experts may say “caveat emptor": buyer beware. Nonetheless, what chance do retail investors—caught as they are in a frenzy built up by investment banks, stock brokerages, financial influencers, business and social media and startup founders who have turned themselves into individual brands—really have to sit down and use their minds before they invest? That is a question well worth asking.

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