RBI's action on Paytm PB puts the spotlight on a few lingering issues

“For want of a nail, the shoe was lost; for want of a shoe, the horse was lost; and for want of a horse, the rider was lost.” Commonly attributed to Benjamin Franklin, it can be a trigger for a fresh look, after the developments at Paytm Payments Bank (PPB), at the following: Should there be a revisit of the domestic-systemically important bank (D-SIB) framework, and is there a case for this to be widened to cover more kinds of regulated entities (REs)? Also, should there be an examination of the root causes that led to the domination of UPI (Unified Payments Interface) apps like PhonePe and Google Pay (owned by foreign capital), and its interlinkage with the pricing of UPI?

Take D-SIBs, a list of which has been released by the Reserve Bank of India (RBI). As of now, there are three banks on it: State Bank of India, HDFC Bank, and ICICI Bank. But the PPB episode tells us that even a payments bank (PB) can cause systemic disturbance – if it does not adhere to norms. The global financial crisis following the dramatic collapse of Silicon Valley Bank, Signature Bank, and the epitaph of Credit Suisse — which now resides in the belly of UBS — tells us that new risks are coming to the fore. And the idea of systemically important institutions may have to be rethought. Or flashback to 2002: Madhavpura Mercantile Cooperative Bank (MMCB) had unsettled the authorities. The bank issued pay-orders (POs) of Rs 1,200 crore to stock broker Ketan Parekh, which were discounted by Bank of India (BoI). The MMCB-BoI saga, a case of conflating POs with cheques, caused instability.

A different approach?

The Bank for International Settlements has assigned a weight of 6.67 per cent for payments in its approach for assessing the importance of global systemically important banks; the RBI, too, has followed this template for D-SIBs. But the huge spurt in the payments business — with fintech companies playing a major part and their partnership with banks (across business verticals) — has meant the plot has changed. In July 2014, when the RBI released the framework for D-SIBs, it said: “The methodology for assessing the systemic importance of banks and identifying them will be reviewed on a regular basis”. While this was a reference to commercial banks, should it now be widened to capture adjacent ecosystem participants?

Ravi Duvvuru’s view is that “payments are no more a peripheral business — they are right at the heart of financial services.” The same holds for the supporting architecture: The National Payments Corporation of India (NPCI), account aggregators (AAs), and even The Clearing Corporation of India (CCIL). The founder and designated partner at Duvvuru & Reddy LLP and member of the advisory group to the second Regulatory Review Authority set up by Mint Road feels these entities — PBs, NPCI, AAs and CCIL — are “systemically important” too, like legacy banks, and non-banking financial companies (NBFCs). Plus, factor in that the NITI Aayog has put out “A Proposal for Digital Banks in India: Licensing & Regulatory Regime”, in July 2022.

Systemic risk is understood as one that can cause impairment to part of the financial system, impacting on the real economy. “While the commonly used entity-based model is leverage based, there’s a good case for looking at an activity-based model that covers PBs and broadly, payment players,” notes R Gurumurthy, former head-governance, RBL Bank. He adds: “An activity-based model can then look at dominant players and build in systemic mitigation methods. Probably, the ‘B’ in D-SIB can be replaced by ‘E’ to indicate an ‘entity’.” His views emanate from the reasoning that “interconnectedness and the ability to cascade problems”, which determine systemic risk are a key feature of non-bank payment players and hence, they should also be covered by a broader framework. Now whether other financial regulators — the Securities and Exchange Board of India, the Insurance Regulatory and Development Authority of India, and the Pension Fund Regulatory and Development Authority — should come out with a list of systemically important entities in their domain is worth pondering.

Other linkages

It also brings into the spotlight Mint Road’s discussion paper – “Charges in Payment Systems (October 2022) — which made a case for pricing UPI (though it did not specifically mention it). “In any economic activity, including payment systems, there does not seem to be any justification for a free service, unless there is an element of public good and dedication of the infrastructure for the welfare of the nation. But who should bear the cost of setting up and operating such an infrastructure is a moot point.” Days after the release of the same, North Block tweeted: “UPI is a digital public good with immense convenience for the public and productivity gains for the economy. There is no consideration in the government to levy any charges for UPI services. The concerns of service providers for cost recovery have to be met through other means.” Even as many wondered what these “other means” could possibly be.

Why should this report be revisited? Because the desirability of pricing UPI (or otherwise) must be read along with the ob­ser­vation ma­de by the Stan­ding Committee on Communications and Information Techn­ology last fortnight: The dominance of foreign firms in the payments business. PhonePe and Google Pay market shares were 46.91 per cent and 39.39 per cent, respectively, by volume during October - November 2023; the market share by volume of BHIM UPI was only 0.22 per cent.

The NPCI had in November 2020 said that payment firms are not to process more than 30 per cent of total volume of transactions on UPI from January 1, 2021. This is exactly what the Standing Committee on Communications and Information Techn­ology has reinforced (the dominance of foreign firms). But what triggered this in the first place? Because banks have almost vacated this turf as pricing of UPI remains unresolved. What’s also lost in the din is that banks pay a switching fee to the NPCI (a not-for-profit entity) running into hundreds of crores every year for UPI, even as they have to offer the service for free — be it for peer-to-peer or peer-to-merchant transactions. And with Paytm being a cause for concern, it may only accentuate the tilt towards Google Pay and PhonePe.

Pricing of UPI can be argued on either side of the debate (whether it should continue to be free or not), but what you cannot get away from is that while it has fundamentally changed consumer behaviour, the reality is that it involves substantial costs to run the payments system. “But the jury is out on how long this (free UPI) is sustainable. There’s a clear push to unlock monetisation opportunities in UPI. As evidenced by digital credit lines, credit cards (on the UPI rail), and charging for wallet-originated UPI transactions,” says Ranadurjay Talukdar, partner and payments sector leader, EY India.

And lastly, where does the know-your-customer (KYC) norm fit in the larger scheme of things? According to Arpit Ratan, chief business officer and co-founder, Signzy, it takes time for some fintech companies to understand the seriousness needed when they deal with Mint Road, unlike legacy REs like banks or NBFCs. “But I am sure that compliance will get more attention from businesses because it’s as important as marketing today for business to grow. Investors will also nudge fintech to take necessary measures as it helps in safeguarding business reputation in the long run.”

Whichever way you look at it, Franklin had hit the nail on the head.