The Reserve Bank of India (RBI) has informed that Paytm Payments Bank has not yet appointed an audit firm to conduct a comprehensive system audit of the IT system of the bank, the Ministry of Finance said in response to a parliamentary question posed on April 4.
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Why does this matter?
On March 11, RBI directed Paytm Payments Bank to stop onboarding new customers with immediate effect due to “material supervisory concerns” observed at the bank. RBI also directed Paytm Payments Bank to appoint an IT audit firm to conduct a system audit of its IT system.
“On-boarding of new customers by Paytm Payments Bank Ltd will be subject to specific permission to be granted by RBI after reviewing the report of the IT auditors,” RBI said.
The above directions were issued under Section 35A of the Banking Regulation Act, 1949, which states that the RBI, in the public interest or interest of banking policy or to prevent affairs of the concerned company to harm depositors, can issue directions to the said banking companies with which it would be bound to comply.
RBI’s action came at a time when Paytm was looking to upgrade its payments bank to a small finance bank licence, after completing five years of operation in May this year.
In response to RBI’s order, Paytm Payments Bank said that it was taking all steps to comply with the directions, however, nearly a month later, it is yet to do so. Given the significant implications of RBI’s directions on Paytm’s growth and consequentially its share price, which has witnessed a steep fall since the company’s IPO in November 2021, it is strange that Paytm appears to be dragging matters out.
Paytm, however, seems to have been provided with a timeline to sort out its issues. “Expectations are clearly chalked out and a timeline has been given to us (by the RBI),” Paytm founder and CEO Vijay Shekhar Sharma told Economic Times. “We believe that we will be able to complete the IT audit within the timeline and submit it,” Sharma said. However, he didn’t specify the submission timelines.
MediaNama has reached out to Paytm asking why the company is yet to appoint an IT audit firm and will update this post once we receive a response.
RBI expected to lay the terms for the IT audit
According to an Economic Times report dated March 16, the RBI will set the terms of reference for an independent system audit of Paytm Payments Bank’s IT system.
Back then, unnamed sources told Economic Times that, over the next few weeks, Paytm Payments Bank will submit the names of several potential audit candidates to the RBI for approval. We do not know if Paytm has submitted these names and is awaiting approval from the RBI or if it is yet to do so.
Why was the bank barred from onboarding new customers?
According to a Bloomberg report, Paytm Payment Bank, responsible for processing transactions for Paytm, was barred because it violated rules by allowing data to flow to servers abroad and didn’t properly verify its customers.
An inspection by the RBI found that the company’s servers were sharing information with China-based entities that indirectly own a stake in Paytm Payments Bank. Moreover, the bank onboarded thousands of clients without adequate KYC (Know Your Customer) documentation raising concerns that some of these could have been mules for money laundering, the report added.
The bank was required to maintain a so-called service level agreement with its technology vendor that would ringfence the entity from its owners as it is a regulated financial institution, Bloomberg reported. China’s Alibaba Group Holding Ltd. and its affiliate, Jack Ma’s Ant Group Co., own a stake in Paytm.
Paytm, however, has strongly denied this allegation. The company put out a statement on Twitter claiming that the Bloomberg report suggesting there was a data leak to Chinese firms is “false and sensationalist” and that “all of the Bank’s data resides within India.”
Paytm CEO Vijay Shekar Sharma also strongly denied the allegation saying:
“I want to inform and confirm that in various observations RBI has shared with Paytm Payments Bank, there is absolutely no reference to any data sharing or servers being outside or data sharing with any unauthorized personnel national or international–any country whatsoever.”
Sharma added that RBI’s orders have to do with “technology-related” matters and that the banking regulator has not raised any concerns about the ownership structure of the bank.
Not Paytm’s first run-in with RBI
October 2021: RBI imposed a penalty of ₹1 crore on Paytm Payments Bank for violating Section 26 (2) of the Payment and Settlement Systems Act, 2007 (PSS Act).
Section 26 (2) of the PSS Act states that entities willfully making false statements or willfully omitting to make material statements for information sought under the Act can be penalized.
Paytm when submitting its application for the issue of the final Certificate of Authorisation (CoA) submitted information that did not reflect the factual position, RBI stated. “After reviewing the written responses and oral submissions made during the personal hearing, the RBI determined that the aforementioned charge was substantiated and warranted the imposition of a monetary penalty,” RBI added.
June 2018: Just a year after its launch, Paytm Payments Bank faced an order from RBI to stop adding new customers to its platform. This was after RBI made some observations regarding Paytm’s process of adding the users and its adherence to know-your-customer (KYC) norms. RBI also reportedly asked Paytm to sack Paytm Payments Bank CEO Renu Satti due to her “inability to lead the banking services” at the company. According to RBI norms of payments banks in India, a payments chief executive has to be a banker.
It is, however, not clear if the recent order is connected to the 2018 order despite the many similarities. “In 2018, there was no fine imposed and we ironed out the issues within months….whether this new issue is linked to that, I cannot comment because I do not remember what that issue was exactly about,” Sharma told Economic Times.
Paytm aims for profitability by September 2023
In a letter to shareholders dated April 6, Vijay Shekhar Sharma revealed that he expects Paytm to breakeven in terms of operating EBITDA (earnings before interest, taxes, depreciation) in the next 6 quarters, i.e. by the quarter ending September 2023. But it is unclear how Paytm will achieve this if it cannot onboard new customers.
Sharma also flaunted the company’s operating metrics in terms of monthly transacting users, adoption by merchants, and disbursement of loans per quarter, but the outlook on these numbers will only be clearly known once the company publishes its fiscal 2022 financial results.
In the same letter, Sharma also stated that his stock grants will be vested to him only when Paytm’s market cap has crossed the IPO level on a sustained basis. At ₹640 at the time of publishing this article, Paytm will have to rise over 230 percent to reach the issue price of ₹2150.
Sharma indicated that the persistent decline in the company’s share price is “due to volatile market conditions for high growth stocks.”
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