[Koninika is a student at School of Law, Christ University.]
The Reserve Bank of India (RBI) issued a cease-and-desist direction on Paytm Payments Bank Limited (PPBL) earlier this year, citing “persistent non-compliances and continued material supervision concerns''. Consequently, PPBL underwent several operational changes raising concerns about proportionality in enforcement regulations and customer protection.
This article compares RBI’s direction against PPBL with SEBI’s balanced approach. The analysis is three-pronged: Firstly, the article examines whether the cease-and-desist direction adheres to the four principles of proportionality. Secondly, it evaluates alternative regulatory measures that could be more effective in addressing the violations. Finally, it provides specific recommendations that would aid RBI in resolving current and future concerns of a similar nature, impacting the financial inclusivity of stakeholders.
Case Study: Analysing Seven Years of PPBL’s Regulatory Lapses
Founded in 2017, PPBL capitalised on the rapid growth of digital payment services in India after the demonetisation wave in 2016. Despite the bank’s pioneering start, it encountered regulatory troubles due to non-compliance with RBI’s Know Your Customer (KYC) norms. In March 2022, RBI restricted PPBL from onboarding new customers and imposed a penalty of INR 5.39 crores. The Financial Intelligence Unit-India flagged approximately 50,000 suspicious accounts out of the 175,000 KYC non-compliant accounts, highlighting severe money laundering concerns, including:
failure to detect and report suspicious transactions;
inadequate ongoing due diligence for payout service and accounts; and
unreliable reliance on third-party KYC.
These violations pointed to systemic issues within PPBL, including allowing numerous accounts to operate under a single Permanent Account Number. RBI issued a cease-and-desist direction to address these compliance breaches in January 2024, prohibiting the bank from accepting deposits or conducting credit transactions. It also advised existing customers to seek alternative arrangements.
Industry experts like Ankit Ratan, CEO of Signzy, highlighted, “Small organisations like co-operative banks and fintechs often lack adequate risk and compliance teams ....[this] is not solely an issue of expertise but also involves systemic problems and limited bandwidth.” This fundamental limitation underscores the need for targeted enforcement measures rather than broad banning that could potentially harm financial inclusive efforts.
RBI’s Regulatory Approach for Payment Banks with Case Laws on Proportionality
Regulating RBI’s enforcement actions on payment banks
RBI has significant powers to regulate payment systems and settlement arrangements under Sections 10, 17 and 18 of the Payment and Settlement Systems Act 2007 (PSSA). While Sections 10 and 18 enable RBI to set managerial and operational standards, Section 17 grants RBI the power to issue cease-and-desist directions for posing systemic risks or affecting the credit or monetary policy of the country. However, the exercise of these powers must be proportional to the nature and severity of violations.
Doctrine of proportionality: Legal precedents
Previously, RBI had issued cease-and-desist directions, with proportionality being an indispensable element. This principle was emphasised first in the Internet and Mobile Association of India v. RBI, where the Supreme Court (SC) cautioned RBI against blanket bans and advocated for careful consideration in enforcement actions.
Initially, there were three principles of proportionality, also called the De Freitas Test. As the House of Lords added in Huang v. Secretary of State, the fourth prong emphasises the need to balance societal interests with those of groups and individuals. This principle was further expanded in Modern Dental College and Research Centre v. State of Madhya Pradesh wherein SC upheld the 4 principles for granting a cease-and-desist direction, viz. assessing whether such measure: (i) serves a specific legislative purpose; (ii) is rationally connected to achieving such purpose; (iii) has no alternative or less invasive measure; (iv) balances the importance of achieving the purpose with limiting the right. While evaluating these four principles with PPBL’s direction, the following can be analysed:
Deviation from legislative intent
As announced in the Union Budget 2014-2015, the legislative intent was clear: empowering RBI to make necessary business operations and management changes as per Sections 10 and 18 of PSSA. This power was given to safeguard the interests of underserved segments, such as small businesses and low-income households. However, a blanket ban on PPBL’s banking services eliminates the customer-bank interaction - defeating the purpose of PSSA. The direction significantly disrupted PPBL’s operation rendering the payment bank’s objective futile.
Rational alternative measures aligning with legislative purpose
The PPBL direction could have been more rational and aligned with the legislative intent of regulating payment banks. PPBL falls under the definition of “banking company” in Section 5 (c) of the Banking Regulation Act of 1949 (BR Act). This is primarily due to its inclusion as a scheduled commercial bank (SCB) and its function as a public limited company licensed under the BR Act. This opens the door for enforcing an alternative measure - superseding the existing board members of PPBL under Section 36ACA of the BR Act and appointing a new one, with the central government’s consultation, to address non-compliance concerns while maintaining banking operations. A change in management, accompanied by a temporary restriction on banking services, would have been a more rational approach.
Weighing the scales: Limitation v/s purpose
The doctrine of proportionality, as also observed in Excel Crop Care Limited v. Competition Commission of India, suggests that penalties should be proportionate to the seriousness of the act and not lead to shocking results. RBI's direction against PPBL needed to be more proportional. It failed to meet all four prongs of proportionality and overlooked alternative measures for balancing the enforcement actions to the severity of PPBL’s non-compliance. A mere blanket ban on banking services indefinitely without holding the management accountable does not fulfil the purpose of instituting payment banks.
Impacting financial inclusivity
RBI’s cease-and-desist direction to PPBL disrupted essential banking services for small businesses and low-income households, who rely on payment banks due to limited access to traditional banks. The direction’s concerns about the future viability of PPBL hinder the socio-economic involvement of these underserved customers. Industry leaders including Policybazar’s Yashish Dahiya urged RBI to reassess the “proportionality of restrictions” on PPBL. Payments banks were established to promote financial inclusivity, but RBI’s direction failed to consider this legislative intent. Therefore, stakeholders need a more balanced approach to regulatory enforcement, acknowledging the unique role played by payment banks in aiding the underserved.
Difference in Regulatory Philosophy of RBI and SEBI
In the context of financial regulation, RBI and the Securities and Exchange Board of India (SEBI) play crucial roles. While both institutions strive to maintain stability and enforce compliance, their regulatory approaches differ significantly. This section explores how both navigate proportionality in their enforcement actions.
RBI “direction” v/s SEBI “order”
An order refers to norms governing human behaviour that prescribe specific actions for non-compliance. In contrast, a direction has broader instructions prohibiting certain conduct through penalties. Directions can be pre-emptive and definitive, while orders are final and narrowly applied. While SEBI issues “orders”, RBI imposes cease-and-desist “directions” under Section 17 of PSSA.
RBI directions provide sparse details in comparison with SEBI orders
RBI directions, like the one issued to PPBL, lack similar depth and analysis, as seen in SEBI’s orders, like in the Mathew Easow case. SEBI orders are contextually detailed and analytical with preliminary findings. They are more severe and immediately affected with a definitive timeline of 15 days. Nevertheless, the PPBL direction is more gradual and focused on systemic stability, allowing time for compliance and improvement.
Contrast in applying proportionality principles
SEBI’s cease-and-desist “orders” are imposed under Section 11D of the Securities and Exchange Board of India Act, 1992 (SEBI Act). In Nirmal Bang Securities Private Limited v. SEBI, the Securities Appellate Tribunal (SA) referred to the proportionality principles upheld in Ranjit Thakur v. Union of India. It modified the penalty to ensure that it was commensurate with the misconduct. SEBI ensures market fairness, while RBI focuses on prioritising financial stability. SEBI’s approach is more proportionate as it sets definitive timelines, revises harsh punishments and makes necessary adjustments, unlike that of the RBI.
Recommendations for RBI and Future Study Implications
As India’s payment arrangements evolve, a proportional regulatory framework by RBI will be essential for compliance adherence. To rationalise the existence of payment banks in a regulated format, RBI must:
Outline exact procedures and conditions for issuing cease-and-desist directions or orders, including follow-up actions and redressal mechanisms for affected entities, as suggested in the 56th Report of the Standing Committee of Finance.
Bring payment banks within the scope of cease-and-desist ‘orders’ under Sections 47 (1) (c) and 46 (4) of the BR Act (as seen in the cases of other traditional SCBs like HDFC Bank, ICICI Bank, Yes Bank and Bank of Baroda). This will hold payment banks to the same standards as traditional SCBs.
Tailor its enforcement actions in proportion to the severity of non-compliance, as done by SEBI. Targeted measures like management restructuring or enhanced compliance measures such as proctored video-KYCs must be considered instead of a blanket ban on banking services.
Communicate clearly in its press releases, notifications, orders and directions, highlighting the exact violations, findings and analysis of the regulator to safeguard stakeholders’ interests.
While this article has limitations, future studies can examine the legality of financial inclusion and compare successful international regulatory approaches for a comprehensive understanding.
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