Penalties on Payments Banks: What Went Wrong?

How Payments Banks Lost Their Early Advantage

Payments banks were meant to bridge India’s financial inclusion gap — lightweight banks built for small deposits, instant transactions, and deep rural reach. When the model launched in 2015, it attracted tech giants, telecom leaders, and fintech pioneers. But by 2026, the dream is under stress. Multiple payments banks have faced RBI penalties or operational curbs, with at least three under enhanced supervision. Through Payments Bank Framework, the question isn’t why the regulator acted — it’s why the model faltered.

RBI’s 2025 penalty spree marked a turning point. The most visible case was the Paytm Payments Bank embargo, followed by monetary fines on Airtel Payments Bank, India Post Payments Bank, and FINO. The reasons ranged from KYC lapses to data governance issues. But the deeper story is one of structural mismatch — regulatory ambition outpacing operational readiness.

Payments banks were licensed to handle deposits up to ₹2 lakh per customer, without lending rights. The idea was to leverage technology for low-cost financial inclusion. Yet, many operators focused on urban transaction volumes, cross-selling, and ecosystem expansion rather than rural banking fundamentals. When compliance caught up, the cracks showed.

Insight: Payments banks didn’t fail at innovation — they failed at integration with regulation.

By late 2025, RBI audits highlighted recurring governance issues — weak segregation between fintech and banking arms, inadequate system audits, and delayed suspicious transaction reporting. India’s fintech regulators, once lenient for innovation’s sake, are now demanding maturity.

Regulatory Red Flags: Where Compliance Slipped

RBI’s enforcement actions follow a clear pattern. Through Kyc Compliance India, it’s evident that the biggest breaches involved KYC verification gaps, unverified merchant accounts, and data sharing without consent. The 2025 Digital Banking Inspection report cited multiple instances of third-party onboarding without due diligence, leading to ghost accounts and circular transactions.

Key regulatory pain points:

• KYC and Onboarding Lapses: Automated onboarding often skipped in-person verification. Some banks relied on external APIs without verifying document authenticity, leading to RBI red flags.
• Transaction Monitoring Failures: Weak fraud detection systems allowed multiple accounts linked to single IDs — a violation under the PMLA and RBI’s AML guidelines.
• IT Governance Issues: Core banking systems operated under shared infrastructure with parent fintechs, blurring boundaries between licensed and unregulated entities.
• Cross-Border Data Flow: Some payment systems stored or mirrored user data on foreign servers — a compliance breach under India’s 2025 Digital Data Protection Act.

RBI’s penalties, while financial, are largely symbolic — they signal stricter governance expectations. The regulator is making it clear that digital doesn’t mean deregulated. Payments banks must now meet the same operational standards as traditional banks, with tighter board oversight and audit accountability.

Tip: In fintech, the regulator doesn’t move fast — but it never forgets.

According to RBI’s Financial Stability Report 2026, 72 % of reported compliance violations in payments banks relate to KYC and AML processes, while 18 % stem from data governance issues. The rest are tied to unapproved partnerships or product bundling that falls outside license conditions.

The Business Model Strain Beneath the Penalties

While compliance headlines dominate, the real strain is financial. Payments banks operate on razor-thin margins — they earn primarily from transaction fees and float income. Through Fintech Risk Governance, their inability to lend limits profitability. As competition from UPI apps and neobanks grew, many turned to aggressive merchant onboarding and cross-subsidized accounts to stay afloat — shortcuts that later drew regulatory attention.

For example, a 2026 PwC analysis found that the average cost-to-income ratio for payments banks exceeds 85 %, compared to 45 % for small finance banks. With limited revenue streams, compliance lapses were not always deliberate — often, they reflected overextension of digital infrastructure without corresponding governance budgets.

Common business challenges:

1. Revenue Concentration: 80 % of income came from a handful of high-volume corporate clients.
2. Operational Overlap: Shared IT and HR systems with parent fintechs blurred compliance accountability.
3. Rural Inertia: Despite inclusion goals, less than 30 % of accounts belong to semi-urban or rural users.
4. High Attrition: Agent-led distribution struggled with churn and cash management inefficiencies.

Ironically, the same innovation that made payments banks agile — API-led onboarding, partner-led scale, embedded merchant flows — also became their compliance Achilles’ heel. RBI’s 2026 circular now requires stricter segregation between payments banks and their parent fintech entities, forcing structural realignment.

Tip: When compliance becomes a cost center, fintechs must learn that discipline is scalability’s foundation.

What Comes Next: Governance, Scale, and Survival

Through Digital Banking Regulation, 2026 marks a new chapter for India’s digital banking regulation — “maturity over momentum.” RBI’s Digital Bank Working Group is now reviewing whether payments banks should be merged or transitioned into Small Finance Bank (SFB) models with lending rights. Some operators, like Airtel Payments Bank, are preparing applications for conversion.

Industry experts predict three paths forward:

• Consolidation: Smaller payments banks may merge or partner with NBFCs to remain viable.
• Compliance-as-a-Service: Fintechs will embed real-time KYC, audit, and data lineage tools to stay regulator-ready.
• Public Trust Rebuild: Expect visible user communication campaigns around compliance, grievance redressal, and data localization.

RBI has also introduced a “Fintech Governance Scorecard,” to be released quarterly from late 2026, ranking regulated entities on data integrity, KYC turnaround, and fraud reporting. This transparency move aims to nudge fintechs toward sustained compliance rather than reactive correction.

Tip: The next fintech revolution in India won’t be about innovation speed — but about operational trust.

For payments banks, the opportunity isn’t over. India’s inclusion goals still need light-touch banks. But survival depends on recalibrating strategy — from growth-first to governance-first. As UPI 2.0 and digital rupee pilots expand, payments banks can still play a crucial role if they prioritize infrastructure reliability and transparent compliance.

The future of payments banks in India will be written not in code — but in compliance.

Frequently Asked Questions

1. Why did RBI penalize multiple payments banks?

Due to repeated KYC lapses, IT governance issues, and data management violations identified during supervisory inspections in 2024–2025.

2. What’s the main limitation of the payments bank model?

They cannot lend or issue credit, making profitability difficult. Many depend on transaction fees and float income alone.

3. Are payments banks shutting down?

No, but several are restructuring operations or seeking conversion into small finance banks under RBI review.

4. What are RBI’s key compliance priorities?

Stricter KYC verification, localized data storage, and independent IT audits across all fintech-linked banks.

5. What’s the long-term outlook for payments banks?

Survival will depend on trust, governance, and digital discipline — not just user growth.