By Archana ShuklaBBC Business Correspondent

Getty Images A QR code for the Paytm digital payment system at a store in Mumbai, India, on Thursday, Feb. 1, 2024. Shares of digital-payments provider Paytm plunged 20% after Indian regulators ordered it to halt a bulk of its business, dealing a severe blow to a high-profile tech pioneer that grappled for years with authorities. Getty Images

The Paytm payments app is used by millions of people

A small grocery store in India's financial capital Mumbai has begun asking customers to pay cash as a popular digital payments service, which it used until now, is facing uncertainty over its survival.

India's central bank has asked Paytm - the company that revolutionised digital payments in the country - to stop all services offered by its banking division, also known as the wallet service, due to "persistent non-compliance" of its rules. The division supports Swift payments through the Paytm app, which has more than 330 million users.

The Reserve Bank of India (RBI) has reportedly accused Paytm of financial crimes, including falsifying customer information and money laundering.

It has asked the company to stop accepting deposits into people's Paytm bank accounts, or wallets, from 1 March, although customers would be allowed to continue making payments until the balance in their accounts is exhausted.

Meanwhile, Paytm has denied the allegations. In a statement the company said that "the Paytm app remains fully operational, and our services are unaffected".

The app can continue to facilitate quick payments between non-Paytm bank accounts as an intermediary but it can't accept direct deposits.

This would severely impact the company's wallet business. Paytm wallet is almost like a bank account in which people can receive deposits, keep money and make payments - all done by scanning a QR code or using mobile phone numbers as their identity.

People can also transfer money from their wallets to their accounts in other banks and vice-versa.

Not surprisingly, the regulatory crackdown has come as a blow to thousands of small business owners who relied on the app for making quick and easy transactions.

It has also left Paytm in a dire state, as investors pulled out billions of rupees after the company's shares began to tank following the order.

Industry experts say the move could be a precursor to the payments bank losing its license in the next few weeks - further adding to investor nervousness.

On Thursday, RBI Governor Shaktikanta Das said Paytm had been given sufficient time to rectify lapses.

"The RBI action is always proportionate to the gravity of the violation and is in interest of systemic stability and protection of consumer interest. Action is taken when regulated entities do not take effective steps," Mr Das said.

A Paytm spokesperson told the BBC that the firm was taking the RBI directive "very seriously".

"We respect the RBI's decision and are working diligently to address the concerns raised," the spokesperson added.

Getty Images A vegetable vendor waits for customers displaying a barcode for Paytm, an Indian cell phone-based digital payment platform, at a market in Kolkata,India on July 04,2023. (Photo by Debajyoti Chakraborty/NurPhoto via Getty Images) Getty Images

Thousands of shopkeepers use the Paytm app

Paytm's founder Vijay Shekhar Sharma, once named as India's youngest billionaire, has been firefighting. He is motivating employees, calming investors and assuring merchants. Mr Sharma met RBI officials and reportedly even approached the country's finance minister for help.

This isn't the first time that Paytm has run into trouble with the banking regulator. Since 2018, the RBI has pulled up the firm at least four times over a series of lapses.

Srinath Sridharan, a financial expert, says that the central bank's concerns are serious.

"The RBI has used provisions of a law that gives powers to the regulator to rule in public interest. This shows the gravity of the situation. Paytm has lost the regulator's trust," he said.

Launched in 2010, Paytm gained popularity after India banned high-denomination notes in 2016, a move that sucked cash out of circulation and boosted online transactions.

People began using the app for a range of transactions, including buying household goods, paying tuk-tuk drivers and even utility bills. Paytm saw big investments by Japanese technology investor SoftBank and counted Warren Buffett and China's Alibaba among its early investors.

The Paytm payments bank - which is at the centre of the current regulatory storm - got its banking license in 2017.

The bank can accept deposits of up to 200,000 rupees ($2,411; £1,907) but it cannot lend money; it offers digital banking services, fixed deposits, and sells third-party insurance and loans.

The bank has 50 million accounts, including those of merchants who accept payments using the platform's blue-and-white QR code stickers.

Mr Sharma has said that his company is exploring third-party banks to provide back-end banking support to merchant accounts, whose transactions contribute half of Paytm's revenues.

But this would mean that the margins earned on deposits and transactions would have to be shared with the partner bank and would further strain an already loss-making entity - Paytm has lost nearly 80% market value since its stock market listing two years ago.

Additionally, the company might face challenges finding a banking partner due to the regulatory hassles its currently mired in.

Paytm has been trying to reassure merchants through calls and messages, but analysts say severe restrictions and uncertainty is likely to impact the company's customer retention.

Traders have begun shifting from Paytm to other payment options. Banks, including the government-run State Bank of India (SBI), have already offered to help merchants transition with new QR codes and point-of-sale machines.

According to data by market intelligence firm, Sensor Tower, Paytm app has seen a 20% reduction in downloads since the RBI ruling, while rival apps like Google Pay and PhonePe have seen a 50% jump in downloads, Reuters news agency reported.

The bigger battle to fight will be on reputation, say experts.

Getty Images A traditionally dressed Indian fan looks at his mobile phone on the third day of the third cricket Test match between Australia and India at the Sydney Cricket Ground (SCG) in Sydney on January 9, 2021. (Photo by SAEED KHAN / AFP) / -- IMAGE RESTRICTED TO EDITORIAL USE - STRICTLY NO COMMERCIAL USE -- (Photo by SAEED KHAN/AFP via Getty Images) Getty Images

People use Paytm for a range of financial transactions

Experts say the ongoing crisis at the firm has raised questions about the efficiency of the firm's managing board, which includes finance veterans and former RBI officials, and that the banking regulator may seek changes in the board's management structure.

They have also expressed concerns over controlling interest of the founder in both the parent entity - One97 Communications, which houses the digital payments business - and the payments bank, saying the two are not operating at arm's length.

The action against Paytm comes at a time when India's most famous and expensive start-up - edtech company Byju's - is facing problems after battling a series of financial challenges. This has led experts to question the role of corporate governance in high-profile start-ups.

It has also sent ripples across the country's fintech and start-up firms - a group of founders have written to Prime Minister Narendra Modi, Finance Minister Nirmala Sitharaman and Mr Das urging a rollback of sanctions on Paytm, calling it detrimental for the Fintech ecosystem.

But Mr Das has clarified that the entire system needn't be concerned as the issue is with a "specific institution".

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