Sunit Arora examines the debate in India on how best to pay for the unified payments interface and the financial innovations it promises to bring.
It’s no secret that digital payments via smartphones have transformed personal and commercial transactions in urban and semi-urban India over the past couple of years. Quick-response codes have proliferated. A staggering 237 million QR codes were used on the unified payments interface (UPI) in December 2022, according to Worldline India. Indians are quick to pull out their phones to make or receive payments.
It’s even spawned a typically Indian innovation. Because retailers need to keep track of multiple transactions in busy retail markets, small ‘sound boxes’ have been installed to read out payment confirmations.
In just a few years, India has become the third-largest fintech ecosystem globally after the US and China by user base, according to Redseer. The jewel in the country’s payments crown is the UPI, which enables instant account-to-account transfers via smartphone. Set up in 2016 by the National Payments Corporation of India (NPCI), UPI commands 75% of retail digital payments in India.
UPI’s architecture binds the consumer’s mobile phone into the payment platform, with one standard app for accessing bank accounts. It has single-click 2-factor authentication, and payment is single-click. That convenience is taken for granted in India, but still a novelty in other parts of the world.
India is starting to build-out cross-border payment agreements, such as with Singapore, UAE and Bhutan, and 13 countries have expressed interest in using the UPI interface for their own digital payments infrastructure. Recently, NPCI’s international arm set up a strategic partnership with the UK-based digital payments infrastructure provider PPRO to allow international payment service providers and merchants to tap into UPI.
The ease of use that makes the app so attractive is, of course, not lost on Indians themselves. According to the Reserve Bank of India, the value of payments via UPI has shot up by 46%, from ₹9.6 trillion (c. £93 billion) in March 2022 to ₹14.04 trillion (c. £136 billion) in March 2023. In volume terms, UPI payments have grown by an impressive 60% over the same period.
This rise in digital payments comes over six years after the shock demonetisation of 86% of the currency in circulation in November 2016. The government served up many justifications for the move; one of them was increased digitalisation of the economy.
To be sure, the exigencies of the Covid pandemic, coupled with seamless ease of use for consumers, has led to some change in mindset in urban and semi-urban India. Still, India continues to be a predominantly cash economy. The ‐ currency-in-circulation-to-GDP ratio was 12.2% as of December 2022. To compare, in the UK it is under 4%.
Two big shifts at UPI
Realizing that there is a window of opportunity to further push adoption of digital payments, the RBI is now spurring innovation at UPI. In particular, two recent enhancements will open up new segments. This could have implications across the financial ecosystem. It could also lead to potential challenges.
First up, the NPCI said on April 1 that it will introduce an interchange fee of up to 1.1% for merchant transactions above ₹2,000 (c. £19.5) made using prepaid instruments (wallets, gift cards and so on). This, the NPCI said, is part of bringing wallets into the interoperable UPI ecosystem.
The interchange fee is not paid by the consumer — at least not directly — something that the NPCI made clear. It is paid by the merchant’s UPI solutions provider to the consumer’s UPI wallet provider. Wallets account for just about 2% of UPI transfers.
On the face of it, this decision has a limited impact on the fintech ecosystem. At best, it will facilitate the interoperability between wallets and UPI; it could perhaps encourage wallet providers to promote products. That said, some industry experts argue that the interchange fee could negatively impact wallets, as merchants may not be happy paying a fee for something that has been free until now.
For context, fintech firms and banks do not make money from facilitating UPI; consumers are not charged for money transfers, which is no doubt an important factor behind its explosive growth. At the same time, UPI payment firms have been demanding a merchant discount rate (MDR) — which is levied on the merchant for processing a debit or credit card transaction but is zero for UPI — saying that they incur costs for every payment.
Clearly, NPCI is testing the waters to levy fees for UPI transactions. Last year, it allowed the linking of Rupay credit cards (an Indian answer to global payment networks like Visa and Mastercard) to UPI — and for this merchants are being charged MDR.
This will have to be carefully thought out. The boom in India’s internet connectivity has been driven by practically free services. The NPCI will not want to risk derailing growth but, at the same time, it wants to signal to the fintech ecosystem that there’s money to be made from UPI.
The other significant move is the decision to enable credit via UPI. Now, banks can issue pre-approved credit lines to consumers. With this, the RBI hopes, banks will be able to structure innovative credit instruments via UPI.
According to the Worldline India report on digital payments in 2022, debit card transactions have seen a steady decline throughout the year and that this is “very likely” an outcome of the increase in UPI transactions.
At the same time, credit card usage is growing. According to Worldline India’s report, banks increased the number of credit cards by 18 per cent in 2022. Indians prefer using credit cards for high-value transactions. If banks can structure credit lines that mimic credit cards, UPI could prove to be a credible alternative to the credit card space.
What could go wrong?
What could go wrong? Plenty. At a talk in March, RBI governor Shaktikanta Das drew on a cricket metaphor — “you are only as good as the last ball faced” — to warn of challenges ahead. The concern is that consumer protection and redressal mechanisms are not up to scratch at payment firms and that a spate of negative incidents could turn away users from UPI.
Das acknowledged that “at times, some payment system operators display unwillingness to comply with regulatory instructions, citing various reasons like cost.” Also, when fintechs innovate with digital lending tools, there is a potential systemic risk from unsecured loans driven by machine learning models. That is why the RBI released guidelines to regulate digital lending in September 2022. Clearly, it’s early days yet.
Another potential landmine in the future is regulating the payment companies. In December 2022, NPCI extended for two years its decision to enforce market share limits in payments to curtail monopoly power.
But, for now at least, India wants to grow UPI at all costs
Sunit Arora is an independent journalist and editor based in New Delhi. His twitter handle is @sunitarora