Two Sides of India’s UPI

Mastercard’s CFO, speaking recently at a UBS conference, has raised issues with India’s Unified Payment Interface (UPI) system. Describing it as ‘fantastic at many levels’, he also said it was an ‘incredibly painful experience’ for its ecosystem participants. He had reservations about its commercial sustainability.

Card penetration in India is low, with debit cards making up 13% of cashless payments, credit cards 26% and UPI 56% (source: Reserve Bank of India). UPI only started seven years ago and, unlike card schemes, functions at almost no cost for merchants. Its growth is helped by support from the government and regulatory bodies and India’s rapid adoption of mobile digital payments.

Mastercard claims that the banks who enable UPI payments make a loss on them, which must be unsustainable in the long term.

The Indian government is also promoting the RuPay card network. This has credit linkage with UPI, and it is seeing rapid growth, competing directly with Mastercard and Visa. The merchant discount rate (MDR) on RuPay debit card transactions is zero, perhaps helping explain the 100% volume and 50% value growth over the last five years. This has come at the expense of a 40% drop in the volume of transactions using debit cards linked to other networks.

Fintech ‘pain’

UPI has led to payment innovation by third parties. For example, Paytm, which has created ‘soundbox’ which offers real-time auditory notifications when a transaction has completed. It processes UPI transactions at no cost to merchants but charges them a monthly subscription fee or a one-time payment of as low as 999 Indian rupees ($12) for using the device.

One advantage of soundbox is it gives businesses access to a wealth of cash flow data from merchants. This has allowed some businesses to develop modern underwriting capabilities and to extend credit to previously underserved merchants. The Reserve Bank of India has recently added soundbox to the Payments Infrastructure Development Fund, an initiative that aims to subsidise the rollout of payment acceptance tools in India’s smaller cities.

In the financial year 2022, NPCI generated over INR 7.2 billion net profit, but fintech startups are still struggling to break even. Is UPI becoming a burden rather than an enabler?

The cost of a UPI transaction is borne by the acquirer app as well as the issuing and acquiring banks based on agreed terms. But since payments apps have to pay for the additional expense of acquiring merchants and customers as well, they deal with a higher overall loss.

Since UPI sits directly on the banking network, traditional banks do benefit from it through lower costs associated with cash dispensing and ATMs. In addition, ATM transactions per capita have fallen from about seven to five over the last four years, saving the banks money.

As a result, AllianceBernstein analysts argued this month that UPI’s benefits outweigh the costs involved in facilitating UPI transactions. Cash deposited in accounts has also risen.

Soon, banks will be able to lend through UPI partners, reducing more of their overheads for loan origination, but these benefits do not apply to startups.

What’s driving UPI?

Cashback is a key factor driving up UPI usage. One particular cashback scheme on one of the apps recently offered a guaranteed INR 5 cashback for peerto-peer transactions. Sending INR 2 to someone else resulted in a bonus for the sender.

Any app driving growth using this sort of promotion will increase its UPI share, but at a significant cost. They end up having to add on other financial services and products to capitalise on the traffic that UPI brings. Typically bill payments, business to business and business to consumer lending, buy now pay later, insurance broking, investments, credit card payments and Ecommerce/marketplace services.

Buying market share is expensive, but is it worth it in the long run?