The rise and rise of UPI

And what it could mean for the Indian banks’ technology planning

The rise and rise of UPI - CIO&Leader
On 22nd October, the Reserve Bank of India (RBI) mandated that only two existing and interoperable payment QR codes, UPI QR and Bharat QR - both developed by National Payment Corporation of India – will be continued and all other QR codes in existence have to be phased out by March 2022. This decision was based on recommendations by a committee chaired by Prof Deepak Phatak. The committee was set up specifically for suggesting measures for moving towards interoperable QR codes. 
“The above measures are expected to reinforce the acceptance infrastructure, provide better user convenience due to interoperability and enhance system efficiency,” said the RBI circular issued for the purpose. 
To be sure, the committee had recommended ‘multiple’ interoperable QR codes. “Considering the scale of the country, multiple interoperable QR codes should drive the acceptance infrastructure in coming years,” it had said.
RBI chose the recommendation by letter, rather than spirit, when it mandated two codes to go by, because of the recommendation of ‘multiple’. 
If anything, the committee had cautioned against a single QR code. “A common QR code or single QR across all payment instruments will create greater concentration risk. RBI should encourage multiple interoperable QR codes like Bharat QR and UPI QR to enable faster on-boarding of all types of merchants for digital payments,” the committee had clearly mentioned. The recommendation was for QR codes like Bharat QR and UPI QR, not necessarily only Bharat QR and UPI QRcodes. These two have been developed by a ‘single’ entity—NPCI. 
In the past, there has been intense debate about whether NPCI is controlled or significantly influenced by the government and/or the RBI—be it in its operational decisions  or appointment of key executives. NPCI is owned by multiple banks, with public sector banks—still heavily controlled by the government—holding a majority stake. 
What, however, helped RBI take this decision, is the immense popularity that UPI (Unified Payment Interface) has enjoyed since its launch. UPI, which has often been described as the brainchild of former RBI governor, Raghuram Rajan, and his ‘parting gift’ to India because it was launched a few months before his tenure ended, has since then, been aggressively promoted by the government. 
Sensing the government was moving towards interoperability and a government backed interface was readily available, many payment service providers promoted UPI aggressively. Especially for the challengers to Paytm, which benefitted immensely from its being ‘at the right place at the right time’ during demonetization and was clearing zooming ahead, it was a good rallying point. 
Google Pay built an early lead in the UPI-based payment market, while PhonePe was a distinct and somewhat distant second. Paytm too moved aggressively and has now picked up market share but Amazon Pay has also emerged as a major challenger. Latest market share figures are not available, but according to a Bernstein estimate, as reported by Business Insider, in May 2020, Google Pay held 38.4% share, while PhonePe had 19.8% share. Amazon Pay and Paytm had 16% and 15.5% shares respectively. Another report by TechCrunch, based on NPCI data, suggested that Google Pay had 540 million UPI transactions, PhonePe had 460 million while Paytm saw 120 million in the same period. Since then, Amazon Pay has clearly increased its share.
While almost all payment service providers have already moved to UPI, many, especially Paytm are still offering their proprietary QR codes for their wallet transactions, which also sees significant transactions. The government has also promoted NPCI-developed BHIM UPI app, which has taken off among certain kind of user base. 
In July, leading financial newspapers, The Economic Times and HT Mint, reported that NPCI was considering capping share of transactions of any single payment company in order to decrease dependence on any single third-party application, to avoid a system failure in case of one system going down. 
 
Rise of UPI
 
What makes RBI bet big on UPI is its immense popularity among users—because of some inherent features. First and foremost: the user does not have to block her money, as in case of wallets which popularized digital payments. Money is directly transferred from the bank account. UPI is also interoperable. A merchant can accept money from any of the payment apps used by the payer. However, a major constraint for many users is that the wallet transaction value is capped at INR 10,000 per user if KYC is not done. KYC is a major inconvenience for the user and is costly and time consuming for the wallet service provider. In UPI, there is no need for any KYC, as the bank has already done the KYC. So, that is a major hurdle removed for both the parties—users and payment apps. 
When it comes to P2P money transfers, unlike direct IMPS, a UPI-based transfer can be done immediately without waiting for the payee to be activated by the system. While for friends and family, it is still a good option, few would like to add a Kirana store or a petrol station to their payees in their bank account. Finally, you need not know/share the bank account number, and IFSC code of the bank branch which does not just make it more convenient to use, but makes it safer in the eyes of the user, as not many are comfortable in sharing one’s bank account number. 
In addition to that, UPI has been aggressively promoted and incentivized by the government. From prime minister to IT minister and all senior government officials have promoted UPI directly on social media. In addition, MDR (merchant discount rate) for UPI transactions was mandated to be zero by the government. What it means is that UPI transactions now do not cost anything to the payee (including the merchant) or the payer. That is another huge reason for the popularity of UPI. 
All this had made UPI grow immensely in the last three years. In October 2020, UPI transaction volumes topped two billion. That is a 20-fold rise in monthly transactions over the last three years. In terms of value, last month saw a total of INR 3,86,107 crores being transacted, which is a 40-fold increase in monthly values being transacted in the same period. They translate to a whopping 170% average annual growth (CAGR) in terms of number of transactions and 242% CAGR in terms of value being transacted on UPI every month. That is impressive by any standard. 
The fact that values have grown at a significantly higher rate than number of transactions shows that the popularity of the system has not just resulted in its widening UPI’s base but also its depth of usage. 
 
 
A comparison with a similar system will put the growth in context. In FY 2016-17, IMPS transactions totalled 507 millions with a total value of INR 4,11,624 crores. UPI, on the other hand, totalled 17.86 million transactions with a total value of less than INR 7,000 crores. The corresponding figures for the last year (2019-20) for IMPS were 2,579 million (more than five times) and the value transacted was INR 23,37,541 crores (close to four times). UPI, by the way, had grown to 12,519 million (about 70 times) while value transacted on UPI rose to INR 21,31,330 (more than 300 times). In the first six months of this year (FY 20-21), UPI had already done 8,487 million transactions with a value of INR 15,49,240 crores while IMPS had done about one-seventh in terms of transactions and about 20% less in terms of transacted value, UPI having overtaken IMPS in February this year, in terms of value—and thus establishing itself as the prime mode of retail transaction. 
Wallets, which actually kickstarted digital payments in a major way, accounted for 397 million transactions as compared to UPI’s 1,619 million transactions. Value of transactions would not be a fair basis for comparison as wallets have restrictions of INR 10,000 per month without KYC and INR 1,00,000 per month with KYC. UPI, on the other hand, does not require any KYC, as that responsibility is with banks, anyway. So, higher valued transactions can be done. In fact, UPI transaction limit of INR 1 lakh per day is not an issue for most of the ordinary users. 
Three reasons have contributed to UPI emerging as the most popular retail payment mechanism – a number of inherent features, almost no cost to the user & the merchants, and very aggressive promotion by the government. 
What needs to be examined is how important are the three reasons in comparative terms. For something to sustain in the market, it has to compete on natural market parameters, not artificial parameters like the first two, though their role in giving an initial impetus cannot be underestimated. 
 
Is it sustainable?
 
It may be too dramatic to ask if UPI is a sustainable architecture, considering the threshold volume that it has already reached. Nevertheless, it is important to examine whether everything is right with UPI and if the growth can be sustained over a period—especially if the above-mentioned push is withdrawn.
Users have been complaining about false success notifications; i.e. while the app said the transaction was successful, the money was not credited to the receiver’s account. Despite several follow-ups with their banks and NPCI, the issue took a long time, paper trail and exchange of several messages to resolve. In a report in March 2018, business daily, Business Standard, wrote about the problem, citing several aggrieved users of UPI. 
But with very tangible convenience and cost advantages, these ‘exceptions’ did not adversely impact the popularity of UPI as a payment mechanism. 
After all, such exceptions were few and far between. These errors happen when the transaction is declined due to technical reasons, such as unavailability of systems and network issues on bank or UPI side and are hence called technical declines (TD) to distinguish them from declines due to user side issues, such as wrong PIN, wrong account number, violating per transaction or per day limits, etc., which are called business declines (BD). While the business declines are not due to the UPI system, technical declines are clearly due to issues on the system side. 
 
 
Till as late as in March this year, these technical declines ranged between 0.1% of transactions to 1.91% of transactions for different banks. From the eight banks that saw high transaction volumes (more than 30 million per month), seven had less than 1% technical decline rates. That was not something to be too concerned about, even though the largest of them, State Bank of India, had seen 1.84% technical declines. 
 
 
Things have deteriorated sharply. In September, the technical decline rate had reached 2.7% of total transactions. For banks with larger transaction volumes, it was even higher at 2.9%. As many as eight of the top 30 banks whose data is available, had more than 3% technical decline rates, with some touching almost 6% (Canara Bank, 5.93%). State Bank of India, which accounts for 27% of all transactions executed by these 30 banks, had 5.31% technical declines. 
 
 
But what is revealing is the sharp contrast that exists between public sector and private banks. While the 11 private sector banks saw a technical decline rate of only 1%, the public sector banks’ TD rate was almost four times higher at 3.8%. Within private sector banks, both the payment banks – Paytm Payments Bank and Airtel Payments Bank - saw technical decline rates of less than 0.4%.
The reason for this contrast is not too difficult to guess. Many of the public sector banks have aging digital infrastructure, which are probably equipped to handle these high volumes. UPI transactions require almost real-time communication involving five servers—payer payment service provider (PSP), remitter bank, UPI system, payee PSP and the receiver bank. Any latency or break in communication can result in transaction failure. In times of high volumes of transactions, server may choke. Since the UPI request hits a bank’s core banking system, unlike the wallets, it puts pressure on the bank’s infrastructure. 
So, even though Paytm Payments Bank and ICICI Bank have high volumes, their technical decline rates are quite low. Most older banks need to upgrade/modernize their infrastructure to ensure that technical declines are minimized. Private sector banks and the new payment banks have state-of-the-art digital infrastructure that handle the transactions better.
But thanks to the zero MDR rule mandated by the government last year, banks are not supposed to charge any fees which means they do not earn anything from the UPI transactions. So, they have little incentive to upgrade the infrastructure. 
Banks and NPCI have been voicing these concerns and have been demanding zero MDR rule to be changed. But even if the government listens to that, it is highly unlikely that things will immediately change for better. 
Another potential threat in the future is the vulnerability of NPCI system. If the media reports are true, NPCI is planning to cap share of transactions of any single payment company in order to decrease dependence on any single third-party application, to avoid a system failure. The same could be asked about NPCI system too. While UPI system uptime has been maintained above 99.8% every month since January, that could be vulnerable too. And even 99.83% (April) or 99.85% (September) are low by a real-time transaction system standard. 
In short, while UPI has had a successful run so far, past performance cannot be guaranteed. Especially, if the government decides to stop intervening. 
For the banks, which have to keep their customers, there is no option but to modernize their digital infrastructure to handle high volumes of real-time transactions, as volumes will only go up.
Beyond UPI too, banks need to assess their readiness for an increasingly 24/7 transactions world with high volumes of transaction. That is the next challenge for Indian banks, especially the public sector and old private sector banks.
 

UPI has been aggressively promoted and incentivized by the government. From prime minister to IT minister and all senior government officials have promoted UPI


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