Changing Face of Payments in India

A Brief History of Payments

Last four years in the Indian fintech industry have been very eventful. Pre-2015, payment gateway and digital wallets was a fairly new concept. Very few people transacted online or paid their bills online. But then came the wave of digital wallets offering huge cashbacks in the race to acquire customers. Some of them faced a dismal death, some of them got acquired and then again got sold, and some of them had to change their business models to stay relevant. Historically, India has been a cash economy (with a significant grey economy) and government has been trying hard to increase the tax coverage, increase accountability and reduce the cost of managing cash. While demonetization came with a promise to change the digital landscape but it failed miserably at the execution level – the intent of the government cannot be questioned. However, demonetization turned out to be a boon for some of the wallet companies and they capitalized on the same really well (it did help bring some of the payment players to the forefront). For a brief period post-demonetization, the cash to digital money ratio did change but a permanent change in consumer behavior does not happen overnight. After few months, cash was again the king. But things are now changing for the good. One metric to measure the growth of digital transactions in a country is the number of digital transactions per capita per annum. This metric was 2.4 digital transactions per capita per annum in 2015 and has grown to 22 in 2019. To give a comparison how we fair on this globally – Singapore has the highest ~730 digital transactions per capita per annum in 2015 and the US was at 420. While there is no dearth of statistics available publicly (smartphone penetration in India, data consumption trend, internet penetration, propensity to spend, gross disposable household income trends, lifestyle changes etc.) to show why digital payments have increased and would continue to increase at accelerated rate, but we have a long way to go.

Nonetheless, the government has been trying to transform the payments ecosystem. Some of the key focus areas have been

-       Build rich payment ecosystem – safety, interoperability & standardization

-       Expanding the acceptance infrastructure

-       Correct the cost structures that inhibit the merchants and acquirers

-       Reduce overall cost for the customer

-       Increase consumer confidence

NPCI was created to lead some of these initiatives and create a level playing field for all the players in the ecosystem - be it banks, technology players, schemes etc.

The Hidden Agenda

The first installment of NPCI was Rupay. Some experts strongly believe that Rupay was created as a parallel system against Visa/Mastercard (MC) to keep them in check. There has been a significant push from the government to banks to issue Rupay cards (under Jan Dhan Yojna) – number of Rupay debit cards stood at 600+ million in 2019 – this is more than 60% of total debit cards in India. Rupay holds more than 30% market share in terms of number of transactions – this is huge given Rupay was launched only in 2012. As the network becomes stronger government will be able to regulate the sector much more strongly which was not possible thus far due to Visa/MC controlling the network of payments (plus to ensure that Indian money stays in India). Another major step (infact bigger than Rupay) from the government has been the launch of UPI (Unified Payment Interface).

UPI as a concept is very unique and one of its kind globally. UPI story has been so remarkable that even the global giants such as Google launched India centric offering called Google Pay (earlier known as Google Tez). The growth rate of UPI transactions has been phenomenal - UPI clocked 1+ billion transactions in December 2019 in just about 3 years - this is mainly driven by companies such as Google Pay, Paytm and Phonepe. Different products are evolving around UPI - recurring payments, refunds, lending etc. – to solve for various use-cases. UPI is a significant threat to not only Netbanking transactions but also to Debit Cards mainly because of the ease of use and the cost factor – already UPI P2M transactions contribute almost 20-25% of the total P2M transactions (and for certain merchant categories even more). The contribution is only going to increase in the future given the cost, ease of use/adoption/experience and push from the government. UPI is expected to contribute almost 60% of payment transactions.

On 31st December 2017, government announced zero MDR on DC & UPI transactions less than INR 2,000 to promote digital payments adoption for the next two years. At the same time government promised to reimburse the banks for these transactions (for the cost that the banks incur in terms of interchange, switching fee, technology etc.). While the government kept its promise but only to give a bigger surprise after the completion of the two-year period. On 31st December 2019, the government discontinued zero MDR on DC less than INR 2,000 transactions for Visa/Mastercard but also made Rupay and UPI transactions at zero MDR. While this created panic across the payments ecosystem (especially among the banks) but it has also created a level playing field for all the players and gives an edge to the ones that can offer the best technology offering. Given their revenue models have gone for a toss, banks have been strongly lobbying with the government to waive-off the interchange fee and the switching fee (and the fee that they have to pay to the various technology partners) which they continue to pay despite not being able to charge any MDR. There is also a strong possibility that most of the banks may oppose issuing the Rupay cards. This change has of course created tremendous pressure across the entire value chain while merchants and customers stand to gain from such a move. Also, this would mean that the overall transactions (mainly driven by merchant and customer choice) may lean towards Rupay and UPI (lower cost options) further reducing the volume share of Visa/Mastercard. The second announcement that came along was from CBDT (Central Bureau of Direct Taxes) to all the merchants doing more than INR 50 Cr. of annual turnover to have UPI and Rupay as mandatory payment options. Again a move to bring more businesses and people under the tax bracket.

Some of the smaller payment players see this as an opportunity to gain volumes by promoting government’s notification of zero MDR, however, commercials alone will not help to win the game – players with a strong technology offering will only survive these changing times.

What does the future hold?

The cost structures in the ecosystem are set to get disrupted again. It will not be surprising if the government plans to change the percentage based MDR on DC and NB to flat rates (for some of the categories). While it is understandable that there is percentage based MDR for credit cards (because issuing banks carry the credit risk and are offering a credit line to consumers) but why should percentage MDR exist for DC and NB. DC and NB are linked to the account of the consumer where there are existing funds and there is literally no risk of default. Of course there are some cost components that the banks bear to build the infrastructure to process DC and NB transactions but does that justify percentage based MDR is the question? Historically, banks have been using cost (across various payment methods) as a main lever to acquire merchants (along with traditional banking levers such as credit line at aggressive rates, float, current accounts, saving accounts of employees etc.) but this advantage is soon going to go away atleast from the payments perspective.

For many years, payment players have been using the two main levers – success rate of a transaction and transaction cost to gain traction, however, with the cost factor gradually becoming irrelevant and success rates converging - the only players that will survive will be the ones that will add value technologically (and through servicing). This also means that the technology players will have to evolve much faster to stay ahead in the game. Businesses are not just about collecting payments from customers, partners or vendors – they have much more complex money flows and many pain-points throughout that journey – from vendor payments to salary payouts/payroll processing to invoicing and government tax payments to managing working capital to converting cash into digital money (and many more). Traditional payment gateway offering alone will not be enough to survive the battle and players will have to expand beyond payments. The only players which continue to solve for use-cases across the various money flows and offer a complete suite of financial solutions will remain relevant (or even exist).

These are exciting times. Unbundling of traditional bank services and offerings had already started – be it offering current accounts to businesses or issuing a credit line or even as a channel to sell insurance/other products. New models on the back of technology are already emerging – started with payments banks and now Neobanking and digital lending are the buzz words in the market. Will it end here, of course not – it is just the beginning of a bigger disruption - next one year would see stronger push from government for digital payments adoption which means further rationalization of cost structures, new offerings, new regulations – and all this may result into further consolidation in the market. Only the ones with the technology muscle power and/or deep pockets can withstand the upcoming challenges.

A good analogy to Payments industry is probably the Telecom industry (with more than 10 players some time). There were significant charges for voice calls (both incoming and outgoing) in the early part of the last decade. Then the voice became free and telcos started charging consumers for data and value-added services and later on started offering 100s of GB of data for free. The ones who could not evolve or survive the cost pressures got acquired or merged. Now every other player has started venturing into content (bundling of various services/plans) and some have already diversified into selling insurance (through the network that they have over last 10 years). Payments industry is expected to go through a similar evolution. Change is the only constant.

This will not be the “Survival of the Fittest” but the “Survival of the Fastest”.

Disclaimer: Above is completely a personal opinion of the author. Topics such as Payments bank, Neobanking, Digital lending are huge in themselves and have been touched upon to present a view where things are moving.