UPI Credit Lines: How NPCI's New Guidelines Unveil a Lucrative Opportunity for Banks

India’s digital payments ecosystem is set for another transformative shift with the upcoming changes to the Unified Payments Interface (UPI), as the National Payments Corporation of India (NPCI) prepares to roll out new guidelines from 16th October 2024.

The key change revolves around allowing banks to charge an interchange fee of 1.2% on UPI transactions made via pre-approved credit lines, unlocking a fresh revenue stream for banks and reshaping the UPI landscape.

This development marks a significant milestone in the evolution of UPI, positioning it as a direct competitor to credit cards by offering similar credit-based payments, but with distinct advantages in accessibility and ease of use.

The move aims to balance consumer convenience with the economic sustainability of banks and fintech players, further expanding the possibilities for digital payments in India.

What Are UPI Credit Lines?

UPI credit lines allow users to access pre-approved credit from their banks, directly linked to their UPI accounts. Essentially, it’s a pre-sanctioned loan that customers can utilize for payments at participating merchants, providing them with a credit option without the need for a physical credit card.

The NPCI’s upcoming guidelines will introduce an interchange fee—paid by merchants—for transactions made via these UPI credit lines. The proposed fee of 1.2% will be applicable on transactions over ?2,000, with no additional cost to the consumer. This fee structure mirrors the existing model for credit card transactions, where merchants bear the cost of accepting credit payments.

Interchange Fee Structure: A Game Changer for Banks

The introduction of a 1.2% interchange fee on UPI credit line transactions could create a substantial new revenue stream for banks. Interchange fees are typically paid by the merchant to the credit issuer (banks) for each transaction and represent the bulk of the merchant discount rate (MDR).

Under the new guidelines, this fee would be divided between various players in the UPI ecosystem, including banks, UPI apps, and payment processors like NPCI.

Banks, which take on the bulk of the credit risk, are likely to receive the majority of this fee—up to 90% of the MDR—while third-party apps like PhonePe, Google Pay, and Paytm are expected to earn around 8 basis points (0.08%) per transaction. This structured revenue sharing offers banks a strong incentive to develop and promote credit lines on UPI, despite concerns that these products may cannibalize their more lucrative credit card business, which traditionally earns higher MDR (up to 2%).

Impact on Banks: Opportunities and Challenges

For banks, the introduction of UPI credit lines offers both opportunities and challenges. On one hand, UPI credit lines present a new, fast-growing market segment that allows banks to tap into India's enormous digital payments landscape. UPI has already transformed payments in India, processing over 10 billion transactions in August 2024 alone. Offering credit directly through UPI could further accelerate this growth and increase consumer engagement.

On the other hand, some banks are hesitant to fully embrace UPI credit lines, fearing it may eat into their credit card profits. Credit cards yield higher MDR rates and often come with additional benefits such as loyalty points and interest-free periods, making them more lucrative. However, NPCI’s directive mandates active participation from banks to foster widespread adoption of credit lines on UPI.

Product Variants: Interest-Free vs. Interest-Bearing Credit Lines

The UPI credit line product will likely be available in two versions:

1. Interest-Free Credit Period: Similar to traditional credit cards, this version will offer customers an interest-free period to repay the credit used.
2. Interest-Bearing Credit Line: This version, akin to an overdraft facility, will charge interest from day one of the credit utilization.

Both versions will follow the same interchange fee structure, simplifying operations for banks and merchants alike. However, these credit lines will not be available for person-to-person (P2P) transfers, as there is no interchange involved in such transactions.

Merchant Response: Resistance and Acceptance

Merchants, particularly small businesses, may initially resist accepting UPI credit line payments due to the additional interchange fee. However, this fee remains lower than the MDR on credit card transactions, making UPI credit lines a more cost-effective option for merchants. As the product gains traction and consumers become accustomed to using UPI credit for purchases, merchant acceptance is expected to grow.

Prepaid Payment Instruments (PPI) and UPI

Another key change coming into effect in 2024 is the introduction of an interchange fee of up to 1.1% on UPI transactions made through prepaid payment instruments (PPIs) such as digital wallets like Paytm and PhonePe. For transactions over ?2,000, this fee will apply, further expanding the scope of UPI-based digital payments and encouraging greater usage of PPIs alongside bank-linked UPI accounts.

Future Prospects: UPI as a Credit Card Competitor

The introduction of credit lines on UPI, backed by the ability to charge interchange fees, positions UPI as a formidable competitor to credit cards. The product offers several advantages over traditional credit cards, including broader accessibility, ease of use through UPI apps, and the potential for wider adoption in semi-urban and rural markets. For consumers, UPI credit lines offer a seamless way to access short-term credit, without needing a physical card or going through the formalities of traditional credit card applications.

Collaboration with Third-Party Apps and Fintechs

Fintech companies and third-party UPI apps stand to benefit from the new guidelines as well. By earning a share of the interchange fee, these companies can enhance their revenue models and reinvest in building better user experiences. Collaboration between banks and fintechs will be crucial to ensuring the successful implementation of UPI credit lines. Apps like PhonePe and Google Pay have already expressed interest in integrating UPI credit lines into their platforms, creating a unified ecosystem where consumers can access credit at the point of payment.

Conclusion: A Win-Win for India’s Digital Economy

The upcoming changes to UPI guidelines offer a promising new revenue stream for banks and an expanded set of payment options for consumers. By introducing credit lines on UPI, NPCI has opened the door for a more inclusive and accessible form of digital credit, while keeping costs low for consumers. Although challenges remain, particularly regarding merchant acceptance and the potential impact on credit card profitability, the overall outlook for UPI credit lines is positive.

As UPI continues to evolve and expand its reach, the introduction of credit lines represents another step towards cementing India’s leadership in digital payments and creating a more inclusive financial ecosystem.