UPI’s Conundrum: To Charge or Not to Charge from Users

In November 2016, when India faced “demonization” and people suddenly had no money for daily transactions, Paytm’s mobile wallet saved the day, and applications such as “PhonePe” and “GooglePay” appeared later.

At the time, most of these apps charged merchants a transaction fee of nearly 1.5 percent, while regular users were charged every time they tried to deposit money into their bank accounts using the payment app’s wallet functionality. So, every time a consumer tries to buy groceries for INR 300, the merchant has to pay a transaction fee of 1.5% or INR 4.5. This may seem insignificant, but when you consider that the ideal profit for a trader is 5-6% (or INR 18), the resulting amount definitely means a lot to the trader.

That all changed when the Indian government introduced the Unified Payments System (UPI) and “BharatPe” started distributing universal QR codes to merchants. Before UPI became popular, it accounted for only 6% of all payments in India, while card payments accounted for 36% of all transactions. But in FY2021, UPI’s market share rose to 63%, while card payments dropped to just 9%.

In India, real-time payments powered by UPI could save an additional $12.6 billion in costs by 2021, according to a report. UPI alone contributed to the Indian economy with an increase of $16.4 billion or 0.56% of GDP. UPI payments are expected to add $45.6 billion or 1.12% to India’s GDP by 2026.

While UPI may have solved the interest rate problem for merchants, at the same time it stopped generating revenue for payment apps.

Also, because the RBI ordered banks to refrain from charging transaction fees on UPI transactions, the banks themselves were unable to record profits through UPI. The adoption of UPI has also slowed down the use of traditional systems such as online banking and NEFT, leading to a decline in profits in the form of transaction fees for banks.

Will UPI be profitable?

If we take data from October 2022, the total value of transactions through UPI was almost INR 12,11,582. Now, if banks charge a transaction fee of at least 1.5%, banks can earn INR 18,173 crore in one month.

Since the main attraction of UPI is that there are no transaction costs, it is reasonable to speculate that the overall utilization of UPI may decline with the introduction of transaction prices. Also, charging transaction fees for UPI transactions seems a bit hypocritical, as India aims to eliminate transaction costs for offshore payments and transfers through UPI.

Are we deadlocked?

Not really, no. BharatPe is one of the many fintech companies operating in the UPI ecosystem that has been able to generate huge profits. But the real question is, are banks copying BharatPe’s business strategy? Or in other words, can the bank support other fintech services like Google Pay, which have been losing money since their launch in the Indian market?

BharatPe’s strategy essentially means extending credit to merchants rather than charging merchants transaction fees. The company understands that 13 million Kirana stores play an important role in India’s $600 billion retail industry. Often, these small businesses need capital but don’t have enough credit to borrow from banks. So BharatPe developed an algorithm to track the cash flow of these small convenience stores and their spending habits.

BharatPe then issues loans based on their algorithm results. The success rate of this model can be analyzed simply by the fact that the company was able to recover 96% of the funds borrowed. The scale is even more apparent when one sees that BharatPe has allocated INR 36 billion in the April-June period alone.

BharatPe does this by deducting a certain amount every month even before the merchant receives the money from the customer. For example, if a trader borrows INR 10,000 from BharatPe and the company charges an interest rate of around 2% per month, that would be approximately INR 200 per month. The app will then deduct the specified amount each month, eliminating the need for manual payments. For example, BharatPe will offer INR 14,500 only if the trader’s cash inflow after deducting some loan repayments is around INR 15,000. This way, neither the merchant nor the payment application is exposed to any significant load.

Considering that the corporate e-Rupee was launched by the RBI on a pilot basis, it could be rolled out to the retail sector just as quickly. Now more than ever, the RBI has the potential to exploit merchant and consumer transaction details.

According to NPCI data, 23.3% of the total transactions processed through the UPI ecosystem in October 2022 will be P2M, amounting to over INR 282,000. According to NPCI, the main industries involved in such P2M transactions are grocery stores and supermarkets, restaurants and department stores.These are specific sectors that require working capital on a daily basis and given the current state of currency development, RBI may consider adopting a business model like BharatPe in the near future.

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