UPI has many subsystems
Indian UPI has created a fanbase globally. Many countries want to replicate the UPI system. But it is not easy. UPI is amongst the final piece in Indian financial system. Lets understand it.
UPI is a mechanism for a direct person-to-person digital payment system. India now has the largest number of digital payment transactions in the world. The success of UPI is like a river with many tributaries. How did it come about?
Going cashless was not easy. Cashless transaction includes
digital transactions (i.e. UPI transactions, all the payment apps, food apps, taxi apps, etc.),
credit card transactions,
Contactless card transactions (Apple pay, Google Pay, etc.)
website transactions,
web-based apps including PayPal etc.
BUT India was always a cash-driven economy. This move did not happen easily.
1960s brings in the Credit Card
The concept of credit cards was difficult to sell to Indians. Gradually Credit Card industry got a foothold. Credit Card needed a telephone line, card, POS machine and verification by bank (issuing credit card) and card provider (Visa/Mastercard/Amex).
But all these items (POS machine, card issuing, credit checks, etc.) imposed a cost. This meant it increased the price of things we buy to the tune of 3 to 13%. Therefore even Indians who had credit card did not use them as much.
Debit Cards join in 1987
To entice Indians, a debit card was introduced in 1987. Here some costs were eliminated (no credit check required) but others remained. Plus debit card is directly linked to account so if it gets lost or stolen your account is at risk. So people used it infrequently.
IMPORTANT: Interest rates were VERY high 15-19% during 70s/80s & 13-16% between 80s/90s. Interest rate on credit card would be even higher. (Today its 20-25%) So people did not want to touch money in bank, spend the cash as it earns nothing. Money in bank earns something.
Fixing the Banking backbone - 2004
While this all was happening, RBI and Indian banks were busy creating a system for settlement of inter-bank transactions. Real Time Gross Settlement RTGS system came up in 2004. The RBI and banks continued to improve the RTGS system.
This made online payments really easy. And online payments were convenient BUT most Indians did not know it. Business did use this option in their B2B settlements but common man was still not taken in.
Then came IRCTC.
IRCTC managed the ticketing for Indian Railways. IRCTC was advertisement for convenience of digital payments across India in mofussil towns and villages. At once digital payments and online ticket booking reduced corruption and allowed people to buy tickets from any place with a computer and internet connection.
Meanwhile bank digitisation entered the next phase.
In 2007-08 National Payment Council of India NPCI took a massive leap in digitisation of bank accounts and interbank settlement systems so banks could exchange money quickly. The idea was mooted if banks can exchange money this easily can individuals do it?
App-based payments enter the fray!
With advent of iPhone and Apps based ecosystem China took a lead in creating payment apps. India was watching. A copy-cat concept was thought of - App-based payments. That’s when the challenges came to the fore.
The complexities of modern banking and digitisation culminated into 3 problems. We needed to identify the users (payer and payee) uniquely. We needed to identify and connect the accounts of the payer and payees to each other. We needed a means to confirm that transaction has indeed happened.
To simplify identity previous UPA government introduced Aadhar. The NPCI had already digitised bank accounts. And settlement system was in place. But still there was a problem.
People did not have bank accounts. Many shopkeepers, street vendors did not have bank accounts. Banks won’t open their account because they cannot verify identity of that person. We were in a JAM.
JAM to get out of a jam!
It was PM Modi realised the potential of Aadhar & digital payment system. He launched the JAM Scheme i.e. Jan Dhan, Aadhar and Mobile.
Aadhar was scaled up pushing every Indian to signup for this Unique identity. Today Aadhar boasts of more than 1.35 billion unique identity cards.
Under Jan Dhan scheme banks were required to open an account for every Indian. The presence of bank account linked to Aadhar meant it became easy for government to give directed subsidy. But the account facilitated more activities.
Both these were tied to mobile.
Then in a masterstroke UPI was launched in 2016. UPI was initially very slow to takeoff. But taxi apps, food delivery apps and grocery apps pushed the digital payments concept deep into India.
The rural push came from SMS about subsidy money reaching accounts. At this time mobile penetration - coverage and Chinese handsets was increasing. People who received SMS about money getting INTO their accounts wanted something that can send money TO others.
To enable this PM Modi openly and actively suggested in national address and on Man Ki Baat that one young person should educate 3 seniors. It did work. More so because getting money was easier.
Street Vendors liked UPI because then they don’t have cash which goons can forcibly take away. UPI was cheap, there is no cost to transact on UPI for vendors, so no increase in price. Digital transactions were preferred by suppliers - as its easy to manage than cash.
With a unique Virtual Payment Address (VPA) serving as an identifier, users can link multiple bank accounts to a single mobile application. This eliminates the need to share sensitive banking details, making transactions safer and more efficient.
While cash handling became expensive, interest rates also declined. Now they are so low so there is no difference in spending cash v/s spending money from bank account.
In sum
A lot of things were played in the right way to get this UPI advantage working.
Soon banks will be able to analyse UPI transaction history to assess credit worthiness of small vendors and extend loans to them.
Digital payments may simplify taxes, compliance and management of fully digital businesses (all transactions digital). During this time income tax became digital now GST is also digital. Yes there are challenges but you see where its going!
In short UPI is a game changer!