UPI success story: How UPI Became a global innovation?

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By vexwift.com

Introduction

In April 2022, Coinbase the crypto exchange announced support for payments made through the unified payments interface or UPI in India. Unfortunately, a few hours later the National Payments Corporation of India or NPCI the company maintaining UPI, said that they were not aware of any such thing happening. Coinbase still doesn’t work in India, maybe it will by the time you are reading this, but this kerfuffle aside, the incident has highlighted UPI’s importance in India. This is a truly interesting piece of national fintech that the Western world should know about. I’ve been interested in writing an article about UPI success story for a while. Now this opportunity is as good as any, to start.

Why is UPI important?

India has long been a cash-driven economy. A vast majority of its transactions are done in cash. In the 2012-13 year, India’s ratio of cash to GDP was nearly 13 percent, one of the highest in the world. To compare the United States is 7.4 percent and Sweden is 1.8 percent.

UPI success story


People love using cash and that has long presented a challenge to the government. One sore point for the Indian government is that, cash transactions help people evade income taxes. Cash helps them hide their wealth from review.
So the Reserve Bank of India has long made it a focused goal to make the Indian economy less cash-dependent. Not totally eliminating the use of cash transactions but making it easier to use digital cashless transactions.
Yet in 2015 Indians made an average of just six non-cash transactions for the entire year. Only a fraction of the country’s 10 million plus retailers accept non-cash payments despite having the capability to do so.
Upi had been in the works for a long time. The story begins in 2005 when the Reserve Bank released a vision document detailing their desire to set up an umbrella institution for all of India’s retail payment systems working with the Indian Banks Association IBA. The Reserve Bank founded and incorporated the MPCI in December 2008.
The following April, the company started operations with a mandate to consolidate all of the country’s disparate systems. Together create a uniform affordable payment system. In 2009, with the blessing of the reserve bank, the MPCI started by taking over the operations of the National Financial Switch NFS, (India’s largest network of ATMs).
Banks have ATMs that help customers deposit and withdraw money. Having as many ATMs as possible around helps the bank better service its customers wherever they are.
But deploying so many of these expensive machines across a vast populace is costly. If a bank joins the switch’s shared network, its customers can use and be serviced by the network’s other ATMs.
At that time the network had about 50,000 machines and 37 banking members. Under the MCPI overview, the network has grown to 256,000 machines and 1200 members. Its ATMs are free to use for customers.
The idea to start with the ATMs was quite astute. To join its ATM sharing scheme, the network’s member banks had to adopt common digital standards to communicate with each other.
the standard can then be leveraged and expanded into new services. The NPCI thus introduced the immediate payment system or IMPS in 2010 built on top of the NFS’s financial infrastructure. With this end users can instantly transfer funds between banks at any time.
banks seem to have heavily marketed this 24/7 feature availability. IMPs require the sender to know certain personal and banking details about the person they are sending money to or requesting money from. This includes their phone number and a seven-digit mobile money ID number, which contains routing and account information.
If they are sending money to a business entity account, then they need to know the beneficiary’s name, its bank account number, and its bank’s Indian financial system code or IFS.

IMPS adoption challenges

The amount of money transacted through IMPS grew in 2014. IMPS facilitated about 54 million transactions that quickly grew in 2020. Indians conducted nearly 3 billion transactions through IMPS.
With that being said, IMPS still had some usability flaws as a transfer service. While transactions can be initiated over the phone, there is still considerable payment friction. It reminds me of the way they send money in Taiwan.
Taiwanese banking infrastructure is quite ancient. To locally send money to a person or company, you need to know their three-digit Taiwan bank code, different from the swift code and their bank account number. This number is often very long and difficult to remember.
So NPCI still felt that improvements could be made. Two major national developments helped pave the way to make them possible. First, the Indian people rapidly started adapting smartphones as telecoms like Reliance and Jio drastically brought down data prices.
Indians enjoy some of the cheapest data rates in the world and the vast majority now have smartphones.
second, the Indian government completed a national identity id service called Adhar.
having this opened the door for improved Know Your Customer KYC security requirements and preventing fraud.
UPI is thus built on top of IMPS, but smooth out a lot of the friction that makes the IMPS system difficult to use.


How UPI works?

With UPI banks, financial institutions, mobile platforms, payment systems, and users can interact with one another. Using a single digital language, UPI is a protocol, not an actual bank account or digital wallet like Venmo. There is no need to first preload anything with money from your bank.
account which skips a frequently inconvenient step. UPI gives each Indian with a bank account the ability to create a virtual payment address. Sometimes also called a UPI ID.
You set it up along with a PIN code for authentication called MPIN when you download a UPI app from your bank.
Once the address is set up you can send or request payments from others without the need to awkwardly share bank account details. QR codes are also available.
The person-to-person payments experience of UPI reminds me a lot of Zell, an American payments network integrated into many big American banks.
Like with an UPI-enabled app zell lets you transfer money directly from one bank account to another without needing to know the gory banking details.
Unlike with Upi however, Zell doesn’t let account holders create unique virtual private addresses. It works using email or mobile phone.
And remember Zell like Venmo, is a service created by a few private companies. UPI is a nationally backed standard. One critical improvement for merchants is the introduction of payment requests, with IMPS like the Taiwan bank account system, you can give your bank account details to the customer. However, it is up to the customer to come through and start the transaction.
with requests a customer only needs to confirm details and accept for the transaction to happen. For mobile e-commerce, UPI makes the payment part much smoother.
Buy something on the website, and the merchant can send the payment request over to your mobile phone. The buyer can then authenticate and complete the transaction there.

How UPI works

The UPI API

UPI is an API which is short for application programming interface. An API turns a service traditionally seen as very complicated, Like the Indian banking system and simplifies it into something much easier for other parties to use.
Banks and third-party banking software looking to provide UPI payment services are referred to in the documents as payment service players PSPs. When someone wants to send money or request money from someone they go through their banking app. The PSP validates the transaction and then fires an API transaction request in XML format to NPCI.
NPCI completes transactions behind the scenes using the appropriate financial mechanism something like IMPS.
upon completion, it sends confirmation notices to both parties. The standardized digital language of an API makes the service very scalable. Some of Silicon Valley’s biggest startups started with APIs. For instance, Stripe is the world’s most valuable American fintech startup, valued in the private markets at 95 billion dollars. They started with a set of simple APIs that allowed any company to accept electronic payments with a few lines of code. NPCI cited stripe has direct influences when designing how UPI would work.

The Launch of UPI

The NPCI launched UPI in April 2016 with just 21 banks. While PSPs like banks and Google Pay can integrate it into their third-party apps to facilitate payment. The government also released an app of its own as a showcase of what the technology can do.
The app BHIM stands for Bharat Interface for Money is India’s official national payments mobile app. The app uses UPI to help people send or receive money between different banks.
Shortly after UPI’s launch, the government initiated another big national policy initiative to help move the Indian people’s cash into the digital realm.

The Demonetization of Indian banknotes

In November 2016 the government announced that it would demonetize the country’s 500 and 1000 rupee banknotes. Holders had until the end of the year to exchange them for new 500 and 2000 rupee notes.
This effectively wiped out 86 percent of the country’s paper currency value the short deadline led to a mad scramble to deposit and exchange banknotes.
People purchased long train tickets as a way to preserve the value of their cash and some people even died in the rush.
The event was a massive shock to the economy but eventually, 99 of the demonetized currency was exchanged. Its macroeconomic merits were and remain questionable. The one thing it did do was, open the door for new systems of payment.

Encouraging people towards cashless payments

To encourage the use of cashless payments the Indian government heavily promoted UPI. When the BHIM app launched, the government spent 65 million USD in cash-back schemes for merchants and referral bonuses for end users.
Then in 2017, the government waived merchant discount rates or MDR on transactions made using UPI and other similar types of payments with values below 2000 Indian rupees. This initial scheme would last until 2020.
the MDR is a fee paid by merchants, something similar to those for credit cards, and is distributed to aggregators banks, and the network removing the fee.
Encourages people to use UPI for low-value transactions. The government disbursed taxpayer money to compensate some players for the loss of these fees. At the time estimated to be about 140 million dollars and 191 million dollars respectively for the two years.
The scheme was estimated to last, then in December 2019 the government announced an extension of the zero MDR policy.
Now all businesses with over 6.5 million dollars of annual revenue must offer UPI payment through a QR code.
This policy has been controversial with various industry players who point out the potential long-term damage.

Role of Pandemic in UPI’s success

Then the pandemic happened with Indians spending more time at home and on their
phones digital cashless payments surged in both volume and value. In October 2020 UPI facilitated over 2 billion transactions worth some 50 billion dollars. Year over year that is 80 percent growth in transactions and 101.7 percent in value.
From its 2016 launch to October 2020, UPI facilitated nearly 30 billion transactions over a third of those 11.8 billion came in a single eight-month period after March 2020.
A year later UPI transaction volume and value doubled to 4.2 billion transactions and 101 billion dollars.
astounding growth considering the staggering transaction volume growth, the zero MDR policy has been a double-edged sword. Networks cost money to upgrade and maintain, especially when scaling up as fast as UPI was during the pandemic.
Halfway through 2020, the MPCI told the Indian government that the zero MDR policy had resulted in some 700 million USD in lost.
NPCI has been in support of abolishing the zero MDR policy. Thinking more long-term MDR fees are the ecosystem’s only revenue model. Removing them commoditizes payment handling and forces those companies to make money in other ways, which is exactly the case to be seen in today’s UPI-based super apps.

Support for third-party apps

UPI’s open API first nature allows it to support an ecosystem of third-party apps. The official UPI website lists the transaction and value statistics for some 65 such apps. The biggest four are Phone Pay, Google Pay, Amazon Pay, and Paytm.
Phone Pay is a Bangaloro-based fin-tech company owned by Walmart through its subsidiary Flipkart. They run the largest third-party UPI app with a 47 percent market share of total transactions.
Google Pay is the second largest third-party app handling 33 percent of total transactions in the ecosystem. And the official national app BHIM is in only third place with a 24 percent market share. Interestingly enough WhatsApp India’s dominant messenger lags far behind those companies with less than a one percent transaction market share. However, they did not get bank approval to offer UPI payments until 2020 perhaps for political reasons.
Many of these payment apps have expanded beyond simple payments into fintech super apps. Something reminiscent of what China and Financial did with their Alipay app.
For instance, Phone Pay has started offering mutual fund investments and insurance through its app. Paytm also has stock investment services along with movie ticket purchasing, flight booking, train ticket purchasing, and bill pay. Kinda reminds me of Meituan’s focus on the online to offline industry.
The Indian government’s zero MDR policy has kicked off a four-way competition between companies, with deep pockets trying to build up their fintech super app. Bloomberg estimated that the Big Four spent over a billion dollars to promote their payment apps in 2019.
Despite this, it is hard to imagine Phone Pay, Google Pay, Whatsapp, or Paytm growing to the same dominance as Alipay.

The conclusion from the UPI success story

I think Indians are quite proud of UPI and they should be. In March, UPI facilitated 5 billion transactions few pieces of national infrastructure, has many users, and experienced such rapid growth.
As a validation of its competitiveness, NPCI has worked to take UPI abroad. In 2022 they announced that a payment system operator licensed by the Central Bank of Nepal will adopt the UPI technology standard as a way to tackle their own cash problem.
Countries like the United States are still struggling to unify and update their spalling financial industry. To allow the introduction of a UPI-like service
Many years of legacy practices, and legacy players each with their own incentives. Have made it challenging to simply launch a smooth experience from end to end. The Federal Reserve’s Fed Now service scheduled for a 2023 launch, is kind of interesting.
It reminds me of the telecom experience, in certain countries. Populations in Asia and Africa skipped the phone poles and went straight to cell towers.
India had the advantage of starting from more of a blank slate. Leveraging other countries’ experiences to create something fresh from the ground up. Cash remains the dominant medium in India’s society but I expect things to rapidly change shortly.
Thanks for reading
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