Enabling Credit Lines and Interchange on UPI (#62)

Analysing the market opportunities for UPI with the guidelines on digital credit lines and interchange charges

Welcome to the 62nd issue of Unit Economics. In this article, I analyse the developments around allowing digital credit line on UPI and the introduction of interchange on UPI transactions via PPI. Dive in!

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We have talked obsessively about UPI recently. In February, we remarked on its brilliance and discussed the headwinds of volume caps, cross-border enablement, offline acquiring, and credit cards on UPI. In March, we shared excitement over the speed and convenience of UPI Lite. And we are here in April, with more compelling things to talk about.

In numbers, Mar-23 was incredible for UPI as usual. Volume growth of 15% month-on-month and 61% year-on-year. This would count as more than reasonable for a startup, let alone a seven-year-old fund transfer system.

The progression and our continuous discussions are a credit to the regulatory pro-activeness and the speed of execution of the market players over UPI. Which, today, brings our focus toward a couple of notable developments again.

Enabling Digital Bank Credit on UPI

Dilip Asbe 🇮🇳 @dilipasbe

Digital Credit on UPI ⁦ ⁦@RBI⁩ ⁦@NPCI_NPCI⁩ ⁦@UPI_NPCI⁩

This week, RBI opened doors for pre-approved credit lines to be drawn directly for UPI transactions. This would be the third form of provision for credit on UPI, after allowing bank-issued overdrafts in UPI 2.0 (2018) and linking of credit card lines (2022).

With the first two initiatives, credit on UPI is yet to see high adoption. Hardly due to a lack of effort though. Overdrafts on UPI struggled with the friction of requiring that the customer avails an overdraft facility on their existing savings or current account. A behavior that did not come naturally to Indian customers, and that set up the functionality for failure.

With the linking of credit cards, the inertia is significantly less. The customers who want to use their credit cards on UPI need to only (a) show intent to link, (b) find and select the bank that has issued them their credit card, and (c) set a UPI PIN for the credit card found linked to the account. Less than ten clicks, and you get the convenience of your credit card line on UPI.

However, the conversations around credit cards on UPI have elements of complexity with the involvement of card networks, the need for high-tech investments, and the never ending no-MDR conundrum. Further, the coverage of card networks remains low for credit cards on UPI.

Will the new provision of pre-approved credit lines be any different? We may want to wear a critic’s hat for a moment here.

What is the market opportunity? Reports suggest that the number of active retail loans is around 78-90 Mn in the country, put around 60 Mn by the end of Mar-22 and growing at a 30-50% annual rate. Credit cards are likely within the same bracket.

But the size of the retail loans segment is a red herring. The majority of these loans, unlike the credit card lines, are transferred to the customer’s bank account either directly or via a self-submitted cheque or demand deposit. This implies that the existing functionality of linking a deposit account to the UPI may already be catering to the need for many to use their credit lines over UPI.

With the new guidance, the RBI would only enable retail loans that (a) are pre-approved as credit lines by the bank to the customer, and (b) are not directly deposited to the customer’s bank account already. These would be credit lines similar to what had recently become standard offerings for fintech-NBFC partnerships: issue a credit line to the customer, maintain it in a pooled disbursal account, and allow draw down or disbursals against the customer only at the point of transaction.

The proportion of such credit lines from banks is unknown, but likely a minority of the current retail loan segment. Further, with the limitation of opening the facility for only banks, the functionality is limited in scope as it excludes NBFCs. Both of these put a dent in the market opportunity for credit-line over UPI.

However, taking off the critic’s hat, the initiative does promise some medium to long-term benefits:

1. An increased inclination for banks to up-sell pre-approved credit to their existing customers with the promise of UPI’s convenience. Lower distribution costs can lend to lower cost of credit for the banks, and consequently, lower interest charges for the customers.

2. Potential for banks to structure their short-term loans on the lines of credit cards, offering credit lines with an interest-free period.

3. Offers stronger argument for bank partnerships to UPI apps, as the likes of Paytm, PhonePe can now tie customers into an on-platform loop of (a) offering a credit line from the bank issuer, and (b) allowing that line to be used directly for UPI transactions on their app.

In the longer term, the efforts of bank issuers and UPI apps to push the functionality, along with the inclusion of non-bank issued credit lines, may decide its adoption. I continue to remain a firm believer that, for customers, using credit-on-UPI tied to a wallet or a credit line would be a win-win, and should see quick adoption.  

Interchange charges on UPI Transactions via PPIs

With effect from 1^st April, the NPCI has introduced interchange fees of upto 1.1% on UPI merchant transactions of above ₹2,000 made via prepaid payment instruments (PPIs). These would exclude P2P and P2PM transactions, wherein P2PM transactions are those made towards small merchants with a projected inflow of UPI payments worth ₹50,000 or less.

The transaction charges would differ basis the merchant category codes, ranging from 0.5% on utility to 1.1% on convenience and specialty stores.

Interchange and caps on transactions basis merchant category; Source: businessline

The transaction fees would be paid to the PPI issuers, such as UPI apps. In return, the PPI issuers are also expected to pay a fee of 15 bps to the remitter bank from where the wallets are being loaded.

The news would be welcome to UPI apps, who would want to further push wallet adoption, and the usage of wallets over UPI rails to monetize their transactions.

However, the minimum transaction value of ₹2,000 is a high bar that likely less than 1/5^th of all UPI transactions may cross, with the average ticket size of a P2M transaction at ~₹667 in Mar-23. Is the market opportunity then large enough here?

Let’s do a little back-of-the-hand calculation to estimate how big this opportunity may be in the short term.

Mar-23 saw ~4800 Mn P2M UPI transactions across all apps. Even in the best-case scenario, we may anticipate a 20% share of these transactions to be of ₹2,000 or higher in value and within those, not more than 1% powered by PPI on UPI. This would give us a monthly run rate of ~10 Mn transactions.

Now assume an average transaction value of such transactions at ₹2,500 and, say, each of these earns an average of 0.8% in interchange (with a 0.5-1.1% interchange range). With 10 Mn transactions earning ₹20 revenue on each transaction – we get a potential industry-wide monthly revenue of ₹20 Crore (200 Mn). Not bad, yet not a disrupter as many would believe – despite some loosely taken assumptions above.

This implies that while Paytm and the likes would want to capitalize on the opportunity – unless more modes of transactions are bought into the ambit or the min transaction value is lowered, the opportunity to monetize remains quite limited.

Unfortunately, the NPCI and the RBI’s stance on bank-to-bank UPI transactions continues to remain one of treating the payment mode as a public good – implying no MDR charges for enabling such transactions in the short term at least. Expectedly, the A2A transactions still make up more than 99.9% of all UPI volumes, highlighting the opportunity gap in revenue that will continue to exist despite the interchange guideline.

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In all this, there is little doubt that regulatory bodies have, impressively, introduced developments to UPI that offer some promise to banks & UPI apps, while not deterring much of what customers have come to expect of UPI.

And with the industry moving the focus towards monetization of financial services and higher digital penetration of payments & lending, the two initiatives – although with their follies – are steps in the right direction.

I might have played the role of a critic in assessing the market opportunity, but with our last discussions around UPI - we continue to have a lot to look forward to, and over the next few months - we will have a lot more to discuss on credit-on-UPI and the interchange as the industry players act on the guidelines. Until then!

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If you have any views or feedback to share on the topic, feel free to add a response below or to share your thoughts with me over Linkedin. In case you feel your friends or family would be interested in reading about payments, feel free to share the blog with them as well. See you in a few weeks!