Regulations, UPI, Credit Cards and reflections from 2023 (#69)
Regulator-led innovation, new UPI launches, credit card economics, and other themes from the year
Welcome to the 69th issue of Unit Economics. As we wrap 2023, in this article, I reflect and attempt to make sense of the many exciting developments in Indian payments and lending ecosystem through the year. Dive in!
2023 has been another busy year for Indian Fintech. UPI, lending, and the regulations continued to dominate much of the conversations, while the ecosystem collectively decided to put sustainability above growth, experimentation, and anything uncertain.
This article is a deeper reflection of the many things that transpired, and an attempt to understand patterns that may directionally point to the future of the payments and lending ecosystem in the country.
But before I go there, let’s start with a rundown of some incredible numbers for the year.
UPI crossed 10 billion transactions a month in Aug-23 and continues to grow >50% YoY in volumes - a remarkable pace given the size of the baseline, tapering down only 15-20 percentage points than the last year
Credit cards, despite the UPI adoption, continue to be in favour with >96Mn credit cards in circulation, increasing 19% YoY as of Nov-23, while a notable ~18% increase in average spend per card put the overall credit card expenditures up by ~39% YoY (!). Quite healthy, although some of it was achieved inorganically due to the regulator’s push for RuPay credit cards.
Personal loans, unsecured in nature, have remarkably grown >32% YoY, with >50% of the volumes serviced by the NBFCs, although with smaller average ticket sizes, underscoring a 4X jump in disbursals over the last six years.
The number of accounts linked via Account Aggregators grew 12X YoY in Nov-23, from 2.65Mn to 33.74Mn, with a continuous MoM growth of >20%, suggesting the coming-of-age of a potentially transformative data-sharing framework.
Throwing weight to more optimism, RBI’s Digital Payments Index (RBI-DPI), a metric designed to capture the extent of payments digitisation, grew 13% this financial year.
However, despite the incredible pace and headroom for growth in payments and unsecured credit, funding in fintech dropped to ~$2.1Bn in 2023, which is only ~1/3rd and ~1/5th of that in 2022 and 2021, respectively. Part of this is explained through a shift in focus away from high-growth to more sustainable growth, and some through the lower appetite for risk from investors.
With that, I will dive into three large themes and many other talking points that defined the ecosystem this year.
Regulators continue to hold the stick and dictate innovation
It was another year directed by the regulators, particularly the RBI, who appear to be mission-driven in
leaving no room for grey, formalising the roles of digital apps and service providers, including any other intermediary roles that fintech companies play, and
putting more systematic safeguards for customers and the ecosystem at any signal of risk, despite the short to medium-term disturbances they often come with
The developments around digital and unsecured lending, prepaid instruments, payment aggregators, and cross-border payments were most suggestive.
On Lending:
The RBI expanded on its landmark digital lending guidelines in Feb-23 and Sept-23, emphasising more explicit and prior disclosures to customers, while also limiting the extent of customer data that may be stored with the Regulated Entities (REs). If not already bitten, the REs should soon expect regulatory stick on the implementation of the guidelines.
The RBI also regulated the high-risk FLDG arrangements by capping the extent of risk borne on the loan portfolio by the non-RE at 5%, with the guarantee expected to be provided in cash, a bank guarantee, or a lien marked against a fixed deposit. With the majority of the risk expected to be borne by the REs, the fintech companies are struggling to drive underwriting approvals and disbursals at the speed they would have wished for.
To further safeguard the high and unregulated growth in volumes of unsecured credit, in Nov-23, the RBI increased risk weights for consumer credit and for bank credit to NBFCs by 25 percentage points, forcing higher capital requirements, a higher cost of capital, and more caution in disbursals.
In Sept-23, the RBI also operationalised “Pre-Sanctioned Credit Lines on UPI”, although rather timidly. Many would hope for the guidelines to evolve more favourably over the next couple of years.
Expect the RBI to go even further in protecting the customer interest next year, with the practices of loan aggregators, including PaisaBazaar, BankBazaar, etc. likely to also be under the scanner.
On Payments:
After the credit-on- prepaid payment instruments (PPIs) directive shook the industry last year, the RBI, in Jun-23, stepped in to also halt the UPI services being offered in co-branding arrangements by any non-PPI firms, i.e. unless a digital app has a PPI licence of their own or a TPAP certification from NPCI, they were disallowed to offer UPI services. This impacted over 15 companies, including DreamX, Fampay, among others.
More welcomingly, the central bank extended the scope of PPI issuance to “Foreign Nationals / Non-Resident Indians (NRIs) visiting India” and to “e-RUPI digital vouchers”. Collectively, it was a good year for PPIs in Fintech, with the IPO of Zaggle and the successful launches of Cheq UPI (with tourist wallet) and Pepper Money (with city-based rewards).
As it did with PPIs, the RBI continues to push the Digital Rupee through the bank’s existing networks and reward incentives. However, the communication from the RBI and the banks appears a little short-handed with little guidance to customers on the benefits and the whys of adopting this new payment method. It would be tough to expect the Digital Rupee to breakthrough as the UPI did.
In Oct-23, the RBI also issued a new regulatory framework for Regulation of Payment Aggregator – Cross Border [Cross-Border Transactions (PA-CB)], which has incredibly (a) put all entities facilitating cross-border payment transactions under the direct regulation of the RBI, and (b) voided the standing OPGSP arrangements of existing fintech companies with Authorised Dealer (AD) banks, and mandated them to apply for fresh authorisation with RBI along with capital requirements for offering PA-CB services, adding more layers to offering the services.
Lastly, to much relief, this month, the RBI approved Payment Aggregator licences for six fintech companies, including Razorpay, Cashfree, and Open, allowing them to onboard new merchants after more than a year - formally recognising the already well-regarded payment gateway aggregators. A win for fintech.
The pace of changes in regulations has unsettled many in the domain, and will likely continue to push most to operate completely away from the grey. Regardless, the formalisation and acknowledgement of the roles that fintech can play, along with clear definitions on the licences required to operate in respective verticals, should hold the ecosystem in good stead for the medium to long term.
A year of new launches and unanswered questions for UPI
UPI had another usual, accolade-filled year. However, the pace of progress was much more than usual for the real-time payments system.
Through this year, UPI went global with real-time cross-border connectivity in Singapore, UAE, and Bhutan. The adoption has, apparently, been quieter than expected and will need a lot more marketing and QR acceptance overseas.
RuPay Credit card on UPI kicked off in Feb-23 and scaled to over ₹100 crore a day in transaction value earlier this year, with the figure expected to be 5X by the year-end. While there has been a lot of push from NPCI and the banks, Credit cards on UPI commanding over 20% of all credit card spends within a year would be nothing short of extraordinary.
The much-awaited credit line on UPI was operationalised in Sept-23, although it continues to be in rather nascent stages.
Further, in Sept-23, NPCI formally launched “UPI Lite X”, an NFC-based offline payments extension to the existing UPI Lite functionality, allowing payments to be performed over UPI without the internet. The adoption curve for this may be comparatively linear given the marketing efforts it would require in tier-3 and rural cities for awareness and trust building. However, an initiative worth a lot of appreciation.
NPCI also forayed deeper into conversational payments with Hello! UPI and BillPay Connect during the Global Fintech Fest (GFF), although little information is available on the efficacy of the solutions at the moment.
And even in Dec-23, NPCI continued to ship, launching NFC-based UPI Tap & Pay and UPI for Secondary Market, both with the potential to change long-standing usage and settlement behaviours in payments.
The speed of execution needs admiration. However, multiple questions, year on year, continue to lurk in the background on the sustainability and practices around UPI.
While the government maintains its stance on UPI as a “public good”, it only belittles the effort of and discourages many from imagining a business model on top of it. This stance also introduces a dilemma wherein the MDR applicable on credit-on-UPI may discourage the merchants from accepting the payment mode, since they are accustomed to the no-MDR savings account route, and it also risks distorting the economics of the existing unsecured credit market if the MDRs on credit-on-UPI are assumed at-cost.
The implementation of the 30% cap on market share rule is also due in Dec-24, and the potential for it coming into effect looks more bleak with the customer habit already built with PhonePe and GPay. Also, if NPCI were sincere in its implementation of the rule, it would perhaps make the playing field equal by allowing the smaller-scale TPAPs to be part of a sandbox for new features, rather than continuing to give head-starts to PhonePe, GPay, and Paytm.
We must also, meanwhile, question the strategy for implementation of credit over UPI over the last couple of years, with credit cards - and RuPay in particular - used to drive its adoption. More naturally, it would have made sense to do a more white-labelled credit line approach with banks instead, given the complexities of networks, card management, etc. that credit cards bring. And if it had to be with cards, perhaps a level-playing field with Visa, Mastercard would have avoided partnership bottlenecks that now surface with RuPay. Lastly, the launch of credit-line-on-UPI appears not too dissimilar from the long-allowed overdrafts on UPI and begs the question on how it should evolve.
Credit card economics go for a toss
The credit card model has stood the test of time, but this year likely tested it more than any and proved to be most transformative for credit card economics.
Interchange revenue had been tapering down slowly, but this stands to reduce further with the UPI layer expected to account for an increasing proportion of credit card spends.
Interest income has further decreased with better reminder and repayment channels for customers to pay on time, along with more restrictive regulations on late payment charges and minimum amount due by the RBI, eating into the revolving revenue.
Further, product costs have increased for issuers due to increase in marketing costs across distribution channels. This is primarily due to the many card propositions targeting the same existing, carded customers.
For the relatively smaller private issuers, the scrutiny on the co-branded model has only added to the woes, with the RBL Bank expected to be most impacted given its co-brand-led strategy.
Interestingly, costs of lounge benefits to customers shot up 60% for banks over the last couple of years, forcing banks to consider significantly reducing lounge benefits.
As is noticeable, while the revenues have fallen across the board, the costs are on the way up - putting a two-sided pressure on the credit card RoA, which is expected to fall by 1-3 percentage points from the commonly assumed 5-6%. Consequently, the economics have pushed almost all top private banks to scale down their rewards, impacting the customer value proposition.
And while the topline suggests continued customer liking for credit cards - (a) the industry forces pushing for credit-on-UPI, (b) the worsening economics of credit cards, (c) a lack of transparent guidance on MDRs, and (d) the continued scrutiny on foreign networks and co-branding arrangements need careful handling before more damage is done.
Other talking points
The pressures of the last year continued to push every fintech company towards monetisation. And for most companies, that equaled a foray into or expansion of the lending business. Not even the investment platforms stayed put. Some, unfortunately, had to shut shop, while many are fighting to survive.
Quietly though, many with more solid fundamentals, particularly on the B2B end, have continued to strengthen their books - including Mintifi and Zetwerk, suggesting that capital is available for those (a) purposefully-focused towards a customer segment, (b) generating predictable and recurring revenue lines, and (c) forming relationships with customers that are deeper than of a lender.
Hardware was in fashion this year, with Razorpay, PhonePe, and BharatPe entering offline acquiring wars with the likes of Paytm and Pine Labs. The competition to win bank RFPs and to increase revenues through value-added services (VAS) appears to be getting thicker, with soundboxes, QRs, and POS devices expected to become cheaper, lighter, and more feature-heavy.
The power equation between banks and fintech companies has skewed more strongly in favour of banks on-ground, with the stick from the RBI forcing banks to be more cautious and risk-averse in their fintech arrangements. It is becoming increasingly clear that offering services to enable banks in any shape or form may be a more worthwhile business strategy to consider.
Final thoughts, and a wish-list for the next year
This was, no doubt, a defining year that (a) shaped regulations in many verticals, (b) shifted the business priorities and models for many fintech companies, and (c) forced higher ecosystem wide diligence in evaluating ideas, assessing metrics, managing P&L, and following regulations.
A consequence of these changes is a drop in enthusiasm and immediate innovation within fintech, but I expect it to be short-lived. Fortunately, the ecosystem continues to see large-scale regulator-led initiatives, which appear the main source of industry innovation at the moment.
As the ecosystem progresses further, I hope that the regulators form a more solid soundboard with fintech leaders, offer fintech companies a little more headroom in the roles they can play with banks, and allow better MDRs and commercials to boost more innovation.
If you have any views or want to casually chat on the subject, drop me a message here. Until next time!
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