UPI’s transformational effect on the Indian banking and economic sector

Abstract:
Imagine this. You are getting late for work and leave your house in a hurry, leaving behind your wallet and the money encased within. You don’t realise this until it is time to pay the taxi driver who has taken you to your office. But it’s the year 2024. Who needs cash to make a payment anymore? You whip out your phone and choose from an array of UPI applications like GPay, Paytm, PhonePe, and BharatPe, scan a QR code and pay the taxi fare. Since its introduction by the Reserve Bank of India in 2016, the Unified Payments Interface, more commonly known as UPI, has quickly become an easy and convenient, cashless payment method that has gained widespread use. From the local tea stall on the side of the road to fine dining restaurants, street urchins selling their wares to professionals charging their fees, everyone now accepts UPI as a legitimate means of payment.
This white paper aims to analyse the impact of the Unified Payments Interface and the role it has played in revolutionising the Indian economy. Through this white paper we analyse how UPI has changed the power dynamics of financial transactions and ushered in a more equitable digital payments future, thereby bridging the credit gap and accelerating the trajectory of Indian economic growth from actions at a macro level. Whilst acknowledging the undeniable impact and the merits of UPI, this white paper also seeks to address the inevitable challenges that lie ahead of the technology and proposes workable solutions to help overcome the same.
Context:
What is UPI:
The Unified Payments System (UPI) is a system, developed by the National Payments Corporation of India, that powers multiple bank accounts in a single mobile application, (of any participating bank), merging several banking features, seamless fund routing and merchant payments under one hood. Seamlessly facilitating inter and intra bank payments via a mobile application, UPI has quickly gained popularity for its convenience and easy payment methods. UPI works by making use of already existing payment systems like Immediate Payment Service (IMPS) and Aadhar Enabled Payment System (AEPS) for interbank settlements.It also caters to peer to peer payment requests that can be scheduled as per convenience.
When was it introduced:
The pilot launch of UPI happened on 11th April, 2016 by then RBI Governor Dr. Raghuram Rajan. Banks were able to upload their UPI enabled apps on Google Play Store from 25th August, 2016 onwards. From 0.8 billion transactions being processed in January, 2018 to 14.4 billion in July, 2024, it now handles approximately 80 percent of India’s digital payments, adding more Indians to the formal financial system everyday.
How does UPI work:
Step 1: User Registration: To use UPI, users must first download a UPI- enabled app like Paytm, PhonePe or Google Pay. Subsequently, they must register by linking a pre-existing bank account and creating a Virtual Payment Address (VPA) such as username@bankname which serves as their UPI ID.
Step 2: Initiating a Transaction: There are several ways that a user can choose from to make a payment: scanning a QR code, selecting a pre-existing contact, entering a new mobile number or the payee’s VPA.
Step 3: Authentication: Before concluding a transaction, the user must authenticate the transaction by entering their UPI PIN- a six digit code created at the time of user registration. This step ensures that only the account holder can authenticate the transaction and works as a safety mechanism against fraud.
Step 4: Transaction processing: Once the UPI PIN has been entered, the app sends the request to the UPI server which in turn notifies the concerned banks of both parties.
Step 5: Confirmation: After the bank confirms the transaction, the user receives a notification regarding the success or failure of the transaction.
Step 6: Final Settlement: UPI ensures that the final settlement of funds between the banks is done in a short time, usually a few hours, although users see the transaction settled in their accounts almost immediately.
Examples of UPI applications commonly used in India:
PhonePe, Google Pay, Paytm and BharatPe are commonly used UPI applications with varying usage. In the third quarter of 2024, PhonePe held around 48 percent share of unified payment interfaces (UPI) usage in India, followed by Google Pay with 37 percent. Leading fintech players have been key drivers of UPI adoption in India
Number of people in India that use UPI: As of the year 2024, UPI has over 350 million users and approximately 440 million daily transactions. With these staggering figures, it’s no surprise that India’s Unified Payments Interface surpassed leading digital payment platforms of the world like China’s AliPay, the United States of America’s PayPal and Brazil’s PIX in the number of transactions processed. In the April- July period, the platform processed nearly 81 lakh crore transactions which converts to a 37 percent increase on a year on year basis. As per Paysecure, a global payments hub, UPI processed 3729.1 transactions per second, a 58 percent increase over the 2348 transitions per second registered in 2022. By providing a simple, convenient and safe means of conducting transactions, UPI has empowered many small scale entrepreneurs across the country and has made a cashless future seem closer than ever before.
How has UPI revolutionised the Indian economy:
Bridging the credit gap: A fairly new addition to the list of financial amenities offered by UPI, credit lines are now bridging the credit gap by democratizing credit access for smaller enterprises with fewer resources. Although MSMEs (Micro, Small and Medium Enterprises) account for almost 30 percent of India’s GDP and are commonly called the backbone of the Indian economy, only a meagre 14 percent of them have access to credit with the credit gap at an estimated $530 billion. UPI is on track to fix that problem through pre- sanctioned credit lines and the option of linking a credit card and through that, a loan account to a UPI account. MSMEs that previously found it challenging to acquire loans from banks due to lack of collateral and had to engage loans from informal sectors, often paying predatory interest rates, now have the option of borrowing money in increments through a QR code on their UPI application. These pre- sanctioned credit lines enable MSMEs to borrow and invest money in their business and pay it back in installments.The reliable data of transaction history provided by UPI streamlines the credit assessment process and acts as a tool by which lenders can assess the borrower’s credit worthiness, eliminating the need for lengthy paperwork and collateral. By allowing Small Finance Banks (SFBs) to provide this service which was previously only limited to scheduled commercial banks, the Reserve Bank of India has moved the Indian economy one step further towards financial inclusion.
Adding jobs to the economy: As the number of UPI users increase daily, so do the number of fintech firms that rush to provide digital payment platforms to an increasing customer base. The number of fintech startups have steadily been on the rise ever since the inception of the Unified Payments Interface in 2016, and with them, the number of jobs created. Reports suggest that these fintech firms have directly employed 80,000 individuals and indirectly added 200,000 jobs to the economy. UPI has played an integral part in boosting India’s economy by aiding the creation of jobs through creating a startup friendly ecosystem. As of December 2024, India has 117 unicorns (startups with a valuation of $1billion USD or more). The cost effective and convenient UPI has no doubt played a great role in the success of these startups and the thousands of jobs created by them.
GDP Growth: UPI’s effect on the Indian economy is an undeniable fact. A study conducted by The Finance Ministry of India recently reported a staggering 15,547 crore transactions from January to November , 2024 worth 223 lakh crore rupees processed by UPI. From processing 0.8 billion transactions in January 2018, UPI processed a record 14 billion transactions in July, 2024, with these numbers only growing from here. This growth has no doubt brought about an increase in GDP growth with studies by post doctoral researchers at the ISB, Amrit Kumar Jha and Kanti Mohan Saini as well as Rohit Bansal,a HBS graduate, showing the results of a regression analysis that establishes that a 1 percent increase in UPI transaction volume correlates with a 0.03 percent increase in GDP growth, highlighting the crucial role of UPI in India’s economic prosperity. The strong correlation (R^2- 0.75) indicates that UPI is a strong indicator of India’s economic growth. At present, the biggest contributor to the growing landscape of digital payments in India is the UPI, with nearly 4 out of 5 digital transactions done via UPI in 2024, according to the Annual Report of the Reserve Bank of India. Reports project that the adoption of UPI as a preference over cash for making and receiving payments will lead to net savings for businesses and consumers rising to 92.4 billion dollars, resulting in 45.9 billion dollars of economic output, equating to 1.12 percent of forecasted GDP for the country.
Deepening economic ties with other countries: By launching UPI on a global scale, India’s position as a leading economic power will soon be concretized. These efforts have already been put into motion. UPI has already been introduced in Bhutan, France, Mauritius, Nepal, Singapore, Sri Lanka and the UAE. These collaborations help to create a friendly atmosphere and foster diplomatic understanding and cooperation. By increasing connectivity and accessibility to domestic and international digital payment systems, trade is greatly promoted and ease of doing business makes an attractive atmosphere for investors. Broadening the reach of UPI globally is an important part of increasing India’s soft power by extending economic influence and creating a friendly atmosphere for trade deals. Moreover, Indians and Non Resident Indians can use UPI to make merchant payments in the countries that UPI is operational in. UPI PayNow linkage has been implemented between India and SIngapore already.
Formalizing the Indian economy: With digital transactions becoming the norm, UPI has helped to formalize the Indian economy as transactions become clearer and more accountable. UPI has curbed the use of black money by reducing the number of transactions done in cash which could have previously been used as a means of tax evasion. By creating a digital trail which can be scrutinized, UPI has brought many people and businesses into the formal financial system. With fewer people using cash for transactions, UPI has enabled many households to use formal banking channels more effectively and has the possibility of reducing household leakage.
Promoting Financial Inclusion: Lack of financial literacy and being uneducated had previously stood as a hurdle against access to financial services and banking. Today, UPIs widespread presence is changing that: in 2023, UPI transactions in rural and semi urban India rose118 percent, compared to the previous year. According to TransUnion CIBIL 2023 ,over half the fintech consumers in India are from semi- urban and rural India with more than a third of digital payment users hailing from rural India. By simplifying digital transactions, UPI has widened access to financial services. Most UPI enabled applications are free or have minimal charge. Traditional banking like RTGS (Real Time Gross Settlement), done offline, is, by comparison, more costly with the fees determined by the transaction amount. By acting as a more affordable and convenient alternative to traditional banking, it has broadened access to financial services for the underbanked.
Problems facing UPI and their proposed solutions:
With the number and volume of UPI transactions increasing rapidly, it is imperative to acknowledge the risks that come along in order to devise suitable solutions to mitigate these risks. Mentioned below are three primary concerns for the technology and workable solutions that can help overcome these.
Cyber security concerns: The rapid growth of UPI has swiftly outpaced regulatory frameworks with new types of frauds being committed everyday, cheating thousands of their hard earned savings with a keen focus on senior citizens. As UPI IDs are generally phone numbers with the UPI provider extension, they are easily exploited by scammers. An article by IndiaTV states that in the first half of 2024-25, Indians lost around 485 crore rupees to fraud UPI payments. According to the Ministry of Finance, 632,000 frauds were reported in this period alone. The Ministry further disclosed that fraud rose a staggering 85 percent in the financial year 2023-24 compared to the previous year. Fake UPI Payment requests, impersonation, where a fraudster pretends to represent a particular organization, most likely a bank, to extract money ,and fake digital arrest scams where the fraudsters pose as police personnel, calling people under the pretense of bail money for a loved one who has apparently been arrested, are common types of scams. Although phishing is now part of our common diction , a new type of online fraud known as ‘quishing’ involving QR codes, is now on the rise. Quishing involves scammers using fake QR codes, often pasted neatly above legitimate ones, which customers scan to make payments, sending money straight into the bank account of the scammer. Another type of quishing is when scanning a QR code directs you to a third party website, usually a duplicate of a banking or e-commerce one, and asks for the user’s PIN which is used to drain the user’s bank account.
Proposed solution: While potential solutions for these frauds can be stronger cyber security measures like biometric access to bank PINs, measures like two factor authentication are already in place. Perhaps the most useful one would be promoting financial literacy with a focus on different types of scams that different age groups fall prey to. Simple everyday actions like not using public WiFi and charging ports, not disclosing sensitive information like ATM ( Automated Teller Machine) PINs(Personal Identification Number) and OTPs(One Time Password) can go a long way in protecting yourself from phishing attacks and UPI related frauds. One way to protect yourself from quishing is by being aware of the QR code you are about to scan and avoiding scanning QR codes sent by unfamiliar sources or on social media platforms.
Emergence of Duopolies: As any industry emerges and gains traction, it is common practice for industry leaders to emerge and compete for market share and customer acquisition. This competition, when healthy, encourages companies to innovate and offer the best possible services to customers. However, this trend is changing for UPI adoption with a highly lopsided market share emerging. With regulators cracking down on One 97 Communications, the parent company of Paytm, a new concentration risk has emerged with skewed market share, tipping the scales in favour of its competitors, PhonePe and GooglePay. The Economic Times reported that in February 2024, UPI processed 12 billion transactions with 6.1 billion done through PhonePe, and 4.7 billion transactions settled by GooglePay. Paytm, the third largest UPI application by number of transactions processed only 10.8 percent of the transactions at 1.3 billion and Cred, the fourth largest, settled only 118 million UPI transactions. These varying numbers ring alarm bells about the consequences of duopolies like limiting free trade, price fixing and possibilities of collusion. The challenge of monetization revolving around UPI due to ‘zero fees’ is the leading contributor to the potential duopoly situation we are currently witnessing.
Proposed Solution: Reducing barriers to entry is a pivotal way of ensuring that competition is free and fair. At present, the lack of monetary incentives due to ‘zero fees’ is a barrier to entry. Running advertisements and charging lending fees for credit can serve as a strong case to entice other UPI applications in staying in the game and gaining a monetary edge over other giants in the field. Introducing MDRs (Merchant Discount Rates )for P2M(Peer to Merchant) transactions may prove to be an attractive avenue for enticing pre-existing UPI providers to stay in the game and incentivize new ones to enter the market, increasing the competition and creating a balanced market share. Another workable solution is to impose penalties on the applications that do not abide by competition and anti- trust laws by crossing the 30 percent threshold of the market share. According to the Economic Times, the Walmart owned PhonePe and GooglePay collectively own a staggering 85 percent of market share, with PhonePe boasting of nearly 50 percent market share. The NPCI previously set 31 December, 2024 as the deadline for implementing the 30 percent market cap but that deadline has now been postponed by 2 years to 31 December, 2026. With Paytm regaining its traction after regulators came down heavily on its parent company One 97 Communications as well as new apps like Navi and Cred gaining speed, the dupoly issue has the potential of sorting itself out.
Long term sustainability: In the short run, a business either makes losses, normal profits or supernormal profits. In the long run however, after loss making enterprises exit a market or new competitors enter a market where enterprises were previously making supernormal profits, most businesses end up making normal profits. A big part of what makes UPI so attractive for consumers and businesses alike, apart from its convenience, is its cost effectiveness ;UPI platforms do not charge any fees for the services they provide: making, receiving or requesting payments. This begs the question- if UPI is not profitable, will it survive in the long run? MDR is short for Merchant Discount Rate, a price that a merchant is charged for accepting debit and credit card payments from customers. At present, the MDR for P2P-peer to peer- and P2M -peer to merchant- transactions is zero. It is also important to note that a significant part of the growth of UPI can be attributed to the zero transaction fees. Although major banks across the country are urging the NPCI for MDR to large merchants for P2M transactions , it looks unlikely that MDR will be imposed for such transactions. (PPIs-prepaid payment instruments-, the equivalent of a digital wallet which is preloaded, is chargeable on UPI for amounts over rupees 2000 at 1.1 percent for transactions.)
Proposed solution: The challenge of sustainability for UPI is a valid one with the government not allowing MDR for P2M transactions. However, UPI’s sustainability can be through a multitude of other avenues. UPI applications can charge fees on a value added basis for models which especially benefit merchants like access to analytics, enhanced cyber fraud protection, loyalty schemes like cashback and others. Another workable solution could be in the form of advertisements and sponsored content where merchants can pay to have their brands and companies appear on UPI applications, taking advantage of the big customer base that the UPI applications have.
CONCLUSION:
The Unified Payments Interface has played a crucial role in the Indian financial landscape and the Indian economy, fostering progress by ushering in the digital era and encouraging a startup friendly atmosphere. By increasing access to credit, UPI has boosted financial inclusion; by accelerating GDP growth and deepening economic ties with other countries, it has played a pivotal role in concretizing India’s role on the global stage against many major world economies; it has encouraged transparency in financial transactions and significantly reduced the penetration of black money in the Indian economy. Although the platform has several significant challenges that lie ahead, its future is bright and promising, to say the least.
Bibliography:
https://www.ndtvprofit.com/business/upi-zooming-merchant-payments-bring-mdr-back-on-the-discussion-table https://www.hdfcbank.com/personal/resources/learning-centre/pay/is-there-any-upi-transaction-charges
https://www.aubank.in/blogs/role-upi-digital-india-advantages-impact
https://www.weforum.org/stories/2023/06/india-unified-payment-interface-impact/
https://razorpay.com/blog/what-is-upi-and-how-it-works/#How_Unified_Payments_Interface_UPI_Works
https://www.npci.org.in/what-we-do/upi/3rd-party-apps
https://www.statista.com/statistics/1034443/india-upi-usage-by-platform/#statisticContainer
https://pib.gov.in/PressReleaseIframePage.aspx?PRID=2079544
https://cashbook.in/blogs/how-upi-can-simplify-your-expense-management-process/
https://razorpay.com/blog/what-is-upi-and-how-it-works/
https://www.npci.org.in/what-we-do/upi/product-overview
https://www.statista.com/topics/10949/msmes-in-india/#topicOverview
https://www.financialexpress.com/business/sme-msme-fin-530-billion-massive-credit-gap-in-indias-msme-sector-out-of-819-billion-addressable-demand-report-3031372/ https://protium.co.in/upi-solving-credit-gap/
https://www.npci.org.in/what-we-do/upi-global/upi-global-acceptance/live-members
https://www.thecitizen.in/index.php/en/NewsDetail/index/4/7866/Cashless-Transactions-to-Guard-Against-Black-Money https://www.federalbank.co.in/how-upi-is-revolutionizing-digital-payments-in-india#:~:text=Formalisation%20of%20the%20economy%20%3A%20By,becomes%20more%20transparent%20and%20accountable.
https://www.cnbctv18.com/business/finance/a-third-of-digital-payment-users-from-rural-india-merchant-adoption-rate-higher-than-consumers-rbi-report-19451084.htm https://www.business-standard.com/finance/news/upi-transactions-up-118-in-semi-urban-rural-retail-stores-in-2023-study-123122000604_1.html https://www.aubank.in/blogs/role-upi-financial-inclusion-empowering-unbanked#:~:text=Benefits%20of%20UPI%20in%20Financial%20Inclusion%3A&text=With%20UPI%2C%20individuals%20without%20traditional,into%20their%20UPI%2Dlinked%20accounts.
https://www.hindustantimes.com/technology/what-is-quishing-scam-all-you-need-to-know-about-new-qr-code-scanning-fraud-101705648853547.html https://razorpay.com/blog/upi-frauds-types-tactics/#Types_of_UPI_frauds_online_frauds https://www.medianama.com/2024/11/223-upi-fraud-up-85-per-cent-fy2023-24-finance-ministry-data/ https://www.indiatvnews.com/technology/news/upi-users-alert-staggering-rs-485-crore-lost-to-fraud-in-the-first-half-of-2024-25-2024-11-28-963785 https://economictimes.indiatimes.com/tech/startups/decoding-the-upi-growth-story-through-the-eyes-of-a-duopoly/articleshow/108625541.cms https://economictimes.indiatimes.com/tech/technology/npci-extends-upi-volume-cap-timeline-by-2-more-years/articleshow/116829131.cms?from=mdr