Payments revolution in India

Payments space in India, today, is observing a huge euphoria with many startups trying to address various problems. The space started to get much more serious attention, especially after an unusual move from the government, Demonetization.

I decided to put down my thoughts on the subject as I have been thinking about it quite a bit for some time. Let’s start.


To understand the peculiarity of payments in India, we should start with understanding the market. There are various ways payments are carried out, let’s look at them one by one.

Cash

Indian payments today are largely cash driven. Even large rare purchases in lifetime like real estate involve very large cash component. This makes a huge room for undeclared/partially declared transactions from the perspective of the government to charge taxes, which are largely based on money exchanging hands. Obviously, the government doesn’t like it and hence recent push of cashless economy. The balancing force is that, it makes corruption harder for the corrupt people in the government, so it can’t be expected for all the cash to be gone. This mode is the most ubiquitous of course.

Cards

Cards are issued by the banks, which are powered by large payment networks (like Visa and Master). This makes the transaction convenient for the buyer, but seller takes a hit (large or small depending upon the business) in his margins. The bank and the payment network end up making a small fee. This makes an easy revenue source for banks as it is entirely an online operation, but it requires some technology capability to carry out well.

Sounds good, right? Wrong. There are a number of problems.

The entire transaction is routed through multiple parties to be successful and until very recently, the failure rates were very high for scaled businesses with large dependency on accepting online payments, like eCommerce. With increased coverage and improved internet connectivity across the country and large banks investing in building the technology infrastructure, the failure rates have been curbed. They are still in double digit percentage range, though, between 20–30%. RBI apparently doesn’t like dependence upon foreign entities as payment networks. The introduction of RuPay, and now UPI is an attempt to free up the ecosystem (more later).

There is another problem here.

A card transaction requires special devices to be carried by both the parties to work. So, a bank has to issue cards to the consumers and card charging machines to the merchants. Issuing cards have a cost (INR 200–300), which banks wouldn’t want to incur which deters them from offering it to everyone for free. On the other hand, machines are too expensive (INR 10k-20k depending upon who you are talking to) for largest merchant base. Hence, most mom and pop stores don’t accept cards.

Another problem with cards is, distributing cards and machines are both offline aspects. There is so much faster it can grow. Given this technology has a long head start, it is still a major player amidst all the players and will remain so for many years to come.

And then, another problem still.

Debit cards expose a card holders entire bank savings making it a lucrative target for frauds. It is a huge deterrent, especially for the middle class which save hard earned money. To prevent this, we have two factor authentication, but every now and then, fraud cases surface which hurt consumer belief in the newly (to them) introduced cards payment system.

Lastly, it’s worthwhile to mention that certain cards have another interesting aspect in it. Credit. It makes the whole transaction business very dynamic as it encourages consumer to take short term loans, make transactions and occasionally defaults, all generating revenue for banks. Given it is very risky, the balancing force here is to issue credit cards carefully.

Mobile payments

This is the newest and most exciting category. Not because I worked with leading mobile payments companies and I have my own bias, but because of the new landscape we have.

The smartphone users have exploded, thanks to various hedge funds and Japanese conglomerates for partly financing it, making it more affordable for many of us in India. The telecom infrastructure vastly improved with various providers upgrading to 3G and 4G. Notably, Reliance Jio is making things even more exciting. Indians, armed with a very capable smart phone and very low cost, fast internet connectivity, will do much more than messaging or watching videos.

Enter mobile wallets (and Payments bank).

Mobile wallets have to be an experiment by RBI given how many things are unclear in the overall operations and with such lower limits. The bank lobby completely discarded the idea that they didn’t even attempt to compete until very late. Riding on high frequency prepaid mobile recharge use case with very large market (roughly 94%, prepaid users), Mobile Wallet players built a very impressive scale. Only this time, Chinese conglomerates partly financed the mobile prepaid users.

There are a number of things about wallets which makes them very interesting.

Firstly, all you need is a phone and an internet connection. No paperwork, no minimum monthly balance to maintain, no hidden charges, no friction. It is a revolution by itself that anyone can open an RBI regulated wallet (in other words, government recognized) account without disclosing his identity. Although there are limits to what the user can do, turns out they are enough for many use cases to work. Although, after doing full KYC, the limits can be enhanced.

Secondly, the way they work, you can put money in your wallet, taking it out is nearly impossible. The reverse limits are absurdly low, for example, you can add up to INR 10k in a month, but can withdraw up to INR 500 back to your bank account. Consequently, this one way constraint leads to user behavior in which users add money to the wallet and spend it almost immediately. Most of the mobile wallets have a very small escrow balance (less than the total daily transaction value). This makes a perfect use case for making online payments. Offline payments are a different story (more later).

Thirdly, the mobile wallet account isolates a user’s bank account which addresses the problem of frauds. Although how much more secure it truly is, is debatable given the key to the bank account (card details) are stored in the wallet account. This does give some sense of safety.

Fourthly, due to how the wallets work, the payments from wallets have no external payment dependency in contrast to cards. Of course, this is true once the money is loaded in the wallet, which is a regular card transaction. The issue of failure rates is almost mitigated by this leading to much more seamless user experience and far less loss of revenue due to abandoned transactions.

Lastly, anyone in payments business can tell you, the commercial transactions are where the moat lies. P2P transactions are only useful to make the platform sticky for the user. Mobile wallets have built a very large merchant network over a period of time. The more acceptable a payment instrument is, the more valuable it becomes to the consumer. Banks, which tried their hands on building wallets later, failed to charm the user just because they don’t have that large acceptability. This is a huge entry barrier by itself.

With above advantages, there are also challenges.

Mobile Wallets have worked well for online use cases where the buyer and seller are clearly identified and the seller settlement happens with the wallet provider. Since the purchase happens online, the user's wallet (semi-closed) is debited and the merchant’s wallet (closed) is credited. Closed wallets have no limits. So, the merchants can collect any amount. It’s not the case when it comes to offline payments. The biggest challenge with the offline use case is unregistered merchants. For example, you go to a medical store and purchase some medicines, the payment from the wallet is essentially a P2P transaction. It can’t be differentiated with a regular P2P transaction, given the medical store owner opened an anonymous wallet. The second problem with these P2P commercial transactions is, the seller can’t take out the money from the wallet as it is a semi-closed wallet. This makes using wallet for offline use cases a less lucrative option. Recently, many such ad-hoc offline wallet payments happened due to demonetization with no real alternative left, I believe, things will be back to normal if the offline unregistered merchants are not on-boarded. For offline registered merchants, this is not an issue. Many QSR chains are registered for example.

Lastly, it’s worth mentioning that the new Payments Banks are only taking this forward. Although the business model is much harder to crack compared to a mobile wallet, which had a surprisingly low capital investment to run. A topic for another post maybe.

The revenge of the Banks

It’s truly marvelous what mobile wallets accomplished right under the nose of the banks. Banks wanted a piece of the action and (bank owned) NPCI came back with a new standard, UPI. A much improved, mobile first version of IMPS.

UPI has the potential to be the most revolutionary financial technology in the world! Consider, you can make real time transfer from your bank account to any other bank account using any app of your choice. It’s like PayPal, but works directly between the bank and not controlled by one entity. The technology is left for the startups to build, banks are just platforms. Technically, banks have opened API interfaces for transfers! API documents are on NPCI website to explore. In a nutshell, you can create disposable addresses and make both push or pull transactions using them. Besides, the cherry on the cake is that, it is Aadhar enabled.

UPI completely addresses the offline payments problems wallets have. It’s great except that, wallets are not allowed to participate. Why? Because banks want a head start. It’s not clear how it will be monetized though, but leaving out wallets is a big threat to them. The balancing force here is, for offline merchants, accepting payments directly into their bank account will make their income discoverable and might have them pay more taxes. Unorganized merchants won’t like it.

The (near) future

I want to conclude by saying that we are all changing when it comes to how we make payments. With great executions, aggressive regulators and very keen investors, a revolution is around the corner.


Navneet is a technology entrepreneur, having an experience of more than 10 years, working with large businesses, like Microsoft and Hughes and numerous startups in eCommmerce/Payments/SAAS/Digital Marketing/Cloud Computing space. He co-founded Chhotu.in, a start-up in Indian eCommerce logistics space. He possesses an excellent mix of business and technology skills, having a core area of interest in building technology enabled businesses. Currently, he is focusing on building mobile-first products. He holds an engineering degree in Electronics and Communications from Delhi College of Engineering.