Throughout history, inventions and new technologies have transformed the way we interact with a type of good or service.
There’s no doubt that the coolest offerings allow us to acquire or do something faster, but the most exciting technologies tend to significantly increase the number of people who have access to it.
The most significant example I can think of is the printing press. Instead of a scribe manually penning each page, texts could suddenly be produced en-masse at a far lower cost. To the extent the population were literate, the availability of literature and ideas expanded dramatically. Indeed, Martin Luther, until then an obscure German monk, realised the power of this new form of media, and within a short amount of time was able to spread his ideas across Europe and trigger the Protestant Reformation. A less dramatic, but still transformative example, is the introduction of public transport. Earliest examples are forms of water transport and are as old as the first ferries. We’ve of course witnessed a myriad transportation types since then, but they all have a common characteristic: more people are able to move around without the need (and cost) for their own vehicle.
The Technology of Accessibility
Three letters, UPI, are beginning to penetrate the Indian payments system and can have far reaching effects on the way Indians are able to interact with the financial system. To be clear, I’m not saying the incremental impact is as significant as the printing press, but this new technology can make a significant contribution to broadening credit access, which in turn will have meaningful impacts economically and socially. More people will have access to credit, and the process through which they will apply will be far less cumbersome than present procedures.
Introduced in the middle of 2016, UPI is a payment system that allows money transfer between any two bank accounts by using a smartphone.
A user can make payments directly to merchants or other individuals without the hassle of typing card details, IFSC codes or banking/ wallet passwords. Instead, UPI introduces the idea of a Virtual Payment Address (e.g. nira@xyzbank) which can be thought of like an email ID for your money. What’s important is that payments can be made or collected without the user knowing the actual bank account details of the counterparty a user is transacting with. Money can be sent or received from a user’s smartphone using just their Aadhaar number, their mobile phone number or their virtual payment address. Sending money through UPI should be as easy as sending a message. Former RBI Governor, Raghuram Rajan considered the advent of UPI as the “Whatsapp moment” for payments in India.
Since its launch, UPI has been gaining traction with number of monthly transactions rising from 1mm in August ’16 to surpassing 11mm in July ’17. More than 50 banks are now fully integrated into UPI. The real fillip for volumes could come when, as reported in the media, Whatsapp introduces payments on its app via UPI. The real Whatsapp moment will be realised with the entrance of Whatsapp!
Things are about to get more interesting. UPI 2.0 is coming. The new incarnation will bring some additional features, including the ability to allow users to pre-authorise transactions and the enabling of bill payments, among others. While these sound like incremental advances in an existing system, they can have a profound impact on broadening access to credit in India.
We think UPI 2.0 will be impactful in 4 ways:
(1) Let there be light: flow-based lending based on digital records
Where it was once dark, UPI can shine a light and illuminate the behaviour of millions of borrowers that are currently out of reach for banks. The adoption of UPI for payments, whether they be to merchants or individuals will create a digital transaction trail for every user. To the extent that people choose this faster and more convenient mechanism instead of cash, the data set will be richer than what we can observe through bank statements today. The inclusion of bill payments will also aid lenders’ ability to assess a prospective borrower’s history of meeting financial commitments even if they haven’t taken loans before. In line with the consent based framework for data sharing that will become the norm, it is the user that owns their transaction data and they can choose to share it with lenders from which they seek credit. Not only will this enable lenders to score more people than before, since they have greater transparency (and therefore confidence) loan rates can also be lower than would otherwise be the case.
(2) Small is beautiful: lower operating costs enables small ticket credit
Lenders have costs associated with onboarding a customer, administering a loan, and then collecting payments from borrowers. Banks, with their branch network, large number of employees and expensive customer acquisition channels, have heavy cost structures which is why a loan size of below Rs. 1 lakh often doesn’t make economic sense for them. UPI will reduce the costs of collections through the e-mandate. This will allow fintech companies to offer even smaller loans than is possible today. The average loan size will reduce as you move down the economic spectrum; the ability to grant smaller loans means that people on lower incomes will now be able to access finance through the formal system.
(3) New horizons: reducing on-boarding costs will unlock larger addressable markets
Banks have a good presence is the major cities of India. However as you move from Tier 1 to Tier 2 cities and beyond, the availability of credit drops due to costs of customer acquisition and collections increasing. These problems become all the more acute as we move to rural areas. It becomes cumbersome for banks to collect paper copies of mandates, again increasing the costs associated with disbursing a loan. Lenders usually deploy couriers to collect documents from borrowers, the availability and reach of which diminishes as we move away from the main metros. UPI’s digital e-mandate, which bypasses the need for collecting paper documents, mitigates this problem entirely. It’s as easy to setup repayments for someone in a small town as it is for someone living somewhere like Bangalore. The willingness to lenders to increase their footprint to more of India should therefore increase.
(4) Tick Tock…Time is Money: faster credit decisions
Related to the point above, UPI’s e-mandate removes the last paper element of a loan application. It will now be possible for a borrower to have a completely digital process. There are a couple of banks that do offer e-mandate today, but they are the exception. With UPI 2.0, a borrower should be able to have money in their bank within 30 minutes of beginning a loan application. Today, in a system where days, or even weeks are the norm, this is truly groundbreaking.
One point that bears mentioning here, and to our knowledge is unaddressed in the technical design of UPI 2.0, is that the borrower is now able to modify or cancel a mandate at any time. In today’s NACH mandate, a borrower must go to their bank branch and get consent from the collecting party to cancel a mandate. UPI 2.0 makes this dramatically easier; it now just takes a few clicks of a button. This introduces a new element of moral hazard risk. To the extent that a borrower has good intentions to repay their loan, it shouldn’t make a difference. Those that are with less noble motives will find it easier to abscond. If loan performance does deteriorate with UPI 2.0, then the at least part of the aforementioned gains will be lost as lenders either raise rates to compensate for higher risk, or backtrack from UPI’s e-mandate completely. This is something that will evolve with time, and participants on both the lending and policy-maker side will need to respond as behaviour is observed.
Overall, we think the new incarnation of UPI will serve to accelerate the availability and supply of credit across the Indian economy. This will have positive implications for both economic and societal development. At NIRA, our mission is to increase financial inclusion by being able to serve more of India’s underbanked population. We look forward to using the new technology to achieve this objective and at the same time delivering our customers with a high quality experience.
