Speaking at the 18th Technology Conference organised by the Indian Banks’ Association recently, RBI Deputy Governor Rabi Sankar rapped banks for their failure to build on the UPI ecosystem. He said: “How is it that a system of transactions between two bank accounts has evolved in a way where most of the business is owned by non-banks? Clearly, banks missed a step here.”

Also around this time the NPCI extended the UPI volume cap rules deadline till December 31, 2024, while exhorting banks and non-banks to “scale up their consumer outreach for the growth of UPI.”

RBI’s frustration and angst is understandable.

The UPI Juggernaut

The UPI revolution began in August 2016, preceded by a pilot in April 2016, with just 90,000 transactions and 21 banks as payment system participants (PSP). The real-time payments app got a boost after demonetisation. It acquired a significant heft when the government banned levy of merchant discount rate (MDR) fee on payment via RuPay and UPI in December 2019.

Today the UPI eco-system encompasses a whole host of services, such as, P2P and P2M transactions, FASTag payment, insurance pay, EMI collections, auto-pay, subscription to Sovereign Gold Bond Scheme, RBI RetailDirect, IPO applications, UPI-based SIP, linking of OD accounts, invoice storing, single-block-multiple debit transactions.

Importantly, UPI has recently been extended to NRIs to make payment from their registered international numbers by debit to their NRE/NRO accounts. Further, India has now signed MoUs with about 30 countries to use UPI for their domestic payments.

Paradoxically, however, UPI is not a household word like the third-party apps (TPAP) — PhonePe, Google Pay, Paytm — that enable the account holders and merchants to complete payment transactions over UPI by settling the transfer on two payment system participants, normally the banks. And together these three TPAPs account for nearly 96 per cent of UPI transactions.

Why is this instant payment mechanism dominated by TPAPs, the ‘non-banks’?

The Beginning

In February 2016, NPCI organised a Hackathon in which over 300 entities participated and provided the UPI platform — somewhat like a financial sandbox — “for start-ups/developers community to accelerate innovations in payment arena” and assured that it “would support banks and solution providers to develop solutions based on the API made available by NPCI.”

From the beginning, it was known that such ‘innovations’ involving enterprise and deep-pocketed finance where future success was uncertain had to be venture backed, not bootstrapped. And this necessitated the involvement of private operators and Fintech players.

But thereafter, why did banks sit and watch while the TPAPs raced ahead to capture the burgeoning instant retail-payment market?

According to payment system experts, the Fintech start-ups supported by BigTech and BigFinance played a prominent role in bringing UPI apps to the masses through “their technology and customer centric innovation.”

The proposed jugalbandi between banks representing “safety and trust” and non-banks offering “informality and convenience” actually sealed the deal in favour of the latter. The prime reason for banks ceding space to non-banks was that given the significant cost involved in UPI transactions, there was no money to be made. And this resulted in banks’ reluctance to create a dedicated UPI app while relying on their mobile banking apps which offer a whole gamut of banking services, including payments, explains Mihir Gandhi, Payment Transformation Leader of PwC India.

For banks, distributing and popularising their own UPI apps was different from mobilising savings deposits. It necessitated the operators’ understanding of consumers’ preferences and a model based on customer-centricity and user convenience.

Govt nudge

Take the example of financial inclusion. The RBI had been exhorting banks to adapt financial inclusion into their working philosophy for about five years prior to 2014. However, the change in banks’ attitude came about only when the North Block issued a diktat to banks, the Prime Minister donned the role of a brand ambassador and mandarins of Department of Financial Services drove bank CEOs to send daily reports on the number of Jan Dhan accounts opened at the end of each day for almost two years. The mission was accomplished at breakneck speed. In case of UPI, there was no such nudge to banks.

The success of TPAPs has not come without significant costs. Walmart, the parent company of PhonePe has outstanding losses of ₹8,340 crore sitting on its books. The company was spending ₹2.25 to earn a rupee in FY22.

Further, according to reports, if the tax laws are not amended by March 2023, the company stands to lose another ₹7,300 crore as a result of its recent separation from Flipkart and by shifting its domicile to India. The recent announcements providing incentives for RuPay and UPILite transactions only partially cover the expenses of acquiring banks and merchant operators. Do banks have the financial band width to suffer this kind of cash burn? And will our administrative-vigilance-regulatory apparatus remain indifferent if they see a big hole in banks’ pockets?

Start-up ecosystem

When losses are mounting, why do BigTech and BigFinance continue to further their operations in India? The answer lies in understanding the economic philosophy of the start-up eco-system. Prior to the recent bout of inflation, easy money was swirling around in the Western world. Aided by borderless technology, the start-ups commence their journey with seed capital, angel investors, venture funds and private equity to make inroads into untapped markets having well developed capital market infrastructure.

For this capital market ultimately helps them to discover their value in price multiples hitherto unheard of. Burning capital is a precondition to sustain growth prior to monetising their value through IPO. PhonePe, Google Pay, WhatsApp pay, etc. are no exceptions. A model which is kosher for start-ups cannot be perceived as a game changer for legacy institutions including new private sector banks. However, “you can’t go back and change the beginning, but you can start where you are and change the ending.”

The writer is a former central banker. Views expressed are personal