Reform the UPI system: We need sustainable digital payments infrastructure

There is no charge on UPI transactions, either peer-to-peer or customer-to-merchant. Many attribute this as the reason for UPI’s outreach and success. Notably, enablers of the UPI system are only partly compensated for their costs by a government scheme. There is also the issue of a non-level playing field between UPI and other payment modes such as debit and credit cards, Immediate Payment Service (IMPS), etc, which charge transaction fees.

The UPI operates in a monopolistic environment. National Payments Corporation of India (NPCI), an initiative of the Reserve Bank of India (RBI) and Indian Banks Association (IBA) that owns the UPI platform, is India’s sole provider of digital payment infrastructure and faces no competition from any other entity. Notwithstanding the good job done by NPCI, some questions arise for wider public discussion. Should UPI continue to monopolize the country’s digital payment infrastructure? Should UPI transactions continue to be free of charge? And should NPCI continue to be a not-for-profit company? The answers to these questions are inter-related.

As for UPI’s monopoly, some argue that such infrastructure is a public good and the private sector is not best suited to provide it. This argument can be contested, as any monopoly tends to encourage complacency. An appropriate business model and regulatory oversight could induce private investment in creating and operating similar infrastructure. Alternative payment systems would deliver competition, improve operational efficiencies and encourage innovation.

There is another conceptual problem with NPCI. Although RBI doesn’t hold any equity in it (various banks do), the central bank is effectively the owner, operator and regulator of UPI. While this model might have been helpful in giving the idea its initial push and establishing the system, a regulator with an interest in a regulated entity is undesirable.

To RBI’s credit, it came out with a policy in 2019 for licensing so-called new umbrella entities (NUEs), envisaged as UPI competitors, and invited expressions of interest from eligible parties. As per media reports, many consortiums, including ones led by Amazon, Google, Facebook and the Tata Group, applied for NUE licences in partnership with companies such as Reliance and ICICI Bank as partners. Surprisingly, in 2023, RBI abandoned the whole idea, stating that it didn’t receive any proposal with value-additive solutions to India’s digital payments landscape. This reasoning sounds unconvincing. It is difficult to believe that such big players had no value-adding proposition. For argument’s sake, even if they had no new ideas but only wanted to invest, why rebuff them? Some media reports at the time suggested that NPCI-owning banks had lobbied against RBI’s NUE move.

There is also the matter of UPI being free of charge. The government’s mandate of a zero merchant discount rate (MDR) for UPI payments is not a sustainable approach. Again, to the credit of RBI, it came out with a public consultation paper in 2022 on “charges in payment systems," suggesting different options for levying MDRs, including for UPI transactions. The RBI paper explained the issues and costs involved, clearly stating the roles of various UPI participants, ranging from the payer’s and payee’s payment service providers (PSPs) to the remitter’s and beneficiary’s banks, apart from NPCI and third-party application providers (TPAPS). However, even before RBI had received public comments on options suggested in the paper, the Union finance ministry dismissed the idea of levying a fee, stating that UPI is a digital public good of immense convenience for people and productivity gains for the economy.

To cover operating costs and reimburse banks and fintech firms for the MDR forgone, the government has a special scheme, but this budgetary provision is inadequate and the basis of apportioning the amount among UPI participants lacks clarity. As a result, not only do banks have little incentive to upgrade their digital payment infrastructure, the business models of PSPs and TPAPs that participate in the UPI system are opaque.

Foreign TPAPs with deep pockets dominate the UPI transaction business in India. At one time, NPCI had envisaged a cap of 30% on the market share of TPAPs to prevent the system’s domination by a few, reduce systemic risk and encourage innovation. That has clearly not worked. At present, two foreign players, PhonePe and Google Pay, have a combined market share of over 80%. Once again, a clamour has arisen for encouraging domestic and smaller UPI players.

Fixing a UPI quota for each player may not be the right proposition; it would be a retrograde step, besides presenting implementation challenges. Instead, other options should be examined. Appropriate steps in this direction would include having a clear MDR policy and mandating a transparent business revenue model for participants.

NPCI, a not-for profit Section 8 company with income arising from fees, made a surplus of ₹809 crore in 2022-23. NPCI’s profits are likely to be even higher this year. Notably, except for NPCI, all other participants in the UPI system—that is, PSPs, banks and TPAPs—are profit-maximizing entities. There might have been some logic of setting up NPCI as a not-for-profit company, but there isn’t any for it to remain so. NPCI should be converted into a regular company. Not just that, going forward, it should aspire to get listed for public trading. That would give its working a new and welcome level of transparency, unlock its true value and encourage fresh investments.

To conclude, the UPI system and NPCI are in need of urgent reforms. To begin with, UPI transactions should bear an MDR fee. PSPs and TPAPs should be mandated to follow a transparent business revenue model to facilitate competition. This should be followed by licensing a few NUEs—perhaps two or three entities with interoperability among themselves and with UPI. As a monopoly in control of over 80% of total digital payments in the country may have systemic implications, it is important to reduce risks associated with market dominance. As for NPCI, it should be converted into a for-profit company and then listed on stock markets in due course.