Hi Chitwan,
 

Let’s talk about the biggest story of the week – the RBI announced that credit cards can now be linked to UPI. It’s a big story because of how big UPI is and how big the current credit card hype is. And when these two worlds are set to merge, there’s enough and more fodder for loquacious FinTech talking heads (I’ll admit, I’m one of them) to spring into action.

While the idea of paying with the ease of UPI but through one’s credit card sounds almost heavenly, there are a lot of nuts and bolts that might need plumbing. Before the system floods. 

First, there’s apprehension about how the move will be received by the merchants who are so used to the zero-MDR regime that credit card MDRs (if present on UPI) will tumble the accounting equations. But there’s also an appreciation for credit card entry on the UPI platform and its potential to contribute to the financial inclusion endeavor. And of course, there are those who have reviled the announcement in no uncertain words.

But let’s back up for a second and see what’s been said by the authorities so far. Here’s what jumps out of the June 8 announcement:

• For now, only RuPay credit cards can be linked to UPI
• Instructions around its pricing will be worked out by banks and system entities.

The central bank has left a burning question unanswered, leaving us with little choice but to speculate – will credit card payments on UPI also attract merchant discount rates (MDR)? 

Who pays for financial inclusion? 

If not, then banks are in for a massive shock. Fees and commissions account for nearly ~50% of credit card companies’ revenue. In fact, of the approximately 2% MDR charged on each credit card transaction, about ~60% goes to the credit card company. 

But that zero-MDR scenario for even credit cards on UPI is highly unlikely. After all, UPI is owned and operated by the Indian Banks’ Association (IBA) along with the National Payments Corporation of India (NCPI). It is much more probable that credit card providers will want to levy transaction fees and be paid for their network, services, and operational investments even when payments are made through UPI.

This could put a spanner in the works of the financial inclusion story since small merchants stayed away from PoS terminals even during demonetization due to their exorbitant costs of owning, maintenance, and the huge MDR that comes with accepting digital payments through cards. 

Now, if credit cards on UPI go the same way - it’s anybody’s guess if merchants will be willing to part with their margins after two years of smooth sailing with almost zero cost. In fact, with a drop in in-store footfall during the Covid-19 pandemic, the number of active PoS terminals in India has dropped even further.

As a result, UPI benefitted at the expense of PoS terminals. A shift towards contactless payments during the pandemic has made it the most preferred payment option for customers. 

So far, it was believed that while UPI will trump debit card usage, its impact on credit cards may be negligible. 

Now, thanks to the high interchange fee, linking credit cards with UPI might tank even the UPI’s progress so far - prompting certain merchants to give it up entirely. Why? Because it’ll likely be unviable to ask customers to pay only through debit accounts or through UPI credit cards (if it has indeed zero MDR) at the cash counter. 

Aggressive play on a tilted turf?

Moreover, RuPay, the NPCI’s reply to Visa and Mastercard, already operates with zero MDR on its debit cards. It’s safe to assume that the government body may likewise waive off fees on RuPay credit cards as well. However, will its two global competitors follow suit? Fat chance.

Then there’s also the question of customer experience. The move might impinge on UPI’s promise of interoperability and convenience if it retains credit cards’ multiple-factor authentication on top of its own authentication process. On the contrary, tapping debit cards and credit cards directly through an NFC PoS terminal eliminates these hurdles in the customer journey.

Did UPI break the PoS hegemony for naught?

UPI ushered in an unprecedented financial inclusion regime. It changed the way digital payments work - not just in India but across the world. The problem with UPI has always been one of aggressive innovation without the larger market’s buy-in or a deeper policy thought to plan and guardrail future hiccups. 

How this plays out is yet to be seen but it’s a territory where the unknown unknowns are higher than the known unknowns. I am going to stick my note and indulge in cautious speculation as to how it could play out over the medium to long term. 

The good:

1. Small merchants might see higher average order values and an overall increase in revenue because of the ability to pay on credit 
2. Deeper long-term penetration of credit cards and formal credit 
3. One-stack payment system with options for both debit and credit - easier reconciliations, accounting, and even cash-flow-based lending for merchants. 

The bad:

1. Any misstep on the MDR tightrope walk could undo even the past progress 
2. The lack of official biometric authentication for UPI and the current fuzziness around the authentication protocols could impede consumer experience 
3. Market incentives need to be restructured to ensure that more players than just RuPay are able to participate and play on a level-playing field 
4. It remains unclear as to how will banks be incentivized to develop credit card infrastructure to enable UPI transactions in the absence of clear financial incentives  

When it comes to payments, UPI stands unvanquished – it has spawned innumerable use cases and truly led financial inclusion from the front. On the one hand, UPI has been introduced on feature phones, and on the other, it is poised to bring aboard credit cards. 

There’s no doubt that the distribution and acceptance of UPI can be an effective vehicle to enable and deliver formal credit. However, it’s going to be a tough day at work for the policymakers to bring bankers, payment companies, and card networks on the same page and ensure a smooth take-off. 

PS: Who’s going to look out for the merchant? 

Do you think credit cards will become more popular with the UPI push or it'll crash and burn?

Hit reply and tell me what you think, I would love to hear your thoughts.

See you next week. 

Cheers, 
Rajat
CEO and co-founder
FinBox