NPCI Introduces PPI Fees. Is the Path to Profitability in Sight for UPI?

A circular from The National Payments Corporation of India (NPCI) was released which says, "NPCI suggests a 1.1% interchange fee on UPI transactions above ₹2,000 through PPIs. Digital wallet companies will pay a 0.15% charge to the remitter bank for wallet recharges above ₹2,000".

The changes take effect from 1 Apr, 2023 according to a circular by NPCI dated 24 Mar, 2023. While this move brings slight relief to UPI players such as Google Pay and PhonePe, who have been struggling to make revenue on the payment network, the question remains: is it enough?

What is PPI? PPIs or Prepaid Payment Instruments are digital payment methods that come preloaded with a set amount of money, similar to an electronic wallet or prepaid card. PPIs can be issued in different forms such as cards, wallets, or mobile apps.

Who pays whom? Cut the clutter

Post the release of this circular, people on social media wrongly interpreted that customers have to pay 1.1% charge for use of UPI and that UPI is no longer free, which is not correct.

In reality, it's the merchants who have to pay up to a 1.1% interchange fee on UPI transactions of over ₹2,000 coming via PPIs (prepaid payment interfaces).

𝗛𝗲𝗿𝗲 are 4 𝘁𝗵𝗶𝗻𝗴𝘀 𝘆𝗼𝘂 𝗻𝗲𝗲𝗱 𝘁𝗼 𝗸𝗻𝗼𝘄

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📌 Customers won't have to pay for any transactions

📌 Merchants won't have to pay if the customer is paying directly from the bank account

📌 No P2P UPI transactions will be charged. That means transferring to your friends and family through UPI is free

📌 In the case of peer to merchant (P2M) transactions, only when the transaction is above ₹2,000 and paying from a wallet/PPI then it's the merchants who have to pay up to 1.1% acc to below slab

Merchant categoryUPI Interchange feeConvenience stores, Statutory payments, Mutual fund, Insurance, Railways1.0%Supermarket0.9%Telecom, Utilities, Education, Agriculture, Real estate0.7%Fuel0.5%

Also, like in the olden days when some merchants used to pass the card transaction charges to the customers, it can happen with UPI interchange fees too but, if a merchant asks for 1.1% from you, it's time to kick him out from your list of preferred merchants.

Behind the scenes: A simple UPI transaction

When you make a transaction, the merchant has to pay a fee called an interchange fee. In UPI, this fee is paid by the merchant's PSP or Payee PSP(Payment Service Provider) to the National Payments Corporation of India (NPCI) for processing the transaction on the UPI network.

Before Covid-19, the fee for UPI transactions included a PSP fee and interchange fee, but they were banned by the government. Since then, only the switching fee is charged. The payer's bank account is immediately debited and the money goes into the nodal bank account assigned by the merchant acquirer. The nodal bank settles the payment into the merchant's bank account, typically the next day. The nodal bank earns float income on the transaction money as it's usually of the same bank as the payee PSP.

Example of fund flow of new NPCI guideline

If a customer loads their Paytm wallet with ₹3,000 via Axis Bank, Paytm will need to pay 0.15% or ₹4.5 to the bank. Wallet interoperability has two scenarios: if the merchant has a QR code linked to Paytm, no interchange will be charged, but if the merchant has a QR code linked to a different wallet, such as Mobikwik, Mobikwik must pay 1.1% to Paytm as an interchange fee. Mobikwik can either absorb the cost or pass it on to the merchant. UPI payments are free for customers, but merchants will only be charged if they agree to accept the fees.

But is it enough?

UPI players such as Google Pay and PhonePe have been expanding their payment acceptance infrastructure in the country. However, the PPI payments use-case on UPI is not clear yet. While the new interchange fee may bring some relief to UPI players, there is still no incentive for a user to use their wallet over their bank account to make a UPI payment. Rather, there is an extra friction layer of loading the wallet, which UPI was solving while competing with digital wallets. In the meantime, UPI players explore new ways to incentivize customers to use PPIs for transactions which can be in the form of rewards, cashback and offers.

Macro impact of this decision

Smaller merchants might resist the change

Smaller merchants will not want to pay 1.1% and would like to pass this cost on to the customer just like with card transactions. In tier 2+ cities, many small merchants are not even willing to pay a minimal fee of ₹125/month for a soundbox, so how do you expect they will pay 1.1% per transaction? But wallet players have one advantage with them. The digital India campaign, COVID-19 and internet penetration have changed consumer behavior and propelled UPI to unexpected heights. So if the merchant is unwilling to pay the 1.1%, the wallet players will offboard the merchant leading to a reduction in the sale of the merchant due unavailability of an online payment option with the merchant.

India's PPI wallet players valuation poised for growth

Indian PPI wallets like PhonePe and Paytm, where customers store funds from their bank accounts to make digital payments, will benefit from the government's decision to make PPI P2M transactions over ₹2,000 chargeable for merchants. This will open a new revenue stream for wallet players.

Morgan Stanley and Citi are bullish about Paytm and believe that the new rules could make a positive impact on its 100 million wallets and create opportunities for more income in the future. They have set high target rates of ₹695 and ₹1,061 per share, indicating that they see the potential for significant growth in Paytm's value. This could be the "Aha moment" for investors considering investing in Paytm.

Banks will come up with their own digital wallets

By incentivizing banks to integrate UPI into their digital wallet offerings and encouraging consumers to use UPI for larger transactions, without the requirement of traditional card products, banks and wallets could potentially earn over ₹10,000 crore annually in interchange alone, thanks to the NPCI decision.

This move could revolutionize the way Indians make payments and make UPI the preferred choice for merchants, consumers and digital wallets alike. The National Payments Corporation of India has hinted at this potential by adding bank accounts, RuPay credit cards and prepaid wallets to the UPI-enabled app options.

We will see many banks coming with their digital wallets to grab this revenue-earning opportunity on UPI.

Interchange fees and profitability: The thin line between profit and loss

The incentive of new interchange fees will lead to wallet operators giving more rewards and offerings to users who make payments using the digital wallet for greater adoption of their wallet than their competitors. The digital wallet players will spend money to offer rewards to users who make payments using them along with shelling 15 bps as wallet loading service charges to the remitter’s bank for loading over INR 2,000 in the wallet.

There is a very thin line between profitability and loss here. The math here is very simple: Rewards + Wallet loading charge cannot be greater than max 1.1% of the transaction value.

The fintech companies were already bleeding money. PhonePe's operating loss in FY22 was ₹1698.56 crore, whereas Paytm's operating loss was ₹2,325 crore according to moneycontrol. The rewards should be less than .95% of the particular transaction to make digital wallets profitable, but in this cutthroat competition and lack of customer loyalty, the customer will adopt the digital wallet that gives them the most rewards.

Path to profitability:

Is the government laying ground for future introduction of MDR on all the UPI payments

According to a CLSA report dated July 27, 2022, UPI could have generated around ₹2,500 crore in revenue for FY 22 (2021-22) if NPCI had started charging 0.15% per P2P transaction and 0.2% per P2M transaction. The revenue would have been distributed among different partners, including NPCI, float income, payer PSP and beneficiary banks.

The government currently subsidizes UPI players and banks for switching fees. If NPCI applies fees on the transactions, it will benefit all players involved, including the government.

As per an IIT Bombay study named "Charges for PPI-based UPI payments--The Deception," the government may introduce a 0.3% digital payment facilitation fee to ensure the financial viability of the UPI payment system and fund the required infrastructure.

Introducing a uniform 0.3% digital payment facilitation fee onto e-commerce merchants alone would generate over ₹275 crore per month from UPI transactions (based on September 2022 data) and the UPI system would generate around ₹5,000 crore in 2023-24.

According to our understanding, if this proposal is implemented:

• The proposed facilitation fee of 0.3% would offer a stable and predictable revenue stream for service providers, including issuer banks, acquirer banks and intermediaries
• The facilitation fee would not impose any charges directly or indirectly on UPI transactions, incentivizing banks and system providers to promote digital payments
• The proposed facilitation fee would make digital payments more affordable and accessible for consumers, thus, boosting the adoption of digital payments in India

Also, the plan to charge transactions on UPI sits very well with the Government's plan to take UPI global. Government can earn extra revenue by exporting UPI stack, earning revenue on remittances from NRI, paying for goods and services and government payments such as tax payments on properties, utility bills, etc.

What is there for UPI in the future is still to become clear but certainly the Government can’t operate UPI without charging fees as it will make UPI unviable in long run and a huge cost center because of its infrastructure cost.

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