UPI and the potential comeback of Digital Wallets

I am going to excuse myself from talking about the incredibly high UPI transaction numbers. But let me reinforce the reality which is — UPI is now a common phenomenon. It is the locomotive of payments — the engine that propels digital payments in India.

Enough said about the glory of UPI. Let’s talk about a less talked about phenomenon which is the humble savings bank account that enables UPI. For UPI payments to work, there must be a store of value which is your humble savings bank account. But I would like to recount a small back story before I venture into a difficult topic.

A little personal story about Savings Bank Accounts

It was the year 2005. SBI was just implementing a core banking system. Only a few branches in the country have been enabled with the core banking system. Prior to the introduction of core banking, a customer had to walk into their home branch for most of the critical operations with the bank account. I was a software engineering intern at Amazon Bangalore which had about 40-odd employees at that time. Amazon India had their banking relationship only with Deutsche Bank (much less has changed since then). But we poor interns only had a zero balance student account with SBI (college branch NIT, Trichy). To pay us our stipend, Amazon gave us two choices (a) open an account with Deutsche Bank and they would remit our stipend into that account digitally (b) take a cheque. The problem was — Deutsche Bank required an AMB of INR 25,000 which was impossible for us at that time. So, we took the option of the cheque. Amazon gave us all our stipend cheques issued by Deutsche Bank. We went to the CBS-enabled Bangalore branch of SBI to process the cheque. The staff there refused to accept the cheque and advised us to process the cheque with our home branch.

Ultimately, we had to courier the cheque to one of the parents in Trichy. One of our parents then went to our college branch, deposited the cheque and finally, we got access to the money, after a week’s time. Phew!

Tech — the advantages and the limitations

I know this must be feeling so ancient to most of you. It was such a big deal back then to network all the branches, centralize the systems and provide access to every customer across all branches. And today, we don’t think twice to whip up our phone to pay 10 rupees for a chai at a roadside shop using UPI which makes a ledger entry into the core banking system after being routed via 4 different institutions (if not more).

And therein lies the problem. You see, for the banks, it is non-trivial to process a transaction. There is a lot of system overhead involved since they have to evaluate several rules before allowing the transaction. All this costs effort and money. The core banking system is not designed for high-velocity-low-value transactions, although it very much is capable of supporting them. Just that, this increases the technology costs for the bank. But the core USP of UPI is that it costs the customers & merchants nothing to transact. That’s a tricky problem to solve.

So, the banks are stuck between a rock and a hard place.

The near-death of Digital Wallets

UPI embraced bank accounts as the only supported store of value on the protocol. It wasn’t a surprise given the structure of NPCI. And QR as a form factor for merchant payments was wildly successful. The regulator ensured that only interoperable QRs existed so as to avoid any confusion among customers. This led to the disappearance of all other proprietary QRs. As UPI provided for both P2P and P2M transactions, it was superior to digital wallets in the most important ways that mattered to customers — ease of use and universal acceptance. Digital Wallets were technically dead except for a few fringe usecases. Only Paytm has remained significant due to its two-sided presence (merchants & customers).

UPI interoperability — the resurgence of Wallets?

In the recent past, the regulator permitted digital wallets as a store of value to be interoperable on the UPI platform. Let’s unpack this with an example. If you are a customer using one of these digital wallets, you can now do a QR transaction at an outlet having any UPI QR, paying with your Digital Wallet. I believe this has great significance for digital wallets. It creates a level playing field on the two dimensions that we spoke earlier — ease of use & universal acceptance. Digital Wallets have some intrinsic structural advantages over savings bank accounts. I believe this will create a resurgence of Digital Wallets. Let me explain why.

Easy KYC and higher limits

Opening a wallet account remains easy with just a mobile number verification (small KYC). A full KYC wallet account is almost equivalent to a bank account itself. Wallets with a small KYC enjoy a limit of INR 10,000 per month. This is sufficient for most users of UPI for their P2M payments. Accounts can be opened instantly with Small KYC and operated in realtime. Once an account is opened via Small KYC, the wallet provider can then slowly nudge the customer to signup for a full KYC which enables the customer to use wallet for higher value transactions and extended limits.

Wallets reduce the Risk of exposure

Using the salary account for day-to-day payments exposes the primary bank account of users to risk from fraudsters. An intelligent way to reduce this risk is to open a different account for conducting day-to-day transactions. As wallets now have higher limits, customers can easily choose a wallet account over a bank account. Even if a wallet is compromised, victims merely lose a few thousand rather than compromising a month’s salary or life’s savings which is held in the primary bank account.

Wallets are a lot faster

As wallets don’t have the system overhead of a typical bank account, the transaction times tend to be much faster. They also tend to have higher uptimes since maintenance is a lot easier.

Better customer support

Digital Wallet companies tend to be extremely tech-savvy in a bid to offer a much better CX. But there is also another reason for such passion — reduce the cost of customer support by ensuring customers don’t call. To that end, they offer much better support tools to their customers than traditional banks. Digital Wallets are much more sensitive to NPS or Play store reviews. They work very hard to ensure that their customers don’t publish negative reviews.

Easy Income Tax Reporting

I am going to assume that you, my reader, are an honest to god citizen that cares about paying the taxes correctly. If not, you can skip this section, but remember that you have to live in fear of a tax audit. While filing the tax, a citizen has to declare all the bank accounts that they have, and also ensure that they pay tax on the interest received from all their bank accounts. This is a real hassle for those having multiple bank accounts and reams of transactions. With Digital Wallets, there is no such obligation.

Wallets will be more innovative

Digital Wallets will offer a fundamentally more innovative product — split with friends, loyalty programs, better security, better merchant offers, etc. They will try to differentiate themselves using product features. Users will find more value in using a Wallet app.

Disinterest of Banks

As UPI gears up to 1 billion transactions per day, Banks will feel the stress on their core systems. Not just the direct cost, but costs of the downstream systems such as financial reporting, analytics, etc will increase due to the exponential increase in data volume. Banks will have a strong incentive to reduce UPI transactions. Ultimately, this will lead to one or more of these — (a) charge customers an additional fee for UPI transactions (b) Limit the usage to a few transactions per day (c) Promote their own wallets. All roads lead to digital wallets. Banks are already doing (c) — HDFC Payzapp, ICICI Pockets, Axis Freecharge, etc.

Closing thoughts

UPI has had exponential growth. There are several forces shaping UPI and its evolution. It is still Day 1 and I believe that Wallets that were once considered killed by UPI will make a comeback and ironically, it will all be thanks to UPI.

What do you think?