The United States, the epicentre of financial innovation and growth, has long been the undisputed global leader in finance. The leadership position may, however, see a swift change in the near future, given the tectonic shifts being witnessed in recent years led by India’s innovative Unified Payments Interface (UPI). It’s a stupendous success story which is revolutionising the payments industry in the country.
The world is taking note and over 30 countries have expressed interest in adopting UPI, a resounding acknowledgement of the revolutionary concept which has unlimited potential on a global scale. In contrast, most developed countries continue to rely on relatively inefficient card systems.
UPI’s impact lies not only in reinventing the payment infrastructure, but also in optimising the behaviour of banks and other participants in the ecosystem resulting in economic growth. Faster and more convenient transactions enable people to buy and sell more goods and services in a shorter period of time, helping the growth of the economy.
Instant transactions help in consummating local commerce and creating and enabling new market places, a must for any economy. What makes UPI even more impressive is its monumental success in bringing competing players (like banks, wallets, etc) onto the same platform with the promise of creating a larger market and reducing the cost of transactions to almost zero.
On the global landscape, no other country has managed to accomplish as much as India has achieved with UPI. This begs the question, why is the rest of the world lagging behind? Especially the US, the world leader in finance. We compared India’s instant payment options (UPI) with the US’ nearest options (FedNow and existing card systems).
The FedNow system (created by and routed through the Federal Reserve) works like the real-time gross settlement (RTGS) system in India and is considerably different from the UPI [which routes itself through a separate non-profit body, the National Payments Corporation of India (NPCI)]. However, it is the closest the US has come to achieving instant remote transactions. The disparities between UPI and FedNow illustrate the backwardness of the US system as compared to India.
According to the Federal Reserve, FedNow is an instant payments RTGS. It carries out transactions between the sender’s and receiver’s banks instantly by automatically crediting and debiting the transaction amount on the federal ledger, thus making the transaction process faster and safer.
To illustrate, suppose a sender sends an instant payment request to their bank. The bank then sends the request across to the FedNow system which validates the message (to ensure all specifications are met) and forwards it to the receiver’s bank. The receiver’s bank then confirms/denies the details of the transaction, based on which the transaction goes through and is then credited/debited from the banks’ master accounts by FedNow.
While FedNow is still in its nascent stages, the prevalent modes of instant payments in the US have been credit and debit cards, with an overwhelming majority of Americans owning credit and debit cards and preferring them over other modes of payment including cash, for almost all transactions. The American payment ecosystem, card networks, are overpoweringly influential and able to charge extremely high transaction fees, without any viable alternative for consumers. It could be argued that this oligopoly of card networks is preventing the growth of not just the payment systems in the US, but also hampering economic growth and innovation.
UPI is India’s approach to instant remote transactions. Essentially, UPI is an open source API (Application Programming Interface) that can be accessed by any mobile payment application. It connects banks, merchants and consumers to ensure seamless and instant remote transactions. UPI’s ability to be available to all parties of the transaction comes from its design as digital public infrastructure. As digital public infrastructure, UPI is open-access for the smallest merchants, service providers and facilitates.
One of the most ground-breaking features of UPI is its accessibility for the consumer. One can access any and all bank accounts on any compliant mobile app. It only requires the knowledge of the other party’s UPI ID (in the form of their mobile number or a QR code that can be scanned on the spot). Contrary to this, FedNow does not involve communicating with the consumer, thereby limiting consumers’ access to FedNow to just bank portals. This means that the consumer needs to sign into their bank account through the bank portal and then provide details of the receiver’s bank account. As for the card systems, they require an external device on the merchant’s side and each card can only access one bank account. Cards can only facilitate a consumer-to-merchant transaction and cannot transfer funds between consumers.
UPI requires a consumer to have a mobile number or a QR code to make the payment through a mobile phone application instantly. On the other hand, FedNow requires consumers to log into their bank account through the bank portal and procure receiver bank details to then make the transaction. FedNow is thus neither friendly nor an easy option for in-person transactions, limiting its utility in comparison to UPI.
Similarly, cards cannot facilitate the kind of transactions that UPI can, apart from requiring the consumer to use external devices, making the transaction inefficient and unsafe. As a result, merchants have to pay huge fees for transactions to the oligopoly of card networks as FedNow and card networks route transactions through banks. An increase in the loops in the transaction not only causes a delay in the payment but also raises the cost of each transaction. UPI, on the other hand, does not allow banks to retain any power over the process, thus cutting down on the opaque processing costs charged by banks and card companies.
Another advantage that UPI possesses over FedNow is visible in the transaction fee. UPI famously has no transaction fees and a zero-MDR (merchant discount rate) policy. This helps cut down transaction costs. On the other hand, FedNow encourages banks to collect more transaction fees. This implies a larger profit margin for banks, at the cost of consumers, to incentivise banks to participate in the FedNow framework and secure their interest above the interest of the consumer, whereas UPI’s removal of transaction fees is an indicator of its consumer-centric approach.
Cards are expensive for consumers, with credit card companies charging as much as 3.5 percent processing fees per transaction, with no price regulations imposed on them by the government. This is reflective of the larger degree of bargaining power that the private sector possesses in the banking industry in the US versus India.
UPI has disrupted the existing status quo of the payments industry in favour of consumers and the economy and played the role of a public good by removing transaction fees, having a zero-MDR policy and diluting the control of bank portals over transactions.
This has caused the share of credit and debit card companies’ control over transaction systems to shrink in India, providing a low-cost, convenient option to the consumer and opening up the space for other fintech innovations.
The biggest drawback of FedNow and the card network with respect to UPI is the lack of interoperability. Interoperability can be defined as the ability of disparate systems to communicate with each other with the purpose of sharing information and transactions seamlessly and cost-effectively. This requires cooperation between all the agents of the transaction. The RBI has been able to bring together many private agents to the same framework and streamline communication.
FedNow, however, limits itself to only one small aspect of the entire transaction and leaves the rest of the transaction to the private sector’s discretion. Similarly, in the case of cards, FedNow can only access the account in the issuing bank and does not create any pathway of communication between different banks. Thus, each bank retains its customer base and doesn’t have to cooperate with other banks. A lack of centralised action holds FedNow and card systems back from being able to consolidate a large and diverse payments sector with conflicting interests.
Change is inevitable and it is time the US adopts consumer-centric solutions like UPI to maintain its hegemony.
Aditi Srivastava and Gouri S Nair are researchers at Centre for Innovation in Public Policy www.CIPP.In working on digital public goods. They can be contacted at [email protected]. Views expressed are personal.
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