Concentration risk should not spoil India’s UPI party

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When we look back at events after the passage of time, we do so with the benefit of distance and wisdom. In the scale of time, a few years can appear as a small stretch in a nation’s long history. But, some years standout from the rest for the transformations during this period that have positively touched hundreds of millions of people.

One way of examining transformations that are sweeping a society and an economy is to gauge changes in people’s social and economic behavioural patterns.

One of the most visible transformations has been in the way people transact on a day-to-day basis. India’s payments landscape is at a point of inflection, aided by rapid smartphone penetration, and millions who are joining the swelling ranks of the middle class.

If one were to draw a graph of the financial spending pattern of Indians based on people’s income, it could well resemble that of an elongated arm chair. Anecdotal evidence would suggest that people with greater cash-based earnings will have a higher propensity to pay for groceries in cash than through digital payment modes.

But that’s changing and how. Rapid digitalisation, reasonably affordable data costs, and quicker smartphone penetration has ushered in easier payment systems, dismantling technology and income barriers. This has resulted in integration of both online and offline spaces that has now become the instrument of choice for small payments. These have become emblematic of significant behavioural change among hundreds of millions of Indians.

The default payment option, even for small purchases such as buying agarbattis, for payment is now through India’s indigenously created United Payments Interface (UPI) system. Most people now reach for the phone, rather than cash, to make a payment at a shop. The UPI recorded its highest ever number of transactions in April 2022 at 5.58 billon, amounting to Rs 9.83 lakh-crore. The next target for the UPI is to process a billion transactions a day in the next 3-5 years.

While all this is commendable, there is a peculiar problem of concentration that is emerging. Two apps — Walmart-owned PhonePe and Google’s GPay — currently dominate the market of third-party UPI apps. Together they account for 82 percent of the UPI transactions by volume (PhonePe with 47 percent and GPay with a 35 percent market share) and 84 percent by the total value of transactions (PhonePe with 49 percent and GPay with 35 percent).

In the UPI ecosystem, Third-Party Application Providers (TPAPs) ride on the compliances of sponsor banks.

In an apparent move to minimise concentration and systemic risk, the National Payments Corporation of India (NPCI) came out with a detailed implementation standard operating procedure (SOP) in March 2021 stating that the existing TPAPs, which command a market share of more than 30 percent will be subject to the “volume cap” stipulations after December 2022.

By definition, a systemic risk refers to the possibility that an unforeseen occurrence in a company could potentially endanger the stability of an industry. The concept of ‘too big to fail’ has its bearings in fear of systemic risks as some institutions occupy a disproportionately large space in a highly interconnected industry.

Prima facie, a more than 80 percent market share by two players presents a text book theoretical case of concentration risk.

“The existing TPAPs, which are exceeding the Volume Cap will have a period of two (2) years i.e. from 01st January, 2021 until 31st December 2022 to comply with the SOP in a phased manner and NPCI will review the same on a half-yearly basis starting from January 2022”, it said.

With less than six months to go before the volume cap stipulations are scheduled to kick-in, two basic questions arise. One, is the NPCI going to set a new deadline for implementing the volume cap, or January 1, 2023 is from where it will come into force? Second, and this follows from the first question, is what happens to those TPAPs that already enjoy a market share far above the volume cap? (PhonePe CEO Sameer Nigam’s recent remark: “can my next ad be: please don’t install my app,” was said in this context.)

India’s UPI success story has emerged as a template for the world. That said, regulators, the NPCI, cannot ignore the signs of a potential systemic and concentration risk.