What is UPI ?— Part 1

I distinctly remember an incidence when one of my friends who had been in the United States for quite some years had come to visit India. We were having some chaat on the roadside. As we were about to finish, I noticed him taking out his wallet(which had only dollars) and then sheepishly looking for alternatives in his pocket to pay the vendor. Meanwhile, I took out my phone, scanned the QR code and paid the vendor. As the sound machine announced that the payment was successful, my friend was left confused and surprised on what had just happened before him. I then realized how far ahead India had jumped as compared to the West in the space of digital payments.

Unified Payments Interface (or UPI) is the revolutionary technology that changed the landscape of payments in India after it’s introduction in April, 2016 by the National Payments Corporation of India (NPCI). In no time, it became the favourite of the common man in India and the merchants alike. But what was it that led to the meteoric rise of UPI, such that as of April, 2024 it accounts for more than 80% of the total digital transactions in India ?

Evolution of UPI

With the vision to proactively encourage electronic payment systems for ushering in a less-cash society in India, NPCI set on it’s mission to ensure payment and settlement systems in the country are safe, efficient, interoperable, authorised, accessible, inclusive and compliant with international standards.

NCPI developed a solution which had the following key features :

1. Simplicity — Paying and receiving payments is as easy as making a call on mobile phone. With UPI system, anyone can send and/or receive money from their mobile phone with just an identifier unacquainted of the bank account details.
2. Innovation — System is layered so that innovations on both payee and payer side can happen with no change to core interface.This unified layer allows application providers to take advantage of enhancements in mobile devices and payment channels.
3. Adoption– System is designed for scalability and mass adoption. This allows interoperability across payment channels, devices, and institutions for inclusive participation.
4. Security — System provides end to end resilient security and data protection by encryption. System allows a mechanism to pay and collect using valid virtual addresses without having to reveal any bank/account details. System provides convenience by offering 1-click 2-factor authentication, risk scoring, protectionfrom phishing, etc
5. Cost — The solution leverages the growing use of mobile phones as acquiring devices and uses virtual addresses instead of physical cards, thus reducing cost on both acquiring and issuing infrastructure.

The Rise of UPI

Source : https://finshots.in/infographic/is-upi-the-greatest-innovation-in-digital-banking/

The ease of payment and the real-time transfer were the 2 key reasons why people adopted UPI. No longer you had to remember long account numbers and IFSC code. UPI solved this problem by introducing the concept of a Virtual Payment Address (VPA). UPI service providers keeping a mapping of the VPA to the actual account details. VPA is analogous to what an email id is for a customer.

UPI leveraged the increasing use of smart phones and the decreasing cost of mobile data very well complemented the growth of UPI. UPI provided single click 2-FA with the mobile phone being the first factor of authentication (What do you have ?) and the UPI Pin being the second factor of authentication (What do you know ?).

Peer-to-merchant (P2M) transactions was where the major adaptation was seen. The hassle of currency exchange and the merchant discount rate (MDR) of credit and debit card transactions had been a major pain point for a number of years. With zero MDR on UPI transactions, merchants preferred accepting payments via UPI over credit cards. Merchants stopped accepting physical currency during the period of Covid-19 and promoted the use of UPI.

Participants in UPI

1. NPCI — the central authority established by the RBI for operating retail payments and settlement systems in India, including UPI.
2. Payment service providers (PSPs) — Bank, Payment Bank, PPI, or any other RBI regulated entity that is allowed to acquire customers and provide payment (credit/debit) services to individuals and entities.
   i. Acquiring PSP — Bank responsible for onboarding customers and merchants onto UPI and maintaining VPAs.
   ii. Issuing PSP — Bank responsible for the actual debit and credit during transactions.
   eg. Virat, a customer of GPay has a bank account in HDFC bank and a VPA virat@oksbi. In this case, HDFC bank is the Issuing PSP and SBI is the Acquiring PSP.
3. Third-Party Application Providers (TPAPs) — Entities that provide UPI-based payment services to users, typically through mobile applications or web platforms.eg PhonePe, Gpay, PayTm.
4. Payment Aggregators — Entity that facilitates online payment processing by acting as an intermediary between merchants and customers. Payment aggregators enable merchants to accept various forms of payments, including UPI, without the need for a direct relationship with each payment method provider. eg. Razorpay, Billdesk, PayU
5. Payer — Person/Entity who pays money. Payer’s account is debited as part of payment transaction.
6. Payee — Person/Entity who receives money. Payee’s accountis credited as part of payment transaction.
7. Customer — An individual person or an entity having an account and wishes to pay and/or receive money.

So how does a transaction actually work and what role do all these participants play in the world of UPI ? All answers coming up in the part 2 of this series.