A couple of months ago, I had questioned the logic of the fee structure for card payments—particularly debit cards—in a piece titled “How to kill cash”. Banks across the board have little incentive to push for greater use of offline card payments, and the way to fix that, I’d argued, is to flip the free structure on its head.
A quick recap: the card payment industry works on a decades-old model. You have an issuing bank—the one that issues you your debit or credit card. Let’s call it Bank A. On the other side you have the acquirer bank, Bank B, which “acquires” merchants—i.e. convinces them to lease card machines, or point-of-sale (PoS) devices.
When you use your card at a PoS terminal, Bank B pays the merchant the amount entered, after deducting a fee called the merchant discount rate (MDR). This is usually a combination of device rental, fixed fee and variable fees tied to the number or value of transactions the merchant accepts.
Bank B then collects from Bank A, which in turn, bills you (if you have a credit card) or debits your savings account instantly (if you have a debit card). But Bank B also has to pay Bank A an interchange fee.
I suggested that Bank A should instead pay Bank B a nominal fee for using the PoS terminal—exactly as it works when you use Bank A’s debit card to pull out cash at Bank B’s ATM. I assumed two things in my hypothesis: (a) debit cards would continue to be the payment instrument of choice; and (b) there is leeway for debit card issuers to fund a payment transaction, given that their costs were very different from credit card issuers.
The article generated lots of discussion, led me to dig deep into issuer-side economics and, surprisingly, has led to a very different interpretation—thanks to the Unified Payments Interface, or UPI, debit cards may be the first roadkill on the way to killing cash.
Consider a few data points. Over a 10-month period starting April 2018 (the latest for which comparable data is available across the payments ecosystem).
- Debit cards in circulation stagnated at 931 million. The number of unique cardholders is much lower—perhaps about 700 million. But according to some estimates, almost half of India’s retail bank accounts are inactive. And while the government has created over 350 million new bank accounts under its flagship financial inclusion programme, the Jan Dhan Yojana, there is no data available on their uniqueness (i.e. did the beneficiary already have an account?) or their usage.
- The number of debit card transactions grew 12%, while the total value of these transactions grew 11%. Each debit card was on average used 0.4 times per month for a payment—less than five transactions per card on a yearly basis.
- The number of PoS devices installed grew 14% to 3.6 million—approximately 30% of the reported 12 million small, neighbourhood stores. Crucially, the number of debit card transactions per PoS per month shrank 2% to 102 per month. In other words, acquirers are investing in terminals but seeing throughput decline.
Clearly, merely opening bank accounts, issuing debit cards and installing PoS terminals is not working. The knee-jerk reaction is to spend on promotions and cashbacks. Unfortunately, the finances on neither the issuer side nor the acquirer side leave any room to invest in aggressive marketing.
On the acquirer side, a merchant generating 500 debit card transactions a year—think of a stationery store near a college, or a highway restaurant, which are just below the top-tier organised retail segment—generates, on average, Rs 1,300 of net income for the acquirer a year, about 16% of gross revenues. A healthy but unremarkable business.
As a veteran of the payments industry put it: “The acquiring business is being held up by credit card usage. These are higher value and more profitable transactions and subsidise the cost of acquiring debit cards at the same merchant. Standalone, acquiring debit cards is a non-starter. Not one bank is willing to go below a minimum threshold of merchants—it just doesn’t make commercial sense.”
On the other hand, the issuer barely breaks even, even after netting out all promotional and marketing expenses. In a classic chicken-and-egg problem, banks can’t afford to incentivise usage; customers keep using these cards at ATMs, increasing the cost all around.
And in a parallel universe, UPI—the real-time bank-to-bank transfer system launched in 2016 by the National Payments Corporation of India (NPCI)—is scaling beyond what anybody may have imagined.
A new world of payments
Over the same 10-month period, UPI transactions rose 254% to reach 672 million per month at an average of Rs 1,634—higher than debit cards.
Absent credible data, if we assume that about 20% of these transactions are what is called P2M (payments from people to merchants), that’s already about 36% of debit card transactions—a point we’ve reached in just three years since UPI’s launch.
According to industry insiders, 4.5 million merchants are already enabled with QR codes that can accept UPI payments through mobile apps. Again unverifiable numbers, but credible to assume that QR codes will scale massively once operational issues of customer experience, app installs and merchant-side reconciliation and dispute resolution are sorted out. (Quick Response or QR codes encode data—links, numbers, text, bits—in the form of a two-dimensional image, similar to a bar code.)
In summary, the cards seem to be stacked against debit cards:
- They’re costly to produce, maintain, distribute. Banks can’t afford to spend on marketing.
- Customers still use them at ATMs and not for payments—increasing costs all around.
- Acquirers aren’t going below a certain threshold of merchants—they aren’t feasible.
- UPI is scaling enormously, and is beginning to get traction in merchant payments.
- Recent policy and regulatory moves—e.g. data localisation—have increased the cost of compliance for card networks.
Where does this leave traditional payments networks like RuPay, Mastercard and Visa? Is there a way to leverage the scale of the installed base of 930 million debit cards and make it work harder? Yes, according to the experts, and it starts with rethinking the consumer.
Getting the end-user
According to Dilip Asbe, CEO of NPCI, a non-profit body owned by a consortium of banks and regulated by the Reserve Bank of India, the consumer base can be divided into three sets of 300 million users each. (Assuming, for simplicity’s sake, that each of the 900-odd million debit cards represents a user.)
The top 300 million customers don’t need a debit card. They need “hugely interactive and contextual solutions—especially affordability,” he says. “For example, physical credit cards have a monthly billing cycle. There is a huge opportunity to create digital lending products on mobile devices—contextual, short-term finance, cross-sell investment products, etc.”
For example, not everyone needs a sizeable personal loan for a fixed X months to buy high-value items. How about digitally savvy consumers with lumpy cash flows through the month who need instant credit for a few days? A student in a hostel who wants to take his girlfriend out to the latest movie and dinner at a nice restaurant before his next tranche of pocket money comes through? Could banks extend him a micro credit of Rs 1,000 for 12 days at a nominal interest rate, credited into his bank account and accessible via his debit card?
Or perhaps a cab driver needs Rs 1,000 at 11 PM tonight to fill up on diesel and can repay this from his next disbursement from the ride-hailing company he works with. Could he use his debit card and earn points from an Indian Oil or a Bharat Petroleum along the way?
“With around 100 million active customers on POS, the per card throughput is around 3-5 per month,” says Asbe, who adds that this has the potential to ramp up to 30-50, considering that an average consumer makes at least 4-5 discretionary payments a day, ranging from grocery to transport.
UPI, in comparison, is at about 10 transactions per user per month, and also has good scope to grow further, he says.
For the middle 300 million, where digital and financial literacy and access is still limited, we need a combination of mobile phones and debit cards. The trick is in getting them to use the card to pay, not merely access cash.
Manish Boricha, chief product officer of Fino Payments Bank, has an interesting anecdote: “Payments and small finance banks cater to remote geographies like Arrah or Syedraja in Bihar. With the ease of access they offer (for example, they are open late in the evening), customers have started depositing their daily earnings into the bank rather than keeping them as cash at home. For these customers, a debit card is a source of pride that some of them have even laminated as a display item in their homes!”
Fino deploys micro-ATMs at banking correspondent locations—typically local grocery stores—where customers can access their accounts. While customers have moved from cash to a digital deposit, they then use these micro-ATMs to move back to cash.
The next step, Boricha says, is to add a payment application to these micro-ATMs. Since they’re already in place, these devices offer an option to grow the electronic payments footprint at almost no incremental cost. And possibly tackling the challenges that have prevented larger banks from deploying traditional PoS terminals to these locations.
The last 300 million continue to rely on Aadhaar biometrics—i.e. the Aadhaar-enabled Payments System (AEPS). This segment still relies heavily on government subsidies, will take at least five years to get into the mainstream and will need patient investments and handholding on the part of the industry.
While I’d earlier made a case for inverting the fee structure, experts suggest a more graded approach. According to the veteran mentioned earlier,
(a) First, “create friction in using cash”: stop free ATM withdrawals, and stop bleeding the issuer’s finance. This single line item accounts for 53% of the costs in an issuer’s profit and loss statement.
(b) Pass on these savings to issuers to re-invest in driving PoS usage by subsidising the acquiring business.
(c) Whatever else, the government should not fund free merchant discount rates—you’re not creating an ecosystem.
Industry experts concur that in a transaction where the consumer is using their own money (read debit cards), the “math has to be driven differently”—we should reconsider the sharing of revenue. Today, the issuer keeps 70% of transaction revenues; we need to ask why, especially when the onus is on the acquirer to “digitise the last mile”.
Porush Singh, division president, Mastercard India, pointed to operating models in Australia and the European Union, where the issuer-acquirer balance is constantly adjusted as volumes keep scaling. Or perhaps depending on the objective. For instance, if you want to increase usage of electronic payments for public transit, which needs investments in PoS, you’d shift the balance to acquirers.
NPCI’s Asbe avers by the huge scope for an asset-light, tech-led play, especially by fintech companies who can combine online and offline payments. He recommends a “ground-up approach”: Use QR as an on-ramp for signing up merchants “in the millions”. Over time, watch their behaviour and graduate them to mobile or fixed PoS payments, or more sophisticated solutions.
Contrast that with traditional acquirers—mostly large banks—which are using an asset-heavy, one-size-fits-all model, dumping PoS terminals on merchants, without really understanding what they want.
As a result, you have systemic inefficiencies: even the largest acquirer has just a 40% merchant activation rate, according to industry experts. Meaning only 40% of merchants who have PoS terminals end up using them.
Mastercard India’s Singh offered a different perspective, pointing to China’s model of the state funding—through China Union Pay—1 million ATMs and 25 million PoS terminals. Having taken capital expenditure out of the equation, the government then pushed banks with aggressive targets to drive retail digital payments.
In any case, reducing the inefficiencies is, arguably, key to keeping debit cards relevant in the overall digital payments push. Which is important, because—as some industry experts caution—QR-led UPI payments are not quite the panacea, at least not in the short term.
Debit cards: The road to relevance
In an industry increasingly focused on an all-digital future, odd as it may seem, debit cards still have hope. Because, in spite of rapid growth, the UPI system is still not without its hurdles. Even low-value payments need an SMS-based two-factor authentication layer on top of the app or device PIN—which introduces friction and latency in the transaction.
Additionally, there are several operational issues—dispute resolution, chargebacks, fraud, etc.—that are already coming up. We need systemic frameworks to deal with these before opening the taps to huge scale. And systemic change does not come quick.
In the interim, the payments industry needs to seriously consider new use cases for debit cards to drive habitual payments—laying the groundwork for greater acceptance of electronic payments as a whole. Especially since the user base of 700-odd million customers dwarfs that of UPI (in a 2018 interview, Asbe had said that NPCI was targeting 100 million UPI users by 2020).
On a more positive note, some corners of the industry are beginning to see innovation of some sort—even if not quite at scale yet—in card payments.
Take the National Common Mobility Card, or NCMC, which was launched last month by the central government as a way to pay for public transport anywhere in the country. Structured as open specifications, the programme is open to any card network to adopt.
On 5 March, NPCI officially launched the NCMC RuPay contactless card with almost 25+ large banks as partners. With this launch, the banks issued debit/credit cards that can also be used to make payments for transit systems like metro rails. News reports suggest that Visa and Mastercard are joining the bandwagon—though, obviously, it’s too early to predict how the system will shake out.
Another way of making debit cards relevant may be through digital lending—and early moves by Visa indicate networks are looking at doing just that. The company last month announced a service that would let any bank offer EMIs—equated monthly instalments, traditionally a feature associated with credit cards—on deposit accounts.
It’s not often you see a decades-old, clubby and comfortable industry such as card payments being disrupted so fundamentally at the grassroots. Platforms such as UPI and the Bharat Bill Payment System for utility bill payments have levelled the playing field for innovators. And everyone from deep-pocketed global players such as Amazon and Google to Indian payments companies such as Paytm and PhonePe to the telecom operator Reliance Jio are taking advantage of it.
There is a finite window for incumbents—banks and traditional card networks—to get up to speed before it’s too late.
The author would like to thank Manish Boricha, chief product officer, Fino Payments Bank, for an excellent teardown of issuer and acquirer finances.
The views represented in this article are the author’s, and have nothing to do with any of his employers—past, present or future.