How recent changes to UPI are helping fill India’s credit gap

The RBI’s payments vision 2025 aims to facilitate financial inclusion by rethinking product designs and underwriting models. 

Riding on the stack and the widespread adoption of the Unified Payments Interface (UPI), India now has the biggest volume of real-time digital payments worldwide, accounting for more than 40% of all such transactions^[1]. This has enabled the formalization of the economy through increased financial inclusion and created a market opportunity for entrepreneurship, as evidenced by the increasing start-up ecosystem.

With a view to drive digital payments in the country, on 6 April 2023, RBI proposed to expand the scope of UPI by permitting operation of pre-sanctioned credit lines at banks through UPI. This move is in line with the RBI's payments vision of 2025, enhancing access to formal credit and digital payments.

Catalyst for financial inclusion

The introduction of pre-approved credit lines on UPI is poised to integrate the formal banking economy and open up a lending opportunity for banks and NBFCs (non-bank financial company) to reach over 30 crore Indian consumers and businesses active on UPI^[2].

While UPI was previously limited to bank accounts and RuPay credit cards, the latest update allows users to link loan accounts as well, making them available for payment via UPI. Under the new policy, the various categories of pre-approved credit lines include credit card, small credit line, business credit line. With this, banks, NBFCs, PSPs (Payment Service Providers), and FinTechs will have the opportunity to create innovative credit-based products that enable embedded financing during a UPI purchase journey.

The borrowers on the other side will have easy access to credit with the convenience and security of UPI. This could be a game-changer for industries such as the Micro Small and Medium Enterprises (MSMEs), which contribute 30% to the GDP, but often face a shortfall in supply of credit estimated between US$250 and US$300b^[3]. UPI-based lending will make banks and NBFCs more efficient and they will provide credit in a much quicker and economical way to the borrowers.

Opportunity to rethink product designs

Banks and PSPs looking to monetize UPI payments and lower the cost of credit disbursement, will  launch newer, more innovative UPI-based revolving credit lines, instant overdraft/EMIs on savings/current accounts and personal loan solutions for consumers. Pre-sanctioned working capital and overdraft credit lines from banks, enabled by UPI, can be used for business-to-business payments with transaction limits. FinTechs focused on digital lending can potentially rethink the BNPL(Buy Now, Pay Later) product, thereby unlocking the true value of the digital payment ecosystem.

As we further progress, new business models can be explored where FinTechs or UPI payment apps can be leveraged to source customers, facilitate transactions, generate bill payment reminders, and accept repayments. This will increase interoperability in the credit domain and FinTechs can leverage UPI based lending data to come up with improved services for the users.

Building robust underwriting models

Digitization of the economy and availability of data provides a more objective and comprehensive basis for credit assessment, thereby enhancing quality lending to both individuals and businesses. This presents a substantial opportunity for the financial services sector, while addressing the credit needs of the Indian diaspora and businesses.

Underwriting such loan products will require lenders to leverage UPI data, which can help build underwriting models using transaction parameters such as declines due to insufficient funds, merchant type (a jeweler is a riskier segment that grocery, for example), geographical location, to assess the borrower’s creditworthiness.

Also, with increased exposure of credit to the customers, the lenders are more likely to review their credit portfolios to avoid any defaults and maintain NPAs (Non performing assets) within the permissible range. In the near future, this move is likely to be a tailwind for account aggregators, TSPs (Technical Service Providers) and alternate data providers as well.

Way forward

With time, we will have clarity on how the economics will work out for digital lending on UPI. The Merchant discount rate (transaction fees merchants pay to accept digital payments) will be vital for sustaining this, as will be the interest or revolving income (the interest rate customers will pay for the loan). For acquiring entities (those who put up the QR codes at merchant locations), this will also open up a revenue stream for fee income from merchants for providing lending services and driving affordability. We might also see subvention models, similar to those seen in the BNPL (Buy Now, Pay Later) ecosystem, emerge as a consequence of this.

The article was first published by ET BFSI.com How Recent Changes to UPI Are Helping Fill India’s Credit Gaps.