India has taken a major step towards achieving a cashless economy with the advent of the Unified Payment Interface (UPI). The new payment model allows you to use your smartphones as a virtual debit card. It has also made possible the sending and receiving of money instant. Recently- UPI transactions have crossed $100bn mark. The value of transactions made using the Unified Payments Interface (UPI) crossed $100 billion in a month for the first time in October, according to data from the National Payments Corporation of India (NPCI), further cementing its position as India’s most popular digital payments system. A whopping 4.2 billion UPI transactions amounting to Rs 7.71 lakh crore (about $103 billion) were clocked in a month, marking all-time highs. But if you were still wondering what is UPI and how does UPI work here we are to explain you what is a UPI transaction and how the entire process for a UPI transaction work.
What is UPI?
UPI is a single platform that merges various banking services and features under one umbrella. This means you can send or receive money or scan a quick response (QR) code to pay an individual, a merchant or a service provider to shop, pay bills or authorise payments. To enable payment using your phone, all you need is a mobile payment application and the virtual address of the payee (that reads something like merawalashop@xyzbank). This implies you can make payments directly to the accounts of a vendor or a person, in one step. There is no repetitive step involved. For example, entering bank details or other sensitive information each time you need to make a payment. It is simple, free of charge and instantaneous. UPI allows you to make transactions 24/7, throughout the year.
What is a Virtual Payment Address?
The Virtual Payment Network (VPN) looks like an email address and is unique to you, for example, xyz@merabank. Your VPA unlocks the immense potential of payments and transfers through UPI. The VPA is the gateway that allows you to pay with your phone, from your bank account. It is also possible to link more than one bank account to the same virtual payment address.
The VPA frees you from having to type in long bank account details of both parties participating inthe payment, i.e. the sender and the receiver. It also protects your bank information. The VPA is the reason UPI is such a user-friendly platform for any payment, when compared to digital wallets, credit cards or normal bank transfers.
In 2016, India launched Unified Payments Interface (UPI), an open (interoperable) digital public infrastructure to accelerate digital payments adoption. It was developed by NPCI (National Payment Corporation of India). Within five years of UPI’s launch, digital payments in India have grown roughly 10.5x and constitute approx 30% of retail transactions in the country. With this growth, India is second only to China and ahead of many developed countries in digital payments.
FinTechs such as Google Pay, PhonePe, and Paytm built their payments offerings atop UPI rails enabling them to acquire approx 75-150 million transacting users in the last 4-5 years. While the UPI has aided rapid customer and TPV growth, the revenue potential of these payment products remains low given the lack of meaningful fees. Further, interoperability of UPI has meant reduced network effects and customer retention, resulting in repetitive CAC (Customer Acquisition Cost) and lower customer LTV (Life time value)
How UPI works?
To process a UPI transaction, the following entities are involved:
1. Payer app/PSP: PSP stands for Payment service provider. Payer PSPs are apps that allow customers to initiate/complete transactions. For example: Gpay, Phonepe, Bhim, PayTM, etc. These apps have replaced the traditional bank apps and allow users to create UPI handles to make or accept a transaction. Any customer can install these apps and can create their UPI handle. NPCI takes care of the app certification and as of now there are 20+ third party apps certified by NPCI for issuing UPI handles. However, all these UPI apps need a sponsor bank to start onboarding users.
2. National Payments Corporation of India(NPCI): NPCI is an umbrella organisation for operating retail payments and settlement systems in India. It is an initiative of the Reserve Bank of India (RBI) and Indian Banks’ Association (IBA) under the provisions of the Payment and Settlement Systems Act, 2007 for creating a robust Payment and Settlement Infrastructure in India. Similar to the role played by VISA in case of Card payments, NPCI makes sure that data flow between banks and payment apps are routed to the correct and verified destinations.
3. Issuing Bank (Sender’s Bank)- In case of UPI payment, the money is transferred from the issuing/sender’s bank account to the acquiring (merchant/receiver’s) bank account. Issuing bank has to debit money on NPCI’s request and send a debit response to NPCI once the debit is successfully done.
4. Acquiring Bank (Receiver’s bank)- The acquiring (receiver) bank’s job is to credit money on NPCI’s request and send a credit response to NPCI once the credit is successfully done.
5. Payee PSP- This is the acquirer or payment gateway used by the merchant in case of P2M (Person to Merchant) transactions.
How does a Transaction Get Authenticated?
UPI uses 2-factor authentication. Commonly used factors are the possession factor and the knowledge factor. UPI being mobile-first, the possession factor (“what a user has”) is the user’s phone. It’s validated using the device fingerprint. The knowledge factor (“what a user knows”) is the 4 digits or 6 digits UPI PIN. The authentication scheme is designed to be flexible and can use different authentication factors in the future.
Advantages of UPI
- Minimal Charges and Instant: –
The biggest advantage of Unified Payment Interface is that there are no or minimal charges on the transactions done through UPI. Also, funds are transferred instantly from one bank account to another bank account which is not possible in case of other modes of transfer like RTGS which takes 30 minutes to 2 hours for fund transfer or NEFT which takes 1 hour to 4 hours for fund transfer.
- No Need to Fill Details: –
Another advantage of UPI is that one does not need to fill the various details like ATM card number or account number or IFSC code rather one has to give only the virtual address to which funds have to be transferred. The virtual address can be in the form of ABCD@nameofthebank, so for example, if you want to transfer funds to your friend Mahesh and his account is in HDFC bank and his virtual address is Mahesh@HDFCbank than you have to input this virtual address and funds will be transferred instantly to his account.
- No need for Registration and always Available: –
In case of other modes of online funds transfer registration of new payee takes time while in case of UPI there is no need for registration of payee and one can transfer funds to the new payee instantly and also one can transfer funds at any time that is Unified Payment Interface is available 24 hours and also funds can be transferred even on Sundays and when there is holiday in the bank.