In India, the global traditional giants Visa and Mastercard are losing their long-lasting dominance to UPI (Unified Payment Interface) based transactions as the government incentivizes local mechanisms. 2019 was the year for the Fintech Industry in India that shook a lot of things.
To understand the reasons, here’s how a basic card transaction works for Visa and Mastercard as per Investopedia. A typical Visa/Mastercard transaction involves four other parties: the account holder or consumer, the issuing bank, the merchant, and the merchant’s acquiring bank. Typically, an account holder uses a Visa/Mastercard branded card to make a purchase with a merchant. Once the transaction is authorized, the issuer bank pays the cost of the transaction (less an interchange fee) to the acquirer bank. The account holder is then charged the cost of the transaction, less a merchant discount. Interchange fees are key in providing value to merchants who accept Mastercard payment products; Visa/Mastercard does not generate revenue from these fees. The merchant discount fee helps to cover costs for the acquirer bank. Visa/Mastercard charges the financial institutions that issue cards a fee based on gross dollar volume of account holder activity. The company also earns revenue from switched transaction fees.
The Indian government launched a homegrown low cost competitor to Visa/Mastercard called Rupay in 2012 and has been promoting it aggressively. Rupay got a major boost through the PMJDY financial inclusion scheme. UPI is an instant real-time payment system developed by National Payments Corporation of India facilitating inter-bank transactions on mobile platform.
The following three trends have recently happened in India, which makes me believe that Visa/Mastercard will be the “losers” in India’s Fintech Transformation.
First, the card market fell by a full 10% in 2019 (versus 2018), while UPI transactions saw a 9X growth in the same period. In September 2019, UPI surpassed cards as the most preferred mode of payment and continues to do so. In January 2020, there were over 1.3B UPI transactions. Even in the credit/debit card market, Rupay held a 58% market share by number of cards issued in 2019, up from a mere 0.3% in 2013 – thanks to the PMJDY scheme. Visa and Mastercard are no longer the dominant players in the card market, which also is losing its dominance to UPI in the Digital Payments space.
Second, starting January 2020, the government has implemented a zero Merchant Discount Rate (MDR) on all Rupay and UPI transactions. MDR was a source of funding the online transaction fees for the acquirer banks, who would pay a cut to Visa/Mastercard. This fee was usually passed on to the consumer by the merchants. Making MDR zero for Rupay and UPI (not for Visa and Mastercard) will result in customers and merchants accelerating the growth of these type of transactions. The banks may be unhappy and will not be incentivised to promote Rupay and UPI. The government is countering this by subsidising the acquirer fees and eventually hoping that the reduction in overheads from cash-based transactions will fund the digital transactions. This might put brakes on the Digital Payment acceleration due to reduced incentives, but the growth seems to be on the right track so far.
Third, the plastic card transactions typically required POS (Point of Service) machines at merchant’s locations and this incurred an additional maintenance cost that would be a part of the MDR. With increasing smartphone penetration in India, and the proliferation of UPI and cardless payment mechanisms, the high-upfront cost POS machines will soon be obsolete. This will pave way for cheaper mobile POS solutions that only require a smartphone. A simple QR code sticker combined with a mobile app should be good to replace the conventional POS systems. This has negligible maintenance costs, and aligns with the zero MDR implementation by the government. Again, that is bad news for Visa/Mastercard as the expansion of POS for merchants will be limited. Deep pocketed tech players including Google, Amazon, Paytm have already been accelerating the use of mobile POS systems and the UPI dominance over plastic card usage. UPI enables the payments directly from account to account, eliminating the need for owning a credit card. This is definitely bad news for Visa/Mastercard.
Given the above trends, Visa/Mastercard should work on innovative models to integrate in the changing Digital Payments Ecosystem in India. They must prioritize virtual cards and explore alternative business models to differentiate their international presence, partnerships and a wealth of data. A key takeaway here for Visa and Mastercard or any international businesses would be to work hand-in-hand with the national governments and regulations to prevent such a disadvantage.