The United States, the epicenter of financial innovation and growth, has long been the undisputed global leader in finance. The leadership position, however, could see a rapid change in the near future. Considering the tectonic shifts seen in recent years, led by India’s innovative United Payments Interface (UPI), it is a tremendous achievement that is revolutionizing the payments industry in the country.
The world is taking notice and more than 30 countries have expressed interest in adopting UPI, a resounding recognition of the revolutionary concept that has unlimited potential on a global scale. In contrast, most developed countries continue to rely on relatively inefficient card systems.
UPI’s impact lies not only in reinventing payment infrastructure, but also in optimizing the behavior of banks and other ecosystem players as a result of economic growth. Faster and more convenient transactions allow people to buy and sell more goods and services in less time, helping the economy grow.
Instant transactions help consume local commerce and create and activate new markets, a must for any economy. What makes UPI even more impressive is its monumental success in bringing together competing players (such as banks, wallets, etc.) on the same platform with the promise of creating a larger market and reducing the almost zero transaction costs.
In the global landscape, no other country has managed to achieve as much as India has achieved with UPI. This begs the question, why is the rest of the world lagging behind? Especially the United States, the world leader in finance. We compared India’s Instant Payment (UPI) options with the closest options in the US (FedNow and legacy card schemes).
The FedNow system (created and routed by the Federal Reserve) operates like the Real-Time Gross Settlement (RTGS) system in India and is significantly different from UPI [which routes itself through a separate non-profit body, the National Payments Corporation of India (NPCI)]. However, it is the closest the United States has come to realizing instantaneous remote transactions. The disparities between UPI and FedNow illustrate the delay of the American system compared to India.
According to the Federal Reserve, FedNow is an RTGS instant payments system. It instantly completes transactions between the sender’s and receiver’s banks by automatically crediting and debiting the transaction amount to the federal ledger, making the transaction process faster and safer.
To illustrate, suppose a sender sends an instant payment request to their bank. The bank then sends the request to the FedNow system which validates the message (to ensure that all specifications are met) and forwards it to the recipient’s bank. The recipient’s bank then confirms/denies the transaction details, based on which the transaction is made and is then credited/debited to the banks’ main accounts by FedNow.
While FedNow is still in its infancy, the most popular instant payment methods in the United States are credit and debit cards, with an overwhelming majority of Americans owning credit and debit cards and preferring them over d other payment methods, including cash, for almost any transaction. The US payment ecosystem, the card networks, are hugely influential and capable of charging extremely high transaction fees, with no viable alternative for consumers. It could be argued that this card network oligopoly not only prevents the growth of payment systems in the United States, but also hampers economic growth and innovation.
UPI is India’s approach to instant remote transactions. Essentially, UPI is an open source API (Application Programming Interface) accessible by any mobile payment application. It connects banks, merchants and consumers to ensure seamless and instant remote transactions. UPI’s ability to be available to all parties to the transaction stems from its design as a digital public infrastructure. As a digital public infrastructure, UPI is freely available to smaller merchants, service providers and facilities.
One of UPI’s most revolutionary features is its consumer accessibility. One can access all bank accounts on any compliant mobile app. It only requires knowledge of the other party’s UPI identifier (in the form of their mobile number or a QR code that can be scanned on the spot). Contrary to this, FedNow does not involve communicating with the consumer, thus limiting consumer access to FedNow to banking portals only. This means that the consumer must log into their bank account through the banking portal and then provide the recipient’s bank account details. As for card systems, they require an external device on the merchant side and each card can only access one bank account. Cards can only facilitate a consumer-merchant transaction and cannot transfer funds between consumers.
UPI requires a consumer to have a mobile phone number or QR code to make payment through a mobile phone app instantly. On the other hand, FedNow requires consumers to log into their bank account through the banking portal and obtain the recipient’s bank details to then complete the transaction. FedNow is therefore neither user-friendly nor an easy option for in-person transactions, which limits its usefulness compared to UPI.
Likewise, cards cannot facilitate the type of transactions that UPI can, in addition to requiring the consumer to use external devices, making the transaction inefficient and dangerous. As a result, merchants have to pay huge fees for transactions to the card networks’ oligopoly because FedNow and the card networks route transactions through banks. An increase in loops in the transaction not only leads to a delay in payment, but also increases the cost of each transaction. UPI, on the other hand, does not allow banks to retain any power over the process, thus reducing the opaque processing costs charged by banks and card companies.
Another advantage that UPI has over FedNow is visible in transaction fees. UPI has no transaction fees and a zero MDR (Merchant Discount Rate) policy. This reduces transaction costs. On the other hand, FedNow encourages banks to collect more transaction fees. This implies a greater profit margin for banks, at the expense of consumers, to incentivize banks to participate in the FedNow framework and ensure their interest above the consumer’s interest, while the removal of transaction fees by UPI is an indicator of its consumer-centric approach.
The cards are expensive for consumers, with credit card companies charging up to 3.5% processing fees per transaction, with no government-imposed price regulation. This reflects the greater bargaining power that the private sector has in banking in the United States compared to India.
UPI disrupted the existing status quo of the payments industry in favor of consumers and the economy and acted as a public good by removing transaction fees, having a zero-MDR policy and diluting the control of banking portals on transactions.
This has resulted in credit and debit card companies having less control over transaction systems in India, providing a convenient and inexpensive option for the consumer and opening the space for other fintech innovations.
The biggest disadvantage of FedNow and the card network compared to UPI is the lack of interoperability. Interoperability can be defined as the ability of disparate systems to communicate with each other for the purpose of sharing information and transactions in a transparent and cost-effective manner. This requires cooperation between all agents of the transaction. The RBI has been able to bring together many private agents in the same framework and streamline communication.
FedNow, however, confines itself to one small aspect of the whole transaction and leaves the rest of the transaction up to the discretion of the private sector. Similarly, in the case of cards, FedNow can only access the account of the issuing bank and does not create any communication channel between the different banks. Thus, each bank retains its customers and does not have to cooperate with other banks. A lack of centralized action prevents FedNow and the card schemes from being able to consolidate a large and diverse payments industry with conflicting interests.
Change is inevitable and it’s time for the United States to embrace consumer-centric solutions like UPI to maintain its hegemony.
Aditi Srivastava and Gouri S Nair are researchers at the Center for Innovation in Public Policy www.CIPP.In working on digital public goods. They can be contacted at [email protected]. The opinions expressed are personal.
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