Payments technology has been on a steady march for the last couple of decades. The introduction of smart phones and the development of new payments infrastructure has increasingly blurred the boundaries between offline and online payments. Credit and debit cards were the original instruments that worked in both the offline and online channels. Then, digital wallets took the payments space by storm and were on their way to becoming a dominant means of payments for small ticket transactions. Then UPI (Unified Payments Interface) was introduced. The ability to make instant bank-to-bank payments simply by using one’s mobile number or virtual payment address was remarkable.  The ease of use coupled with the affordability for both customers and merchants has led to mass adoption of the same in India.

 

In 2016 the total value of digital retail P2M (merchant payments) transactions was Rs. 5.6 trillion. That has grown to Rs. 26 trillion as of FY21. While that growth itself is impressive, the growth of UPI is more remarkable. From zero in 2016 when it was introduced, UPI now makes up close to 35% of the total transacted value in P2M transactions.

As even offline transactions become digitized, ever-increasing amounts of data is available to lending firms to create credit scoring models. And every transaction becomes a potential lending opportunity. In this piece, we touch on five interesting trends that we see playing out in the digital payments and lending space.

 

Trend 1: Digital Wallets to struggle in original avatar

Digital wallets were on their way to become the “next big thing” in payments in India. However, stricter norms from the RBI coupled with the introduction of UPI cut this trajectory short. UPI transactions do not involve any fees for the customer or the merchant. The digital wallet model depends on merchant fees. Quite simply, in the face of these economics, wallets cannot compete with UPI.

Some customers do still prefer wallets over UPI due to the security they provide or the rewards that they may give out. However, that has not proved sufficient to overcome the distinct advantages of the UPI system.

We believe that wallets will now evolve into mechanisms for financial firms to provide their lending products. With rich transaction data being generated by wallet and UPI transactions, new-age lending firms can generate credit scores. They can then simply create the equivalent of an over-draft limit in the user’s wallet. With the payments revenue stream being disrupted by UPI, credit is likely to become the dominant revenue stream for wallet players.

 

Trend 2: Is there any money to be made in the payment space?

Several standalone consumer payment apps have been launched in the last few years.  Along with this, many consumer-facing apps have launched their own payments services as a feature. Given the stiff competition, one wonders about their ability to make profits.

We believe that consumer-facing payments apps such as Google Pay/PhonePe are unlikely to make money from just offering payments. Most of their transactions are on the UPI rails and therefore generate no revenue. At best a user-friendly payments app is a customer acquisition channel, to then sell other products such as insurance, mutual funds, loans, etc. Payment instruments with in-built credit, such as credit cards, BNPL, EMI financing can be profitable. However, one can argue that the money made from this is from lending and not payments.

Payment acceptance methods (think POS terminals, online gateways) could be revenue generators. However, immense competition here as well will keep profitability in check.  Card networks have been profitable enterprises globally and similarly there could be new “networks” or technology providers here who could charge a small fee for their products. These could be quite profitable.

On the merchant side, payments services players could focus on providing merchant loans using the data flowing through their networks.

To summarize we believe that a pure play consumer payments player is unlikely to be profitable unless they offer additional products/services. However, merchant side payments services are more likely to make money.

 

Trend 3: Cards to face stiffer competition

With the advent of alternative digital payment infrastructure in India, a card’s value to a merchant has declined to the extent that it is now not the only means to accept cash-less payments.

The fact that UPI also costs next to nothing to a merchant while a card payment can cost up to 2-3%, the incentive for a merchant to accept cards is that much lower. As for the credit function of cards, BNPL in its many avatars is also marginalizing the credit card.

That then leaves us with the customer. In their bid to acquire customers, credit cards over the years have competed by offering rewards to the customer. These rewards were funded from the MDR (Merchant Discount Rate) that the cards charged. With the MDR under pressure due to UPI, the ability to fund these rewards drops.

UPI has eaten away at the smaller ticket transactions, largely cannibalizing debit cards. However, credit cards are still the preferred mode of payment for larger value transactions. This is presumably because of rewards as well as what amounts to free credit.  As credit cards increasingly go virtual (such as Apple Pay), they might become indistinguishable from other BNPL/Wallet solutions now available. In that transition, their ability to retain their lucrative economics will also become threatened.

As long as there is a critical mass of credit card users, though, merchants will have to continue to accept them, and card issuers will be able to offer some rewards to customers. But this feedback-loop could eventually break down, as an increasing number of users migrate to alternative payment methods.

Given these trends, we believe that debit and credit card businesses may face some headwinds to growth and profitability.

 

Trend 4: BNPL – Nothing new

Consumers, at the point of sale, had two options for credit. Either pay by credit card or take an EMI finance loan for the product. There is now a third option, Buy Now, Pay Later (BNPL).

In its essence, BNPL is not very different from the first two. There are companies which are offering BNPL loans as a credit limit on a wallet to be used across the entire merchant network. Repayment is due at the end of the free credit period (15/30 days). Very similar to a credit card. There are other BNPL loans which are more like EMI financing, you convert the purchase into a Pay in 4/Pay in 6 loan.

BNPL is picking up in volumes because of multiple reasons. In India, credit card penetration is very low, so a vast majority of transactions are still without credit. BNPL offerings by the fintech/payment providers are reaching out to a larger customer base. Also, small ticket transactions that were never targeted by EMI financiers are now being offered Post-paid (BNPL) options, on platforms such as Zomato, PayTM, etc.

Eventually, any merchant, whether an electronics retailer or an eCommerce company, or a food delivery business, that sees a large number of customer transactions, can offer BNPL loans. If you look back in history, store cards at Macy’s, JC Penney, etc. were exactly the same thing. BNPL sounds like a new concept but is essentially the same product in new packaging.

What makes it very exciting, though, is the sheer number of users that some of these fintechs have. As an example let’s look at HDFC bank and PayTM. The PayTM app is said to have close to 450 million registered users¹ and close to 69 million monthly transacting users². Compared to that, HDFC Banks entire user base is around 68 million³. From that base, their digitally transacting app users are going to be significantly lower than PayTM’s MTU.

 

 

Trend 5: Good Underwriting will still be paramount

While BNPL seems like a huge opportunity it’s important to be wary of poor underwriting. Portfolio manager Lyall Taylor touched on the idea that eventually there are three categories of people in the population.

1. Those who do not need credit.
2. Those who need credit and will responsibly pay it back on time.
3. Those who need credit but will not manage the money they receive responsibly, and will eventually default.

Good underwriting is all about being able to distinguish between the second and the third category. When the dust settles on the multi-way fight between wallets, BNPL, credit cards, and others, one of the most important determinants of success will be good credit underwriting abilities.

We believe that traditional lenders and banks currently have better underwriting abilities. They also have strong balance sheets to support the lending. Quite simply, they have been tested over different economic conditions making them more robust.  They, however, lack the reach and user experience that recent fintech players have.

As fintechs and traditional financiers battle it out, the winning strategy for now could be one of collaboration and partnerships. We believe that through these collaborations, there is a lot both parties can learn from each other.

This article is Coauthored by Mehul Jani, Parijat Garg and Dhruv Maniyar. Mehul Jani is Principal & Fund Manager, Parijat Garg is Fund Manager & Sr. VP and Dhruv Maniyar is Assistant Manager (Research) at IIFL AMC. Views are personal.

 

Sources :
1.findly.in  – https://findly.in/paytm-users-in-india/.
2. PayTM Investor Presentation – https://paytm.com/documents/financial-results/fy2021-22/Paytm-Update-Operating-Performance-Q4-FY22-February2022.pdf.
3. HDFC Company Report – https://www.hdfcbank.com/content/bbp/repositories/723fb80a-2dde-42a3-9793-7ae1be57c87f/?path=/Footer/About%20Us/Other%20stakeholders%27%20Information/Disclosure-PDFs-for-2022/4-Outcome.pdf

 

This Article was initially published on Economic Times. It is co-authored by Mehul Jani, Parijat Garg and Dhruv Maniyar.