UPIs become virtual credit cards: A game changer in credit delivery

– Vinod Kothari & Abhirup Ghosh | finserv@vinodkothari.com

The recent notification^[1] by the RBI permitting banks to provide pre-sanctioned credit facilities to be used by Unified Payment Interface (UPI) is a game changer. The full dimensions of this new mode of extending credit will possibly take some time to develop or demonstrate, but clearly, as UPI itself changed the way the country handles payments, the linking of UPI with pre-sanctioned credit facilities is also a major change.

Currently, UPIs may pull money from the customer’s bank account (current or savings account), overdraft accounts, prepaid wallets or credit cards. Now, UPI may have a linked credit facility as well, and a customer may dip into that credit line while making any payment for which she currently uses UPI.

Between FY 2017 and FY 2023, the annual volume of transactions through UPI increased from 178.6 lakhs to 8375.11 crores at a CAGR of 234.54%, and the value of transactions done through UPI increased from Rs. 6,952.14 crores in FY 2017 to Rs.139.21 lakh crores at a CAGR of 196.24%. In July 2023 alone the number of transactions were 996.46 crores and value of transactions conducted were Rs. 15.33 lakh crores^[2].

Convenience of UPI coupled with the increase in the purchasing power through the proposed lines of credit, could have a long standing effect on the level of consumption in the country.

Some features of UPI-linked credit

1. Open-ended payment instrument: Since UPI as a mode of payment may be used for settling any payment, of course, within a daily limit of Rs 1 lakh, the credit facility linked with UPI has the same potential of being used for making any payment, be it for the bill at the restaurant, or simply for the taxi drive, or for buying goods or services at e-commerce outlets.
2. It is “any time” disbursement. The borrower will have the same flexibility as he/she has with UPI itself.
3. It will have all the convenience of a virtual credit card, minus the hassles and costs involved in credit cards.
4. Unlike in case of credit cards, there will be no “interest free” credit in this case. Notably, in case of credit cards, that interest free credit is provided because the lenders are granted a credit period by the merchant itself. In this case, the merchant would have been paid immediately by the UPI-user, therefore, the credit cost will have to be charged to the customer.
5. As in case of credit cards, this is also quite likely an unsecured line of credit.
6. UPI transactions are also noted for their quick settlement and low cost per transaction. Hence, once linking credit facility to UPI becomes operational, Banks may also consider offering their working capital limits via UPI instead of the borrower having to draw cheques on the Bank. Of course, this facility will have to operate within the daily transaction amount limit set for UPI.

How will the mode of repayment work?

The credit-linked UPI may be disbursed any time by simply using the line by making UPI-linked payments. However, the issue is, how will the credit be repaid? There may be several possible options:

1. A revolving line of credit, with the borrowing making payment any point of time.
2. A line of credit with the borrower settling the entire debit balance at the end of a particular period, say, a month.
3. The disbursements get converted into EMIs or periodic equated instalments.

The first option is almost like a credit card receivable; it becomes an exposure on a revolving line of credit for the bank. This becomes a committed facility, which can be drawn at any time by the customer, exposing the bank to capital requirements, as also asset liability mismatches. It is quite likely that a bank will price it at par with the expected returns on credit card receivables.

The second option is a short term funding, expected to be repaid fully at the end of the period (say, a month or a quarter). Such a facility may work well for pay-day loans (where the credit availed by the borrower is to be paid when the employee receives monthly payment), or any other similar cashflow mismatch for the borrower. However, if the intent of the borrower is to avail credit, it is unlikely that the borrower will be inclined to take a short term credit option.

As in case of credit cards, the facility of converting disbursements during a month into an EMI option is likely to be the major way of using UPI-linked credit.

How will a bank fix the sanctioned limit?

The credit underwriting for this should be conducted with the same level of thoroughness as applied to other facilities, such as credit cards. The approved limit should be determined based on the borrower’s creditworthiness. Additionally, key terms like the interest rate, repayment schedule, and other relevant details should be established and clearly communicated to the borrower.

In terms of customer sourcing, we do not see this to be any different from the likes of credit cards. The banks may target their existing customer base, but need not restrict itself to that.

Will it be digital lending?

One of the key questions that needs to be answered is whether these would qualify for digital lending or not. The term digital lending has been defined in the RBI Guidelines on Digital Lending (‘DL Guidelines’) in the following manner:

A remote and automated lending process, largely by use of seamless digital technologies for customer acquisition, credit assessment, loan approval, disbursement, recovery, and associated customer service.

UPI can be used for physical transactions as well and digital transactions as a mode of payment. If UPI is used for digital transactions, can it be considered as digital lending? – In order to be treated as digital lending – a loan transaction must be based on a remote and automated lending process using seamless digital technologies. The parts of a lending transaction that need to be digital or contactless in order to be called digital lending is subjective but must involve, at least to a significant extent (the DLGuidelines use the term “largely”), the use of digital technologies as part of lending processes involving customer procurement, credit assessment and loan approval, loan disbursement, loan repayment, and customer service. This was also clarified by the regulator in the FAQs that DL Guidelines are applicable to ‘digital loans’ offered over any digital platform which meet the definition of ‘Digital Lending Apps/ Platforms’ (DLAs).

Now returning to the case in hand, if say, the customer acquisition, and underwriting process is done physically, and it is only that the loan is used to settle digital transactions, it cannot be treated as a digital lending.

On the other hand, if a significant part of the transaction, like customer acquisition, credit sanction etc, digitally, and the customer uses the UPI to settle physical transactions, such would qualify as digital lending.

Will NBFCs have a role to play?

In recent times, the heightened collaboration between banks and Non-Banking Financial Companies (NBFCs) has acted as a potent catalyst for credit expansion within the country. These two types of entities leverage each other’s strengths to maximize their potential. While most banks are flush with liquidity due to their convenient access to Current Account and Savings Account (CASA) funds, NBFCs possess the capability to execute the crucial last-mile functions.

Additionally, NBFCs have effectively addressed another pain point for banks, particularly concerning retail lending. Prior to the involvement of NBFCs, banks generally struggled with unsecured short term retail credit, causing them to be hesitant in expanding their product offerings. However, the willingness of certain NBFCs to provide a level of protection has instilled confidence in banks to venture into retail products.

A pertinent question that emerges from this situation is whether NBFCs have opportunities to capitalize on this collaboration, and the answer to this question is likely affirmative. Similar to any other type of loan, NBFCs can once again undertake operational functions such as customer acquisition, credit underwriting, and customer servicing. There is also potential for credit participation through a co-lending arrangement. However, it’s worth noting that this may introduce some operational challenges, given the unpredictability associated with the timing of drawdowns. Therefore, it remains to be seen how this aspect of the collaboration develops.

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^[1] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12532&Mode=0

^[2] https://www.npci.org.in/what-we-do/upi/product-statistics

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Our Resources related to the topic:

1. RBI Regulations on Digital Lending.
2. The emerging concept of embedded finance.
3. The Credit Card Business for NBFCs.