The increasing share of Unified Payments Interface (UPI) transactions in merchant payments has begun to gnaw at banks’ and non-banks’ fee incomes. The homegrown payments channel does not earn merchant fees due to government rules and the growing trend of UPI usage is now coming to bite banks and other payments players who have been its biggest champions.

Merchant establishments, especially small storefronts across the country, have taken to UPI QR-based payments in a big way since they do not have to shell out a merchant discount rate (MDR) to their bank or non-bank service providers, also known as acquirers. In contrast, all non-RuPay card transactions are chargeable by banks and tend to hurt merchants’ margins. The shift to QR-based payments has been accelerated by consumers’ tendency to use their mobile phones for making payments instead of handling cash during the pandemic.

Industry estimates suggest that half of all merchant transactions in 2021 happened through mobile phones. At Rs 1.63 trillion, the value of merchant UPI transactions in February 2022 stood well above the value of debit and credit card transactions at point of sale (POS) terminals, which was Rs 1.43 trillion.

UPI has emerged as the preferred mode of merchant payments for low-value transactions, accounting for nearly three-fourth of the transaction volumes below Rs 500, HDFC Securities said in a recent report. “The shift in merchant payments towards low-yielding form factors such as UPI, coupled with rising competitive intensity across payment modes, is driving the overall payments fee yields lower across the ecosystem,” the report said.

For instance, HDFC Bank saw its fee on payments products falling on a year-on-year (y-o-y) basis in the quarter ended December. Axis Bank’s retail card fee income as a share of card spends fell to 1.9% in the third quarter of FY22 from 2.5% in Q1FY18.

The payments industry is hopeful that the government will allow some charges to be levied on UPI transactions once the volume of transactions reaches a certain critical mass. In March 2022, the number of UPI transactions was 5.4 billion. Payments players are also looking forward to the Reserve Bank of India’s (RBI) working group recommendations on transaction charges which, they hope, will signal a return to market-determined pricing.

Banks are hardly the worst hit by the surge in UPI usage. Fintech players are set to be hurt a lot more as they have fewer avenues of earning revenue. A case in point is One97 Communications, or Paytm, which derives around two-thirds of its consolidated operating revenue from payment business gross merchandise value (GMV).

However, with the rising component of non-MDR bearing UPI transactions to almost 50% from under 5%, payment take rates have contracted from 74 basis points (bps) to 38 bps, ICICI Securities said in a recent report. “Compared to 36% CAGR in merchant GMV over FY22-26E, we expect payment business revenue to grow at only 26% as proportion of zero MDR UPI is estimated to rise to 62% and there will be further pressure of 4-5 bps on take rates of MDR bearing instruments,” the report said.

Other sector experts have pointed out that the nature of UPI as a payments system offers limited scope for cross-selling of products, further shrinking revenue streams for fintechs. Despite their dominance, fintechs do not have exclusive access to transaction data on the UPI, according to analysts at Moody’s Investors Service. Funds in every transaction originated on a customer app move from the sender’s bank account to that of the recipient through intermediary banks acting as payment service providers (PSPs) because only banks can perform such functions on the UPI network . Therefore, banks have access to transaction data as fintechs do. “Because of this, fintechs’ dominance in digital payments does not result in a significant data advantage over banks,” Moody’s said.

This is reflected in the fact that Paytm Payments Bank, even after three years of operation, had a deposit market share of less than 0.1% as of March 2021. Its market share in wealth management products, such as insurance and mutual funds, is similarly minimal, Moody’s said, even as banks have increased their market share in the sale of third party products such as life insurance in the past five years.