UPI-PayNow Link Sets The Stage For Future Adoption Of Central Bank Digital Currencies

Much has been written about the linkage between India’s Unified Payments Interface and Singapore’s fast payment system, PayNow, on Feb. 21, 2023. 

The importance of the event for all parties concerned was underlined by the presence of Indian Prime Minister Narendra Modi, Singapore Prime Minister Lee Hsien Loong, Monetary Authority of Singapore managing director Ravi Menon and Reserve Bank of India Governor Shaktikanta Das.  

While Unified Payments Interface remains one of India’s best innovations, and this global linkage is a massive move forward beyond our own shores, this may well be a precursor to a much bigger move on cross-border payments involving the central bank digital currency (CBDC).  

This may seem like a big leap since the controlled pilots for wholesale and retail CBDC by RBI was launched only in November-December 2022. But, in India, use of UPI for retail payments is already ubiquitous and free, so the CBDC or e-rupee just provides another additional option for payments for fast transactions.  

A key difference is that UPI remains a largely online payments system, although pilots are underway for more offline payments. However, as the RBI officials have pointed out the e-rupee will be available for use even in places with limited or no internet connectivity, with additional specific use cases such as delivery of government subsidies. This is great not only from the perspective of financial inclusion but also over time can see a sharp decline in cost of delivery of such aid and support.  

But isn’t central bank digital currency meant for domestic transactions with UPI already a proven commodity that can be exported and connected more seamlessly with global systems?  

The answer isn’t a simple yes or no.  

UPI is already an accepted system for fast payments and there are already payment linkages being built with Singapore, United Arab Emirates and Bhutan. Additionally, there are QR code-linked systems being built on the UPI base for linking payments with countries such as Nepal.  

Eventually, UPI is a bank-driven system that still uses the traditional banking architecture and systems. Unlike in India where UPI is subsidised by the government and other participants, in the case of global payments, there are still underlying costs that need to be paid for such real-time or fast payments that are embedded in the payment architecture. So while the pace of payments may improve with such real-time links, there will be associated costs when cross-border payments have to be executed.  

Cross-border payments have always been expensive since there is an element of risk in money transfers happening between entities that have different systems and different legs of compliance as per their jurisdictions. There is the additional element of time taken for verification to prevent fraudulent transactions, so security costs tend to be embedded in the fees. 

This has led to many existing cross-border payment specialists such as banks, wire transfer services and even new age digital payment platforms, charging a fairly high cost for ensuring safe transfers across country borders. Despite global regulatory push, the existing players have shown little effort to bring down cross-border payments costs to enable cheaper transactions, and reduce the incentive for those who try to bypass the formal systems for payments to avoid paying these costs and taxes.  

This is where RBI’s CBDC or e-rupee can play its part, especially if the corresponding country also has its own version of a fiat digital currency.  

Imagine a money transfer that is effectively taking place between someone in India and a person in Singapore (which has conducted pilots for its own retail CBDC). In a normal circumstance, this would have happened via banking systems and now is even possible via UPI, albeit with a cost involved.  

Imagine if both countries have a CBDC framework that effectively reduces or even negates the security checks and compliance costs for a customer since the underlying ledger system is controlled by the respective central banks of both countries.  

This is not something in the realm of theory, as RBI has literally stated this interoperability of as an objective post the launch of the digital rupee.  

“Among the various benefits of CBDC, perhaps the most important is its potential to make cross-border payments faster and cheaper,” RBI Deputy Governor T Rabi Sankar said in a speech on Dec 27, 2022. “Here again, a necessary precondition is that other countries develop their own CBDCs and there is a global understanding on the need to make CBDCs interoperable (basically by linking the various CBDC systems) and develop standards for effective interfacing.”  

And we don’t need to look too far to see an example of the RBI doing exactly this to expand a payments system that was largely limited to a few players, and ironically the example is the ideation and launch of UPI.  

Since digital payments have become all pervasive since April 2016 when Unified Payments Interface was announced, many have forgotten that just seven years ago, bank customers shied away from digital payments.  

Payment wallets, prepaid payment instruments and closed loop transfers between banks through tie-ups existed alongside card transactions even before UPI was launched by the National Payments Corp of India. 

But, despite RBI pushing banks to look at more interoperable systems to bring down cost of digital payments and money transfers, there was little real effort to do so. Most banks chose to create payment wallets that worked only within their customer universe, and even the prepaid wallets followed suit. 

Banks baulked at the capital costs involved in research, cost of infrastructure such as servers, and the low fees on offer from smaller value payments with little visibility of success. For many standalone payments players and banks, payments and money transfers was a lucrative fee business, and no one wanted to disrupt a system that was working. However, this rent-seeking approach of these players meant that digital transactions were restricted to peer-to-merchant transfers, and large value payments.  

The pool of people accessing such transactions remained limited, with limited effort by banks to promote digital payments to a wider public base.  

Realising this initiative needed a public infrastructure approach, the RBI first set up NPCI in 2009, issued a vision document for digital payments in 2012 and finally backed UPI’s launch in 2016.  

The rest as they say is history with UPI being widely heralded as one of the greatest success stories that has emerged out of India, leapfrogging India far ahead of many developed countries on this front.  

While NPCI is owned by banks, it is widely seen as an extension of the RBI and the government because of how it has been backed by them. Almost all product launches of the NPCI have been done by senior officials of the government or the RBI, thereby providing much needed gravitas to the actual product.  

Why should RBI feel the need to disrupt cross-border transactions when it is a system that has existed over the decades? Because the world has changed, thanks to improvements in technology and network speeds, fintech revolution has occurred enabling improvements and easier cross-border linkages. 

In that scenario, why should someone making a small value cross-border transfer or remittance pay as high as 11-12% of that amount as fees?  

The existing players have their arguments around security of payment settlements, need to avoid frauds, cost of compliance with different systems, foreign exchange currency costs and more. While there may be some merits in these arguments, it is clear that there is a fair amount of ‘rent seeking behaviour’ that benefits from maintaining a status quo system that is lucrative and not built from the perspective of customer convenience. 

However, the ambition of using e-rupee for cross-border transactions will hinge a lot on how much the RBI can do to make it popular. It will also need to engage with central banks globally to create a seamless cross-border payments experience. There may even be need to pilot this CBDC-based payment system with those countries that India has sizeable trade and remittance flows with.  

The existing system isn’t broken, and the players involved will do well to realise that central banks are looking at options beyond what has been traditionally been in place. So far, efforts to bring down cross payment costs have hinged on banks and payment players seeing the central bank perspective.  

With full control over their own CBDC, and direct interactions with their central banks that have their own CBDC, there is a case for serious disruption of the cross-border payment system and also the fee structure that has been in place for so long.  

Is this going to happen tomorrow? No. Has the work begun in this direction? Is success guaranteed? No.  

But, what is guaranteed is disruption and when the disruption is led by central banks and effectively the government, the marketplace needs to sit up and take notice.   

T Bijoy Idicheriah is a senior financial journalist who has been writing on the world of banking and central banking for 17 years.

The views expressed here are those of the author, and do not necessarily represent the views of BQ Prime or its editorial team.