How UPI became India’s biggest digital payments system — and its next challenge

Almost a decade-and-a-half later, in 2025-26, the number of digital transactions was an astonishing 28,174 crore. And 86% of these payments were from a system that didn’t even exist until a decade ago — Unified Payments Interface (UPI).

More than 55 crore people use UPI now and 703 entities — from banks to payment service providers — are involved in facilitating its transactions. Having completed 10 years this month — it was launched as a pilot in April 2016 before becoming fully operational in August that year — it is now at a crossroads of sorts. An amendment to the Payments and Settlement Systems Act of 2007 has now removed the barrier to merchants being charged a fee for receiving payments via UPI.

Cash on delivery and ‘spontaneous proliferation’

UPI was developed by RBI-regulated National Payments Corporation of India (NPCI) and the Indian Banks’ Association (IBA). Work on it started as long back as 2012-13, with the payment systems “vision document” for 2012-15 making several noteworthy points, including how despite attempts to move towards a less-cash society, nearly a third of e-commerce purchases were being paid via cash-on-delivery. Several of the ongoing, short-term, medium-term, and long-term action points in that vision document can be recognised in the UPI we use today.

The possibilities were spelt out further in the RBI committee report on Comprehensive Financial Services for Small Businesses and Low Income Households. Submitted in late 2013, the committee said the emergence of Immediate Payments Service — or IMPS — meant “there is the very real and very welcome possibility that there will be rapid and spontaneous proliferation in the network of individuals and merchants that are willing to participate in ‘money services businesses’ allowing purchase and sale of goods as well as cash-in-cash-out and remittance services using mobile based transactions to grow rapidly”.

As it turns out, that possibility became reality in 2016. While the government’s demonetisation decision in November 2016 helped spur activity for a short while, movement was still slow. Until December 2017, monthly transaction value was under Rs 10,000 crore and it took another year for that figure to cross Rs 1 lakh crore. As such, it was felt that more was needed for digital payments to truly take off. And a key hindrance was the Merchant Discount Rate (MDR).

The MDR obstacle

Led by Nandan Nilekani, the High-Level Committee on Deepening of Digital Payments said in May 2019 that customers and small merchants not be charged by their banks for digital transactions and the government must subsidise MDR on transactions of up to Rs 2,000.

This was seemingly accepted and the government in 2020 began subsidising UPI and RuPay debit card payments of up to Rs 2,000 to small merchants through its ‘Incentive scheme for promotion of RuPay Debit Cards and low-value BHIM-UPI transactions (P2M)’. Capped at 0.15% of the transaction value, the subsidy was shared between banks, payment service providers and third-party app providers.

UPI payments vs ATM withdrawals

What followed was an incredible rise in the use of UPI, with no small role played by the coronavirus pandemic, as people looked to avoid any potential human contact that may occur in the process of transferring cash.

Investments drive innovation

But even before the MDR was removed and coronavirus discouraged the use of cash, private money was flowing into India’s digital payments sector at a tremendous pace, driving the entry of players and innovation.

“Investment in Indian fintech firms spiked in early 2019 and again in 2021 when payment firms took up nearly half the volume, marking a shift in investors’ interest. The majority of investments was in companies whose core business was providing payment services and point-of-sales (PoS) devices,” a December 2024 paper by the Bank for International Settlements (BIS) said.

Investments into India’s digital payments sector. Chart source: A December 2024 paper by the Bank for International Settlements (BIS)

“The spike in the value of investment deals in 2019 related to the growing adoption of UPI and large deals by Paytm and PhonePe. In 2021, the surge in investment followed from an increased preference for using digital payment systems after the Covid-19 pandemic,” it added.

‘Too late’ for banks

That period of immense interest and investment in India’s digital payments sector has led to an entirely new crop of players dominating the space in such a manner that even the country’s top bank, State Bank of India, can’t hope to catch up.

“I think we have definitely missed the payments bus and it is too late to catch up,” SBI Chairman C S Setty said last week. “I don’t think any bank can reach the kind of volumes they have built.”

Setty was referring to the players hogging the UPI volumes: Walmart-backed PhonePe and Google Pay. Together, the two apps backed by US giants handled 80% of all UPI transactions in July, accounting for 83% of the value. 

Such is their stranglehold over the top two positions that no one has been able to eat into their share and even regulations to restrict any one player’s market share to 30% has had to be postponed on multiple occasions. The current deadline is December 2026.

SBI handled just 0.1% of UPI transactions by volume and 0.2% by value in July, fourth amongst banks. The top-ranked bank was Kotak Mahindra Bank, with 0.6% of share in UPI transactions by volume and value.

Costs pile up

The volume of UPI transactions has risen so sharply they have left behind more traditional non-cash payment methods such as debit and credit cards.

UPI’s expanding share in digital payments.

The number of credit and debit card transactions — excluding ATM withdrawals — in May this year were just 17% higher at 70 crore than in November 2019. In comparison, the growth in UPI transactions has been 1,800%.

This huge increase is not without a rise in its underlying costs that range from the technology to banking and compliance infrastructure.

“The scale of digital payments today means that even a relatively small unrecovered cost per transaction can translate into a significant financial burden across banks, Payment Service Providers, and other ecosystem participants,” said Sridhar Guntuku, Vice President-Alliances and Partnerships at fintech infrastructure platform Decentro.

It is in this context that the payments industry, for several years, has been calling for the return of MDR on UPI and RuPay debit card transactions. Sure, the Centre has been subsidising person-to-merchant payments of up to Rs 2,000, but that money is just not enough to cover payment infra costs that are to the tune of Rs 20,000 crore a year or so.

“For core UPI, zero MDR has been the right call; it is what allowed the ecosystem to reach smaller merchants and drive adoption at scale,” Anirban Mukherjee, CEO of PayU, said. However, the future can’t be only about processing more transactions and its next phase needs to be about creating more value per transaction for consumers, merchants and the ecosystem.

“As UPI deepens its reach, it also lays the foundation for something even more transformative, that is credit. Affordable, accessible, data-driven credit for merchants and consumers who have never had it. A calibrated MDR framework for larger merchants could help get us there, without compromising the accessibility that made UPI successful in the first place,” Mukherjee added.

This is why the payments industry is batting for an MDR of 0.3-0.6% on payments of more than Rs 2,000 to large merchants. Transactions of more than Rs 2,000 might make up just 4% of all P2M payments, but they account for 68% of total value.

‘Next wave of growth’

The message from the government has been similar, with the finance ministry saying in a statement on Saturday that relying on subsidies alone is not viable for the “next wave of growth”.

This next wave of UPI growth, according to the government, will come from the rural and semi-urban areas. Payments industry executives also point to international opportunities, with Dilip Asbe, NPCI’s CEO, saying this week that just as India is self-sufficient when it comes to domestic payments, “we would like to be as self-sufficient on cross-border payments as well”.

Already, UPI is operational in as many as nine countries — Bhutan, France, Mauritius, Nepal, Singapore, Sri Lanka, UAE, Qatar, and Cambodia — to varying degrees. Efforts are on to increase acceptance further in countries that are hotspots for Indian tourists and migrant workers — people who would want to send money back home or use that one mobile app they are comfortable with to spend while travelling abroad.

Leading the charge is the partnership with Singapore, whose PayNow fast-payment system has been linked with UPI for more than three years now. And this is the future. Why? Because international bank transfers can take several days to settle, with the costs being as high as 7% of the amount that must be transferred.

“If UPI is to grow further and even across borders, more funds are needed. And for this, public funds cannot be used. So, money has to be generated,” a payments industry executive told The Indian Express last week, requesting anonymity.

So, is MDR the answer? The payments industry thinks so: the Payments Council of India says on its website it has made several representations to allow the MDR to be decided by “market forces”. The Nandan Nilekani-led High-Level Committee on Deepening of Digital Payments said so, too. The problem, it noted, was “that does not appear to be working”.