Explaining UPI

I just paid my cook his salary for November. Given the cash crunch, I paid him through a bank transfer, using IMPS. Earlier today, my wife had asked him for his account details (last month I’d paid him on his wife’s account).

An hour back he sent me his account details (including account number and IFSC) via WhatsApp. I had to wait till I got home and got access to my laptop (Citibank app doesn’t let you add payees on mobile banking).

I get home, log in to Citibank Online. Add payee, which includes typing his bank account number twice. Get SMS asking me to confirm payee addition. I authorise payee. And after all this I am able to finally do the transfer – and I expect him to have got his money already.

For a long time I was wondering what the big deal with UPI was, given that IMPS is already fast enough. Having finally tried UPI earlier this week (it’s finally coming to iOS, but only available on ICICI now. And the implementation so far sucks, since you need to pull out your debit card for two factor authentication – defeating the point of UPI. I’m told it’s better on Android), I realise how much easier and safer the transaction would’ve been.

Firstly, the cook needn’t have sent me his account number. All I would need was his virtual payment address. I would then open my UPI app (in my case, iMobile) and click on “send money”. And then I’d add his virtual ID there, following which his name would appear. Two or three more clicks, and entering my PIN code, the transfer would be done.

No bank account number. Not even a mobile number or an email ID. Just a random string of characters would allow me to transfer money to him! And later I could give him my UPI ID, and next month onwards he could simply send me a request via UPI for his salary. And two clicks later it would be done!

Mint has reported that there are massive delays in merchants installing point of sale devices in response to the cash ban. Banks should instead seek to acquire merchants to accept money via UPI. It’s simple, it’s quick and it protects privacy.

In fact, if the bank sales staff now have bandwidth, it can be argued that all the planets have aligned for UPI to take off for merchant payments – people have less cash, point of sale devices are not available, and both merchants and shoppers have shown openness to cashless payments, and there is a push from the government.

If only the banks can bite…

Why PayTM is winning the payments “battle” in India

For the last one year or so, ever since I started using IMPS at scale, and read up the UPI protocol, I’ve been bullish about Indian banks winning the so-called “payments battle”. If and when the adoption of electronic payments in India takes off, I’ve been expecting banks to cash in ahead of the “prepaid payments instruments” operators.

The events of the last one week, however, have made me revise this prediction. While the disruption of the cash economy by withdrawal of 85% of all notes in circulation has no doubt given a major boost to the electronic payments industry, only some are in a position to do anything about this.

The major problem for banks in the last one week has been that they’ve been tasked with the unenviable task of exchanging the now invalid currency, taking deposits and issuing new currency. With stringent know-your-customer (KYC) norms, the process hasn’t been an easy one, and banks have been working overtime (along with customers working overtime standing in line) to make sure hard currency is in the market again.

While by all accounts banks have been undertaking this task rather well, the problem has been that they’ve had little bandwidth to do anything else. This was a wonderful opportunity for banks, for example, to acquire small merchants to accept payments using UPI. It was an opportune time to push the adoption of credit card payment terminals to merchants who so far didn’t possess them. Banks could’ve also used the opportunity to open savings accounts for the hitherto unbanked, so they had a place to park their cash.

As it stands, the demands of cash management have been so overwhelming that the above are literally last priorities for the bank. Leave alone expand their networks, banks are even unable to service the existing point of sale machines on their network, as one distraught shopkeeper mentioned to me on Saturday.

This is where the opportunity for the likes of PayTM lies. Freed of the responsibilities of branch banking and currency exchange, they’ve been far better placed to acquire customers and merchants and improve their volume of sales. Of course, their big problem is that they’re not interoperable – I can’t pay using Mobikwik wallet to a merchant who can accept using PayTM. Nevertheless, they’ve had the sales and operational bandwidth to press on with their network expansion, and by the time the banks can get back to focussing on this, it might be too late.

And among the Prepaid Payment Instrument (PPI) operators again, PayTM is better poised to exploit the opportunity than its peers, mainly thanks to recall. Thanks to the Uber deal, they have a foothold in the premium market unlike the likes of Freecharge which are only in the low-end mobile recharge market. And PayTM has also had cash to burn to create recall – with deals such as sponsorship of Indian cricket matches.

It’s no surprise that soon after the announcement of withdrawal of large currency was made, PayTM took out full page ads in all major newspapers. They correctly guessed that this was an opportunity they could not afford to miss.

PS: PayTM has a payments bank license, so once they start those operations, they’ll become interoperable with the banking system, with IMPS and UPI and all that.

ATMs and their security

Paul Volcker, former chairman of the US Federal Reserve and proponent of the Volcker Rule following the financial crisis of 2008 once remarked that the only useful financial innovation in the last twenty years is the ATM. The biggest advantage of the ATM is that because you can get money at any point of time on demand, you don’t need to keep too much of an “emergency stash” at home. For example, you are now extremely unlikely to find more than five thousand rupees in hard currency in my house at any point of time (including my wife’s and my wallets, and our “emergency stash”). In the pre-ATM era, when we would have to wait to visit a bank branch to withdraw money, we would have to keep a much larger sum at home as an emergency fund.

So how does this help the economy? Lesser cash in people’s homes and wallets means more cash in the banking system. Which means that at any given point in time, the banks have more money to lend out, and so the supply of credit is higher, reducing the cost of credit. Reduction in the cost of credit improves investment and thus leads to higher economic growth – which is good for everybody. The ATM is thus pareto-positive in stimulating economic growth.

And this is not all. The presence of the ATM has meant that one of the basic activities for which people would visit bank branches – to withdraw money – has now declined massively. Thus, it is possible for banks to run with much leaner branch infrastructure and this again pays back to the general public in the form of a lower “spread” between the cost of a deposit and the cost of a loan. I read on twitter yesterday (unable to find link now) that the average cost of servicing a customer at a teller counter is Rs. 176 while at an ATM it is Rs. 6. This order of magnitude difference is hard to ignore.

And we are not done yet, for we haven’t yet factored in the ease of drawing money now in the age of the ATM. Ten years back I remember having to wait at the bank branch at IIT for about twenty minutes to withdraw cash. I would have to fill up and submit a form, collect a token and wait till my number was called before I was handed my money. The transaction cost (for the customer) of withdrawing money was way too much. And one had to go during the branch timings. It is all so different now!

Now that we have established that ATMs have a socially and economically useful purpose, let us get to their security. On Tuesday this week in Bangalore a woman was mugged at an ATM when she had gone to withdraw money. The assaulter threatened her with a pistol and a machete, and assaulted her anyway and decamped with her money. The event was caught on the CCTV camera at the ATM and the footage was played out on national television.


Following this incident the Home Minister of Karnataka has given a directive that banks appoint security guards at ATMs or shut down the ATMs. Initially he gave an ultimatum of three days to implement this rule, but then the impracticality of the suggestion dawned on him and the deadline has now been extended. The question, however, arises on who is responsible for safety of the ATM.

There are two components to safety at an ATM – safety of the cash and safety of the customers who visit it. The cash at the ATM is the bank’s private property, and the bank has chosen to put the cash there (and not somewhere else), so it can be argued that security of the cash inside the ATM machine is the bank’s responsibility. I don’t think there needs to be too much debate on this.

What is debatable, however, is the responsibility of security of people visiting the ATM. The question is if it is the responsibility of the bank or as a public good it is the responsibility of the government. Let us draw an analogy. Let’s say you are visiting my house, and at exactly the same time a robber happens to pay a visit. In the course of the robbery you get injured. Can the state hold me liable for your injury for not securing my house enough against the robbers? Isn’t it the state’s responsibility in the first place that the robbers were on the prowl and they just happened to rob my house when you were visiting?

Public safety is a public good. To get technical, it is non-rival (by keeping the streets safe for you, the streets are also kept safe for me) and non-excludable (having kept the streets safe, you cannot exclude me from enjoying the safe streets). And it being a public good, it is the responsibility of the state to provide it. It also means that it is the responsibility of the state to provide public safety everywhere – be it private or public places. Arguing that the ATM, since it belongs to the bank, is not a public space and hence the state is not responsibility for security there is thus wrong. So the state has no right to demand that banks employ private security guards to guard the ATMs.

So if it is the state’s responsibility to keep ATMs safe does it mean that police be appointed to guard the ATMs? Of course not, for the police’s job is not to guard private property that is the ATM – their job is to ensure public safety. Effective policing would mean that the thug who attacked the woman at the ATM wouldn’t be in business at all, and that he wouldn’t have thought of committing this crime.

So if we don’t have private security guards or cops guarding the ATMs how are we going to keep them safe? I argue that it is a matter of design. If you were to watch the video above, you will notice that the first thing the thug does on entering the ATM behind the victim is to pull down the shutters – thus the happenings of the ATM is shielded from the public eye. If ATMs are by definition perennially open what is the purpose of the shutter? You might also notice in the video that the thug pulled down the shutter once again while exiting. Consequently the victim was found only three hours later and that might have had serious consequences in terms of her health. Would the ATM not be better off without that shutter?

Then, there is the question of whether we need a room at all to house the ATM. Here in India, everywhere except in malls, ATMs have their own rooms, and it was in one such room that the mugging happened on Tuesday. On my few visits abroad, however, I’ve noticed that ATMs there never have their own rooms – they are simply holes in walls on the street from which you can get cash. That automatically puts the ATM in a public space and makes them safer (especially if they are on busy streets). The ATM rooms only provide a false sense of security and can prove counterproductive like in the case we just saw.

As we saw in the first part of this piece, ATMs perform a socially valuable function and it is in the interest of banks to encourage customers to use them. That, however, doesn’t mean that banks appoint guards to all ATMs – there might be an alternate solution that might be cheaper and easier to implement, and it is for the banks to find it. It is NOT the state’s business to mandate how the banks get customers to use their ATMs – the state has to concentrate on maintaining public safety.

In June last year the Reserve Bank of India allowed non-bank entities to run “white label ATMs” – cash dispensing machines that are not affiliated to any banks. The first such ATM came up earlier this year. I’m hopeful that some of these ATM companies will gain enough scale that they can solve the ATM design issue and make them safer and more customer friendly.

The Global Financial Crisis Revisited

When we talk about the global financial crisis, one question that pops up in lots of people’s heads is about where the money went. Since every trade involves two parties, it is argued that every loser has a corresponding winner, and that most commentary about the global financial crisis (of 2008) doesn’t talk about these winners. Everyone knows about the havoc that the crisis caused when prices went down (rather suddenly). The havoc that the crisis caused when prices initially went up (rather slowly) is less well documented.

The reason winners don’t get too much footage is that firstly, they are widely distributed, and secondly they spent away all their money. Think about a stock or a CDO or a bond being a like a parcel that you play by passing the parcel. The only thing is that every time you receive the parcel, you make a payment, and then pass on the parcel after receiving a higher payment. Finally, when the whistle blows, one person has the parcel in his hand, and it explodes in his face, ruining him. We know enough about people like this. A large number of banks lost a lot of money holding parcels when the whistle blew. Some went bust, while others had to be bailed out by governments. We know enough of this story so I don’t need to repeat here.

What is interesting is about the winners. Every person who held the parcel for a small amount of time was a winner, albeit a small winner. There were several such winners, each of whom “won” a small amount of money, and spent it (remember that the asset bubble in the early noughties was responsible for increasing consumption among common people). This spending increased demand for various goods and services produced in several countries. This increasing demand led to greater investment in the production facilities of these goods and services. Apart from that, they also increased expectations of growth in demand of these goods.

The damage the crisis did on the way up was to skew expectations of growth in different sectors, thus skewing investment (both in terms of financial and human capital). The spending caused by “small wins” for consumers put in place unreasonable expectations, and by the time it was known that this increased demand came as a result of an asset bubble, a lot of capital had been committed. And this would create imbalances in the “real economy”.

Yes, the asset bubble of the last decade did produce winners. The winners begat more winners (people whose goods and services were bought). However the skewed expectations that the wins created were to cause damage in the longer term. Unfortunately, I don’t see this story being told adequately, when the financial crisis is being talked about. After all, the losers are more spectacular.

IPOs Revisited

I’ve commented earlier on this blog about investment bankers shafting companies that want to raise money from the market, by pricing the IPO too low. While a large share price appreciation on the day of listing might be “successful” from the point of view of the IPO investors, it’s anything but that from the point of view of the issuing companies.

The IPO pricing issue is in the news again now, with LinkedIn listing at close to 100% appreciation of its IPO price. The IPO was sold to investors at $45 a share, and within minutes of listing it was trading at close to $90. I haven’t really followed the trajectory of the stock after that, but assume it’s still closer to $90 than to $45.

Unlike in the Makemytrip case (maybe that got ignored since it’s an Indian company and not many commentators know about it), the LinkedIn IPO has got a lot of footage among both the mainstream media and the blogosphere. There have been views on both sides – that the i-banks shafted LinkedIn, and that this appreciation is only part of the price discovery mechanism, so it’s fair.

One of my favourite financial commentators Felix Salmon has written a rather large piece on this, in which he quotes some of the other prominent commentators also. After giving a summary of all the views, Salmon says that LinkedIn investors haven’t really lost out too much due to the way the IPO has been priced (I’ve reproduced a quote here but I’d encourage you to go read Salmon’s article in full):

But the fact is that if I own 1% of LinkedIn, and I just saw the company getting valued on the stock market at a valuation of $9 billion or so, then I’m just ecstatic that my stake is worth $90 million, and that I haven’t sold any shares below that level. The main interest that I have in an IPO like this is as a price-discovery mechanism, rather than as a cash-raising mechanism. As TED says, LinkedIn has no particular need for any cash at all, let alone $300 million; if it had an extra $200 million in the bank, earning some fraction of 1% per annum, that wouldn’t increase the value of my stake by any measurable amount, because it wouldn’t affect the share price at all.

Now, let us look at this in another way. Currently Salmon seems to be looking at it from the point of view of the client going up to the bank and saying “I want to sell 100,000 shares in my company. Sell it at the best price you can”. Intuitively, this is not how things are supposed to work. At least, if the client is sensible, he would rather go the bank and say “I want to raise 5 million dollars. Raise it by diluting my current shareholders by as little as possible”.

Now you can see why the existing shareholders can be shafted. Suppose I owned one share of LinkedIn, out of a total 100 shares outstanding. Suppose I wanted to raise 9000 rupees. The banker valued the current value at $4500, and thus priced the IPO at $45 a share, thus making me end up with 1/300 of the company.

However, in hindsight, we know that the broad market values the company at $90 a share, implying that before the IPO the company was worth $9000. If the banker had realized this, he would have sold only 100 fresh shares of the company, rather than 200. The balance sheet would have looked exactly the same as it does now, with the difference that I would have owned 1/200 of the company then, rather than 1/300 now!

1/200 and 1/300 seem like small numbers without much difference, but if you understand that the total value of LinkedIn is $9 billion (approx) and if you think about pre-IPO shareholders who held much larger stakes, you know who has been shafted.

I’m not passing a comment here on whether the bankers were devious or incompetent, but I guess in terms of clients wanting to give them future business, both are enough grounds for disqualification.


We live in an era of unprecedented liquidity. Think about the difference from just about ten years ago. Back then, there was a much larger amount of cash reserve that one had to keep in one’s home, or on one’s person. There were no ATMs. There were no credit cards. All purchases needed to be meticulously planned, and budgeted for.

Now, because we don’t need to carry as much hard cash, there is so much more money in the banking system. While that gives depositors the nominal daily interest rate (at some obscenely low rate), there is much more money available with the banks to lend out, which increases the total amount of economic activity by nearly the same amount.

Just think about it. It’s fantastic, the effect of modern finance. And I don’t disagree with Paul Volcker when he says that the most important contribution of modern finance has been the ATM.

PS: My apologies for the break in blogging. I was in and around Ladakh for a week (yes, I was there when the cloudburst happened) and there were some problems with my laptop when I returned because of which I wasn’t able to blog. Hopefully I’ll be able to get back to my one-post-a-day commitment. And I have lots of stories to tell (from my Leh trip) so hope to keep you people busy.

Discontinuous Yield Curves

I think that the equity markets have topped out and have cashed out all my equity and equity mutual fund holdings, and am thus sitting on a pile of cash, which I’m looking to invest in debt. Happened to check out the websites of a few banks where I hold accounts and what caught my eye was the discontinuity in the yield curves.

Here is HDFC Bank:

1 year 1 day – 1 year 15 days Below Rs.15 Lacs 6.00% 6.50% May 18, 2009
1 year 16 days Below Rs.15 Lacs 6.50% 7.00% August 03, 2009
1 year 17 days – 2 years Below Rs.15 Lacs 6.00% 6.50% May 18, 2009
2 years 1 day – 2 years 15 days Below Rs.15 Lacs 6.00% 6.50% May 18, 2009
2 years 16 days Below Rs.15 Lacs 7.00% 7.50% August 03, 2009
2 years 17 days – 3 years Below Rs.15 Lacs 6.00% 6.50% May 18, 2009
3 years 1 day – 5 years Below Rs.15 Lacs 6.00% 6.50% May 18, 2009

Notice the discontinuity? About how for a couple of randomly chosen dates the interest rates suddenly shoot up?

Similarly with ICICI Bank:

391 days to 589 days 6.25 6.25
590 days 6.25 6.25
591 days to less than 2 years 6.25 6.25
2 years to 789 days 7.00 7.00
790 days 7.00 7.00
791days to 989 days 7.00 7.00
990 days 7.25 7.25
991 days to less than 3 years 7.00 7.00

Again same story. On certain “magical” days, interest rates shoot up. The degree of increase in rates here is much less dramatic, though. Nevertheless this is extremely interesting, and I wonder why. I remember last year going to Karnataka Bank and asking for a 1 year deposit, and they asked me to make one for 400 days saying that I’ll get 0.5% per annum better for that.

This morning I went to State Bank of India and found that they don’t offer these special rates. I had a friend check at another nationalized bank and found that they too don’t offer special rates. Wonder why the private banks are offering it, though. Why it makes that big a difference to them that the deposit is for 990 days as against 991 or 889. Or is it some way to prevent early closure?

In other news, SBI is offering teaser rates for home and auto loans. Their ads have been there all over the airwaves for the last few weeks. They offer 8% for first year, 8.5% for second and third years and then what they call as “normal rates” after that. If SBI is getting into teaser rates, god only save Indian finance.

Tenure Matching

One of the fundamental concepts of finance is to match the tenure of assets and liabilities. That the tenure of source of funds (equity, debt, etc.) need to match the tenure of what they are used for. So, if you need money to tide over till your next payday, you need to take an extremely short-term loan. If you need to borrrow to fund a house – an application that has a long tenure – you need to take a longer-term loan. And so on.

In fact, a common refrain about banking crises is that they happen mainly due to the tenure mismatch – banks borrow by means of short-term deposits, and then invest these in long-term loans. Most theories regarding liquidity crises cite this as a common problem.

Now, my contention is that this banking/finance rule is just a special case of a much larger rule in life. Remember that funding, or raising money, can be looked at as a “problem”. By classifying it as a problem, I’m not necessarily saying it’s a very tough problem. All I’m saying is that it’s a problem. And when you do raise money, it is a solution to the problem. Thus, the generalized form of the rule

The tenure of the solution needs to match the tenure of the problem.

So before you look for a solution for any problem in life, you need to first figure out about the tenure of the problem. And then generate a list of possible solutions which have similar tenures, and then pick the best among them. And based on my limited anecdotal experience, most people don’t really appreciate this concept when they suggest, and sometimes even implement, certain solutions.

So on Monday I called up a friend and told her that I was going through a strong bout of NED and we should meet up. She started philosophising and said that this is a fundamental problem and that I should think of a fundamental solution. That I should get a new hobby, or learn a new instrument, or some such long-term thing. Of course, I know myself better than she does, and so I knew that my problem was short-term, and so all I needed was a nice evening out. A short term solution to a short term problem.

On the other hand, during my previous job, I used to go through prolonged periods of NED. A little analysis revealed that the fundamental reason for this NED was my job, and that until I got a new one, I wouldn’t be happy. It was a long-term problem that deserved a long-term solution – of finding another job. However, most of the advice I got for my NED was of the nature of “go get drunk, you will be fine”.

My mother also doesn’t seem to appreciate this tenure concept. Nowadays I’m afraid to crib to her about anything, because if I crib, she assumes it’s a long-term problem and suggests that I should get married and that she’ll intensify her efforts in the arranged-marriage market.

Yes – people not appreciating this tenure concept is a long-term problem. The solution to this should also, thus, be long-term. They need to be taught such a lesson regarding this, that they won’t forget this concept for the rest of their lives.