Can ‘Offline’ Drive Digital Payments in India?

In the fifth blog of the Digital Payments for the Next Half Billion series, we explore the importance of 'offline' digital payments in furthering financial inclusion in India.

Imagine you’re on the flight back home after a long day’s work. You feel hungry and suddenly the chicken junglee sandwich offered on the flight seems irresistibly good. You request the air hostess for one. ‘Cash or Card?’ she asks. You take out your wallet but find you’re out of cash. Such has been the impact of digital payments in India, that you’ve probably not visited an ATM in months. You don’t have a credit card on you either¹. Looks like it's going to be a hungry couple of hours for you!

Imagine another scenario where you’re parked in the underground basement of a shopping mall. You need to pay the parking charges and reach out to scan the ‘omnipresent’ QR Code. It doesn’t work! No, it's not the absence of sunlight but the lack of network connectivity that’s the problem here. You scramble to find any stray cash you’ve left around in the car at some point and manage to get out of the parking lot. 

In both cases… you are reminded of what makes cash so helpful. It works everywhere and is not dependent on anything. If only… the much beloved UPI and other digital payment platforms could work that way… it would be so much more convenient!

Digital payments are increasing but so is the dependence on the backend!

Payments are becoming increasingly digital with nearly INR 55 Lakh Crores² worth of retail digital payments in February 2023 alone. UPI alone accounts for nearly INR 12.35 Lakh Crores worth of these transactions. However, increased digitalisation has also meant a higher dependence on internet connectivity for making these payments.

For several segments of Bharat (particularly in rural geographies), the above-described scenarios are not just a matter of ‘inconvenience’. Parts of the country are still without consistent internet access³. Even in regions with reliable connectivity, service outages still happen, often due to temporary congestion either in the uplink or at banking servers. We highlight this in one of the earlier blogs in this series. For the affected population, digital payments and their associated benefits are exclusionary and out of reach. This results in the persistence of a cash-heavy ecosystem. Cash has desirable characteristics that ensure the transaction's privacy and are not prone to failures. These perceptions of cash are compounded by existing technological and financial capability limitations that these vulnerable segments already have.

The payments sector in India has been evolving constantly. It is providing new and enhanced payment mechanisms to increase the use of digital payments in even the most remote regions and decrease the amount of cash flowing through the economy. One such element of this evolution is offline digital payments.

What are ‘Offline Digital Payments’?

While offline digital payments as a concept seem easy enough to understand, there are different interpretations of its definition that have resulted in several approaches in terms of solutions available. For example, it can mean a transaction that is recorded offline but settled at a later point in time. Certain types of wallet transactions would come under this definition. From a pre-requisites point of view,  it can mean a transaction that occurs between users without an internet connection. This includes transactions that involve a telecom service (non-internet) such as the case with USSD. Finally, the purists may define offline digital payments as transactions that can occur without a connection to any type of external power source or ledger⁴. These include transactions using specialized hardware devices or stored value cards. Put more simply, offline digital payments refer to the ability to complete a payment transaction without infrastructural or backend dependencies. From this perspective, there are several advantages of enabling offline digital payment solutions in the Indian context.

How do offline digital payments really work?

Payment system operators in various countries are exploring the use of offline payments to improve the functionality of traditional payment systems and to experiment with the design of Central Bank Digital Currencies (CBDCs)⁵. While the workings of an offline digital payment system can be extremely complicated, there are two broad design choices⁶ that a solution provider must consider, in layman's terms.

1. Choice of Payment Rails: There is a choice between creating a token-based system vs an account-based system for processing payments. In a token-based system, a token or digital representation is used to represent a specific account or payment method. The token prevents exposing sensitive account details, such as credit card numbers or bank account information. Cryptocurrencies are a good example of this approach. In an account-based system, the payment is processed directly through the user's account, such as a bank account or credit card account. The user must provide their account information directly to the payment processor or merchant, which can pose a potential security risk but also has many more use cases. UPI takes this approach.  A token-based approach offers greater security and anonymity in making a transaction while an account-based approach can have more use cases as they are linked to existing user accounts.

2. Choice of Trusted Environment: This determines whether a transaction will be carried out using a hardware-based approach (use of specific physical devices to facilitate transactions without an internet connection such as chip-based cards or POS terminals) or a software-based approach (use of software applications on a smartphone like payment applications). A hardware approach is more secure but involves high costs in terms of production and distribution of physical devices, while a software approach does not require distributing newer devices but is more prone to malware and security concerns.

Once these design choices are made, any offline digital payment solution works by bypassing the need to connect to the internet or even intermediaries that are present in the flow of a typical payment transaction such as a bank. This can happen through Bluetooth, NFC, or other technologies enabling connectivity between two devices. The settlement, in the case of banking systems, typically happens at a later stage when the device is online. It's important to note that offline digital payment solutions at present are not intended to replace online payment systems but rather provide an additional payment option in situations where internet connectivity may be limited.

Current Offline Digital Payment Solutions in India

In terms of current solutions in India, the UPI Lite offering from NPCI has partially enabled offline digital payments, however, this is largely in response to huge stress on the core banking infrastructure of the banks, which has led to reports of system glitches and a higher rate of rejection for initiated transactions using the UPI platform. A user needs to top up a UPI Lite wallet currently enabled for a few banks in India. Small-value transactions below Rs. 200 can then be initiated using this on-device wallet. This step removes the need to connect to the payer’s bank and reduces the chance of a transaction failure. While the NPCI has indicated a second phase of completely offline payments. There are few details around it at the moment. A typical UPI Lite transaction flow (bypassing the payer’s bank) looks like this:

From a user’s perspective, however, offline digital payments would be meaningful if dependency on network connectivity could be eliminated completely during the course of a transaction. The RBI as part of its Regulatory Sandbox, focusing on offline payments, started a pilot with HDFC Bank to explore Offline Retail Payments (ORP)⁷. The current solution, ‘OfflinePay’ is a mobile payment solution that allows customers to make digital payments without the need for an internet connection. A typical P2M transaction happens through a basic five-step approach:

It is expected to allow merchants and users to accept and make payments even in low or no internet/ network scenarios. However, interoperability remains a significant concern as the solution would be limited at first to only HDFC OfflinePay onboarded users and merchants. IDFC bank is part of the ongoing testing to demonstrate an interoperable solution.

Designing Offline Digital Payment Solutions for Bharat

The value of enabling offline digital payments from a financial inclusion lens is immense. With the success of UPI, users have become familiarised with an intuitive transaction flow. Any solution is expected to build on this seamless and convenient experience. A scalable offline retail digital payment solution must keep in mind the following design principles in mind:

1. Must ensure Interoperability: UPI has advanced the convenience of systems that are interoperable, which means that they should be able to work with different payment platforms, banks, and financial institutions. This will help to reduce the fragmentation of the payment landscape and increase convenience for users in the Indian context, as highlighted in the RBI's Payment Vision 2025⁸.

2. Ease of Access: Offline digital payment methods must be easily accessible to Bharat, especially in rural areas where internet connectivity may not be consistent. The solution must leverage existing devices that lower-income households possess, typically a feature phone. There are still 450 million feature phone users in India⁹. Offline digital payments will benefit these cohorts the most.

3. Must build Trust through Security: Security is a top priority for any payment method, and offline digital payments are no exception. Payment systems must have robust security measures in place to prevent fraudulent transactions and protect users' sensitive information. According to RBI Payment System Indicators¹⁰, 1 in every 72,426 transactions was fraudulent in December 2022. While this amounts to less than 0.103 basis points, the incidence is likely to be much higher among users with lower technology capabilities.

4. Should be fast: Offline digital payment systems should be fast and efficient to encourage adoption. Users should be able to complete transactions quickly and easily, without any delays or technical glitches. This ensures user retention and expanded usage. One-click payments for amounts under Rs. 200 through UPI Lite demonstrate this.

5. Must Support Vernacular: India is a diverse country with many languages and dialects. Offline digital payment systems should support multiple languages to cater to users from different regions. Nearly 9 out of 10 new internet users are vernacular first¹¹ and this pattern is likely to continue with users for whom offline digital payments will be most beneficial.

6. Simplified Payment Flow: The payment systems must be user-friendly and intuitive, even for users who are not tech-savvy. This can be achieved by simplifying the payment process and providing clear instructions. Designing accessibility options¹² for cohorts with low literacy, such as oral users, is crucial to expanding the digital payment user base.

As solutions in this space are being piloted, the Reserve Bank of India (RBI) has recently indicated an interest in exploring offline payments in its central bank digital currency (CBDC) pilot to broaden use case scenarios¹³. Stay tuned as we explore this space more closely.

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Part of our series on Digital Payments for the Next Half Billion

With transactions over INR 12 lakh crores clocked in February 2023, the impact of UPI in furthering the digitization of payments is unprecedented. The next wave of growth is likely to come from Tier 3-6 locations, as evidenced in the past two years wherein these cities have contributed to nearly 60-70 per cent of new mobile payment customers. Recent initiatives have highlighted the need to make digital payments accessible for all. With digital payments deepening financial inclusion, we explore the opportunities and challenges that these new initiatives offer to the next half-billion through this series.

1. Most airlines don’t accept transactions via debit card onboard.

2. https://www.rbi.org.in/Scripts/PSIUserView.aspx?Id=21

3. Govt. of India data from 2021 shows nearly 25000 villages without internet connectivity. https://www.businesstoday.in/industry/telecom/story/over-25000-villages-lack-mobile-connectivity-govt-data-shows-321376-2022-02-03

4.  https://mb.cision.com/Public/14959/3735511/a28c5d92259c13cd.pdf

5. https://www.mckinsey.com/featured-insights/mckinsey-explainers/what-is-central-bank-digital-currency-cbdc

6.  Enabling offline payments in an online world. A practical guide to offline payment design (Lipis Advisors, 2023)

7. https://www.outlookindia.com/business/hdfc-bank-launches-offline-digital-payments-pilot-project-across-16-cities-news-261859

8. https://rbidocs.rbi.org.in/rdocs/PublicationReport/Pdfs/PAYMENTSVISION2025844D11300C884DC4ACB8E56B7348F4D4.PDF

9. https://economictimes.indiatimes.com/tech/technology/report-says-over-700-million-active-internet-users-in-india-as-of-december-2022/articleshow/98673654.cms

10.  https://rbi.org.in/Scripts/PSIUserView.aspx?Id=19

11. https://tech.hindustantimes.com/tech/news/over-500-million-users-to-access-internet-in-indian-languages-by-2021-google-story-6SV7GlYWssoZZQjm4O5n6I.html#:~:text=According%20to%20Google%20officials%2C%20the,English%20users%20(175%20million).

12. https://www.w3.org/WAI/GL/task-forces/coga/wiki/Payments

13.  https://www.indiatoday.in/cryptocurrency/story/india-to-look-into-cbdcs-offline-functionality-rbis-top-official-2343218-2023-03-06