What is a Digital Payment?
It is a payment which is done through digital or online modes, with no exchange of hard cash being involved. Sometimes it is also called an electronic payment (e-payment). It is the transfer of value from one payment account to another where both the payer and the payee use a digital device such as a mobile phone, computer, or a credit, debit, or prepaid card.
The payer and payee could be either a business or an individuals. Therefore, in order for digital payments to take place, the payer and payee must have a bank account, an online banking method, a device from which they can make the payment, and a medium of transmission. This means that either they should have signed up to a payment provider or an intermediary such as a bank or a service provider.
A digital payment transaction can happen both on the internet and in person to the payee. For example, if a buyer pays via UPI on an e-commerce website or buys from his local grocer and pays him through UPI while purchasing at the store, both are digital payment transactions.
There are various modes of digital payments, including UPI, NEFT, AEPS, mobile wallets, and PoS terminals. UPI is the most preferred mode, having crossed the milestone of $1 trillion in the value of transactions.
Why Pay Digitally?
The transition to digital payments and receipts has some clear benefits, especially for small businesses. Consumers and businesses now expect the digital payments facility to be made available for faster and more secure payments with no risk and no charges. The payer has a mobile phone which provides additional authentication via fingerprint or other verification or biometric method, minimizing risk.
For business transactions too, there are several benefits of going cashless.
- Cash management is eliminated resulting in a lower risk of theft and reducing the cost of security and storage.
- Digital payments are often quicker transactions, thereby resulting in shorter queues and enhancing the customer’s in-shop experience. Customer convenience is thus driving sales.
- A clear trail is available for easy accounting, helping simplify operations and tax compliance.
Mobile-based digital payments also provide the payee with the ability to collect customer data for analytics and market segmentation. This enables retailers and issuer banks to use digital payments, along with loyalty and reward programs, to drive customer acquisition and retention through targeted marketing and customized offers. Credit Cards, one of the oldest payment methods, and the new age Buy Now Pay Later Model, supported by digital payments provides access to credit for customers.
How Do Digital Payments Work?
It may seems that it takes only a few clicks to pay digitally, the digital payments ecosystem has several intermediaries that work seamlessly to facilitate a successful transaction.
The entities involved in the end-to-end processing of a digital payment transaction include the merchant (payee), the consumer (payer), the bank, and the payment network. ‘Merchant’, in this context, refers to local Kirana stores, shopping malls, retail outlets, as well as e-commerce portals and service providers that provide the facility to transact or settle dues using digital payments.
The bank that debits an amount from the payer is known as the issuer bank. On the other side is the acquirer bank, or the payee’s bank, which credits the amount on the receipt. Therefore, both parties must have a bank account and an online banking method to transact digitally.
Working of Digital Payments System
To understand the process of how digital payments work, let’s illustrate it with an example.
Anjali Singh purchases apparel worth INR 5,500 from Rupesh Garments, a shop on busy Kalbadevi Road in Mumbai. She opts to make the digital payment for this amount using her debit card on the Point of Sale (PoS) machine or pay through UPI for any app (QR Code) in the shop.
When the shopkeeper swipes the card on the PoS machine, several steps take place before the payment is made. Since the payment is being made with Anjali’s debit card, the PoS provider checks for a sufficient balance in her bank account. This is only after Anjali enters the transaction PIN, which is verified and then, if there is a sufficient balance, the digital payment is processed, and the money is debited from her account and credited to the business account of Rupesh Garments. In case a credit card is used for digital payments, the available credit limit is first verified with the card provider of the payer before the transaction is processed further.
If Anjali buys from an eCommerce portal, then for digital payment, a payment request is sent from the eCommerce player to the payment gateway that it has tied up with. Then, the payment gateway seeks authorization through an OTP or PIN from Anjali, accepts the amount from her bank, and settles the amount with the bank that the e-commerce portal has an account with. The gateway has to first check the balance in Anjali’s bank account and accordingly either proceed with authentication or reject the request if she has an insufficient balance or inputs incorrect payment details.
The payments industry is constantly innovating to make digital payments simpler and faster for users. By offering a range of options and making it as convenient and secure as possible for them to pay, businesses can nurture user stickiness and enhance their experience.
The Digital Payment Boom
The pandemic has changed virtually everything about the way we live, from how we access healthcare to how we shop and pay for goods.
As going contactless became more common, digital payments skyrocketed, and the trend is showing no signs of slowing. In fact, more than 4 in 5 Americans used some form of digital payment in 2021, according to McKinsey’s 2021 Digital Payments Consumer Survey. This includes browser-based or in-app online purchases, in-store checkout using a mobile phone or QR code, or person-to-person (P2P) payments.
According to Visa’s 2022 Back to Business Study, 73% of small businesses surveyed said new forms of digital payments are fundamental to their growth. Consumers share similar sentiments. 36% of surveyed consumers said digital payment acceptance is a top factor for store purchasing choice, aside from price, while 41% of surveyed consumers said they had abandoned a purchase in a physical store because digital payments weren’t accepted.
Consumers are increasingly turning to mobile wallets like Apple Pay and Google Pay for their convenience. These have the ability to manage credit cards, rewards cards, memberships and more directly on a mobile device. Recent FIS PACE research finds that 32% of mobile wallet users now have three or more mobile wallets downloaded on their smartphones.
The machine learning and artificial intelligence technologies that make digital payments possible are able to study shoppers’ experiences and improve them over time — leading to greater fraud protection and security.
Contactless digital payments and P2P payment apps like Venmo, Zelle, and Square’s Cash App, continue to grow in popularity as well, allowing consumers to digitize the payments they make in-store and online. All three players reported unprecedented growth during 2020, which only continues to rise. Experts estimate more than $1 trillion will transact via mobile P2P apps in 2023.
While the pandemic sparked an unprecedented need for digital wallets and payments, consumers and businesses are continuing to use them for their convenience, security and safety. According to Visa’s Back to Business Study 2021 Outlook, 49% of consumers think using contactless payment methods like digital wallets is among the most important safety measures for stores to implement and maintain.
With this rise and emphasis on digital payments, online and offline businesses that fail to provide relevant payment methods in a secure way will fall behind and lose revenue. In the Visa 2022 Back to Business Study, 59% of small businesses said they plan to shift to using only digital payments within the next two years or are already cashless.
With digital payments at an all-time high, it is paramount that consumers and payment organizations understand emerging trends and ways to ensure a safer shopping experience.
The Perks And Risks Of Emerging Payment Trends
Another payment avenue that is booming as a result of the pandemic is buy-now-pay-later (BNPL), giving shoppers the opportunity to stagger payment installments, typically interest-free, while the merchants receive the full payment upfront from the BNPL fintech (e.g., Klarna, Affirm, Afterpay) or now increasingly from the issuing bank. The traction of Visa and Mastercard enabling issuing banks to offer installment payments to their cardholders has been monumental.
Consumers use BNPL providers not only for deferred payments but also for the convenience and user experience that is often far superior to that of card payments.
Despite the perks, the relatively new payment offering is not without risks. BNPL providers are not yet subject to some consumer protection laws, and BNPL loans currently lack some of the consumer protections that apply to credit cards, such as dispute protections and chargeback options in cases where the purchased goods may be faulty.
Other emerging trends include account-to-account payments, real-time payments (RTP) and open banking. These alternative payment methods are gaining a lot of traction and grabbing market share away from traditional card transactions, but payment organizations must be diligent about new and existing risks.
RTP increases the chance of fraud with more instances of phony transactions and scams among P2P payments. Open banking, while designed to provide greater financial insight and transparency, can lead to security breaches and fraudulent activity with third-party access.
To combat this, Jennifer Lucas of EY states in “Three ways COVID-19 is changing the payments industry” that we can expect to see “greater adoption of machine learning and artificial intelligence both for authentication and in risk management models and the development of risk and analytical tools that can leverage big data in new and innovative ways.”
Creating A Safer Shopping Experience
As a payment provider, it is paramount to track evolving developments and proactively prepare for changes and regulatory framework challenges to the growing and ever-changing market.
Here are three steps to consider for creating a safer shopping experience.
1. Create a strategy to ensure your merchants follow your unique policies. This strategy will also help reveal any vulnerabilities, such as bad actors laundering money through your business.
2. The digital payment world requires deep-dive risk assessment tools. Merchants can be connected to a wider ecosystem of fraud and should have the tools that are capable of looking beyond surface-level risk assessments.
3. Adopt an automated solution to scale and grow into new markets. This is necessary to keep up with the fast-paced digital payments industry.
The rise of digital payments has created countless opportunities for the payments industry and has transformed the way businesses interact with customers. As criminals evolve techniques in the digital, real-time payments space, payment organizations must evolve their strategies and technologies to identify and mitigate fraud and money laundering risks.
With the boom of the internet and the payments industry continuing to grow, we must all pay attention to emerging trends and regulations to stay safe and competitive.