How a Cash Crunch in India Led to the Widespread Adoption of E-Pay Technology
Skip to content
Finance & Accounting Jan 2, 2020

How a Cash Crunch in India Led to the Widespread Adoption of E-Pay Technology

The rapid spread of a fintech app offers lessons for companies and policymakers.

fintech growth among customers and retailers

Lisa Röper

Based on the research of

Nicolas Crouzet

Apoorv Gupta

Filippo Mezzanotti

On the evening of November 8, 2016, India’s government made a surprise announcement that pertained to 86 percent of the country’s cash. Starting at midnight, 500- and 1,000-rupee cash notes would be invalid. Instead, people had to deposit those bills in banks, then withdraw an equivalent amount in new notes.

It’s “a policy intervention of unprecedented scale,” says Nicolas Crouzet, an associate professor of finance at Kellogg. And it also offered an intriguing laboratory to study how people adopt fintech, or new financial technology.

India’s demonetization was aimed at curbing production of counterfeit bills and at reducing tax evasion by forcing people to disclose how much cash they actually owned. But because of logistical hiccups, replacement bills weren’t distributed fast enough, and the country entered a huge cash crunch that lasted about three months.

This allowed a group of Kellogg researchers to study how people approached financial transactions while cash was in short supply. Crouzet, along with Kellogg assistant professor of finance Filippo Mezzanotti and PhD student Apoorv Gupta, looked specifically at one large Indian fintech app, which offered users the ability to make e-payments. They found that the cash crisis spurred people to adopt this app more quickly. And in areas that had been particularly hard-pressed for cash during the demonetization, e-payment adoption continued to grow long after the crisis ended and new cash had found its way back into the hands of the public.

This study suggests that even a temporary policy intervention can be sufficient to motivate people to switch to e-payment permanently. However, in order to design a policy intervention and predict how consumers will respond, it is also important to understand the importance of “network effects” for the technology—that is, how the technology might become more valuable to users as more people adopt it. And while the authors aren’t advocating for a massive monetary crisis, more moderate policies could also be effective in encouraging fintech use.

To spur adoption of new fintech, “you need to induce some sort of snowball effect,” Mezzanotti says.

Easier Access

“Fintech” encompasses products that use technology to change the way financial services are provided. Think Quicken Loans, which enables people to apply for loans online, and e-payment systems such as Venmo and Apple Pay.

The idea is to “lower the access cost,” Mezzanotti says. Traditional systems such as debit or credit cards may involve more fees and take longer to set up. In India, credit cards in particular tend to be difficult to obtain, Crouzet says.

To spur adoption of new fintech, “you need to induce some sort of snowball effect. ... You wouldn’t use Uber if there are no Ubers outside.”

— Filippo Mezzanotti

And for vendors, accepting debit- or credit-card payments requires buying a machine to process transactions. “It’s maybe a trivial cost for a store in the United States, but it may not be a trivial cost for a small vendor in India,” Mezzanotti says.

E-payments also have other advantages over cash. Customers and stores don’t run the risk of getting robbed. And from the government’s point of view, e-payments reduce people’s ability to hide income and avoid taxation.

Building A Network

However, such technologies often rely on building a large network of users. If most vendors don’t accept e-payments, customers may not bother setting up the app. And if most customers don’t use the app, vendors may not see the point either.

“Oftentimes, that’s what slows down the adoption of network technology,” Crouzet says. “The network is pretty small to begin with, so nobody really wants to join.” Mezzanotti adds, “You wouldn’t use Uber if there are no Ubers outside.”

With the Indian demonetization, the team saw an opportunity to study whether an economic shock could help overcome this roadblock.

“This is a really cool case of a natural macro experiment, which doesn’t happen very often,” Crouzet says.

A Burst of Growth

The Kellogg researchers focused on a free e-payment system in India similar to Venmo. Vendors and customers could link bank accounts to the app, and the vendor was assigned a QR code that the customer could scan. If Internet access was unavailable, payments could be made via text messages.

When the researchers analyzed data provided by the company, they saw a huge increase in usage after the demonetization. Within a week, the number of transactions nation-wide jumped 150 percent, then roughly doubled each week over the next three weeks.

And usage didn’t drop off as soon as the cash problem was fixed a few months later. While growth slowed substantially, people kept using the app “long after things were over,” Crouzet says.

“This is a really cool case of a natural macro experiment, which doesn’t happen very often.”

— Nicolas Crouzet

Debit-card usage also rose during the demonetization, but the increase was largely limited to people who already had debit cards. The number of new debit cards issued didn’t change much, perhaps because of the fees or time involved. In contrast, “the app takes five minutes” to set up, Mezzanotti says. (The number of credit cards and credit-card transactions stayed fairly steady.)

The researchers then developed a model to better understand the specific factors that contributed to the e-payment growth. Their analyses confirmed that network effects played a key role—that is, when more users signed up, others were more likely to jump on the bandwagon, too. In a hypothetical scenario where network effects didn’t affect usage, the researchers found that the rise in the adoption rate would have been about 60 percent lower.

The Snowball Effect

The team wondered what lessons the demonetization could offer to policymakers interested in pushing people toward fintech.

Even if they are committed to demonetization, or other policies that would have a similar impact, such as subsidizing the fintech product or taxing cash, policymakers might be unsure of how heavily to intervene or for how long.

So the researchers calculated the varying effects of shocks of different sizes. For a shock that was only half as severe as the intervention in India—say, 43 percent of cash taken out of circulation rather than 86 percent—they found that the average increase in terms of the share of stores that adopt the payment option would have risen by about half of the observed rate.

And what if the cash crunch had lasted only two weeks? The average adoption rate would have risen by about one-third of the observed rate, the team estimated.

However, a three-month cash crunch is still relatively short. So the fact that it prompted usage to spread quickly suggests that policy changes need not drag on forever. If the shock is dramatic enough, “it could be sufficient to have a relatively temporary intervention,” Mezzanotti says.

Risk of Usage Inequality

But there is a catch, the team cautions.

The model predicted that geographic areas would respond differently depending on how many people were already using the app there before the demonetization. Because of network effects, having a large existing base of users nearby should increase the chances that a customer or vendor would follow suit. The prediction was borne out in the data: if a place was close to a high-usage hub, e-payment growth tended to be higher than in a district farther away.

If a policy intervention is fairly short, it may widen differences in adoption rates, Crouzet says. Imagine you’re trying to get people in California (a high-tech hub) and Iowa to adopt Apple Pay. If a discount is only offered for a couple of weeks in both states, “you’re going to get a much larger long-run effect in California,” he says.

Whether this inequality is bad depends on the situation. If policymakers want citizens to start using a certain technology to pay taxes, they might prefer uniform use across the country. For other products, widespread adoption might not matter as much.

But variation in fintech use could lead to bigger disparities later. If the e-payment company in India expands its financial services, users might get easier access to other benefits such as assistance in learning how to save. Signing up is “probably a stepping-stone into participating in traditional financial services,” Crouzet says.

Fintech companies can also learn from the study. Considering network effects is “extremely important,” Mezzanotti says. When firms offer, say, a temporary discount to build their user base, they’re on the right track. But to figure out the best way to set up and scale the program, it is important to understand the network effects.

“At some point, the technology builds the critical mass to essentially be able to grow on its own,” Mezzanotti says. “They have to kick the can down the road, and then the can goes on by itself.”

About the Writer
Roberta Kwok is a freelance science writer based near Seattle.
About the Research
Crouzet, Nicolas, Apoorv Gupta, and Filippo Mezzanotti. 2019. “Shocks and Technology Adoption: Evidence from Electronic Payment Systems.” Working paper.

Read the original

Most Popular This Week
  1. Sitting Near a High-Performer Can Make You Better at Your Job
    “Spillover” from certain coworkers can boost our productivity—or jeopardize our employment.
    The spillover effect in offices impacts workers in close physical proximity.
  2. Will AI Kill Human Creativity?
    What Fake Drake tells us about what’s ahead.
    Rockstars await a job interview.
  3. Podcast: How to Discuss Poor Performance with Your Employee
    Giving negative feedback is not easy, but such critiques can be meaningful for both parties if you use the right roadmap. Get advice on this episode of The Insightful Leader.
  4. 2 Factors Will Determine How Much AI Transforms Our Economy
    They’ll also dictate how workers stand to fare.
    robot waiter serves couple in restaurant
  5. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  6. The Psychological Factor That Helps Shape Our Moral Decision-Making
    We all have a preferred motivation style. When that aligns with how we’re approaching a specific goal, it can impact how ethical we are in sticky situations.
    a person puts donuts into a bag next to a sign that reads "limit one"
  7. Will AI Eventually Replace Doctors?
    Maybe not entirely. But the doctor–patient relationship is likely to change dramatically.
    doctors offices in small nodules
  8. What’s at Stake in the Debt-Ceiling Standoff?
    Defaulting would be an unmitigated disaster, quickly felt by ordinary Americans.
    two groups of politicians negotiate while dangling upside down from the ceiling of a room
  9. How to Manage a Disengaged Employee—and Get Them Excited about Work Again
    Don’t give up on checked-out team members. Try these strategies instead.
    CEO cheering on team with pom-poms
  10. 5 Tips for Growing as a Leader without Burning Yourself Out
    A leadership coach and former CEO on how to take a holistic approach to your career.
    father picking up kids from school
  11. One Key to a Happy Marriage? A Joint Bank Account.
    Merging finances helps newlyweds align their financial goals and avoid scorekeeping.
    married couple standing at bank teller's window
  12. Why Do Some People Succeed after Failing, While Others Continue to Flounder?
    A new study dispels some of the mystery behind success after failure.
    Scientists build a staircase from paper
  13. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  14. What Went Wrong at AIG?
    Unpacking the insurance giant's collapse during the 2008 financial crisis.
    What went wrong during the AIG financial crisis?
  15. Daughters’ Math Scores Suffer When They Grow Up in a Family That’s Biased Towards Sons
    Parents, your children are taking their cues about gender roles from you.
    Parents' belief in traditional gender roles can affect daughters' math performance.
  16. Take 5: Research-Backed Tips for Scheduling Your Day
    Kellogg faculty offer ideas for working smarter and not harder.
    A to-do list with easy and hard tasks
  17. Leave My Brand Alone
    What happens when the brands we favor come under attack?
  18. The Second-Mover Advantage
    A primer on how late-entering companies can compete with pioneers.
  19. Take 5: Yikes! When Unintended Consequences Strike
    Good intentions don’t always mean good results. Here’s why humility, and a lot of monitoring, are so important when making big changes.
    People pass an e-cigarette billboard
More in Finance & Accounting