Two Sided Payments - The Fundamentals

Why should you care reading this?

You should read this if the goal is to start a platform such as,

• Online Marketplace

• Ad network

• P2P lending

• Ticket Booking Platform

• Crowd Sourcing

• Vendor Payments Platform

• Hotel Management (Payments Included)

Who is this for? For people who find payments solutions intimidating. Platforms, products, Saas, which gives information, connects people, share messages, etc., are all great. And, when it comes to real world problems which involves quite more than just tech, there's a good amount of time a person needs to understand the infra working behind-the-scenes, making services seem buttery.

The content is for the techies and whoever wants to learn. This article has depth and cannot be skimmed quick. Make sure you go thoroughly. Every particular element in play is explained quite well with reasoning.

Concept

The idea is simple, at-least: -

• You create a platform

• There are two people, one who sends money and one who receives money.

• The payment is made through your platform

Sounds great, doesn't it?

Example

Let's consider an example of an event booking platform, Planet (it's a made-up thing). Planet needs two kinds of customers, the organizers and the audience.

1. A person (audience) who wants to purchase a ticket, goes to Planet's website or app. Selects a show, pays for a ticket.

2. The payment reaches the organizers bank account somehow magically.

I'll be detailing this magic in a great detail. I'll try my best to detail every aspect that's involved. Plus, I've listed all the reasoning as well.

Important Terms and Things to know

1. Types of Accounts

2. Current and Escrow Account

3. Payment Gateways

4. Payment Aggregator

Types of Accounts

1. Savings Account - This is a bank account on which banks give interest. Dump your money and see it rising paisa by paisa (penny). It's the most used account. People generally use to get their salaries.

2. Current Account - This is the Holy Grail for businesses. It's a type of account which is meant purposefully for businesses. No interest is given on the money sitting here.

3. Escrow Account - This is a kind of account which is only handled and operated by banks and entities with Payment Aggregator License. A person cannot use it. It's a special one, different from the everyday savings or checking account.

It is a secure account which is operated by a neutral party, generally banks. These accounts are meant to accept funds and hold funds before they are sent to the beneficiaries. We'll discuss more on the use of Escrow Accounts below.

Payment Gateways and Aggregators

A Payment Gateway (PG), in simple terms, is service that enables businesses (registered and non-registered both) accept online payments. These are companies or entities which primarily provides the technology to facilitate online payments.

A Payment Aggregator (PA) is a company or entity that actually is involved in handling funds from the customer and settling them to the merchants. Both banks and non-banks can act as a PA, where a non-banking entity would require a PA license. Banks don't require it because they already have a banking license.

We're done with the terms. Now, let's dive deeper into the ocean where all these entities will come into play.

Most important points

• Remember the Planet's example discussed above.

• It needs to be a registered company.

• It should have a current account in the company's name

How the money flows?

If you think money settlements happen in real time, possibly because you use UPI! The larger ecosystem of payments where-in payments made to businesses do not happen in real time. Please don't consider the UPI Merchant thing, that's a whole different story to write an article on.

1. Customer pays: The customer goes to Planet's website or app. Pays for the ticket which costs ₹400.

Deeper info:
Since Planet will be handling the funds as intermediary i.e., collecting money from the customer and disbursing to the event organizer, this kind of activity falls under RBI's supervision. According to which, an entity involved in such activity is required to get a Payment Aggregator (PA) license from the RBI.

Getting a PA License is a huge capital-intensive undertaking. Along with a long list of compliances to adhere with. Hence, it's a common approach for small startups like Planet to partner with a licensed PA (like Razorpay, Cashfree Payments, Paytm PG, PayU, etc.) who also have an Escrow Account infrastructure.

Planet has integrated with a PG and implemented their Payment Collection APIs on the checkout. This way they will be able to accept money. Generally, PGs have a PA license.

2. Money enters Escrow Account: The PG (with a PA license) verifies the payment method (UPI, card, net banking or wallet). The money is deducted from customer's account and is received in the Escrow Account of Planet. PAs are legally the ones holding the account and managing the funds on Planet's behalf.

Deeper info:
Money parked in these accounts cannot be used for any company or personal usage. It's meant to be sent to the real beneficiary, in this case, the event organizers. Money settlements do not happen in real-time; it generally takes T+1, T+2, or T+3 business days. Now, why is that? There are a number of low-level complexities which come into play, let's have that conversation another time.

Some banks and payment providers offer Same Day Settlements (SDS) too but that comes with a caveat. They charge a nominal extra fee for this service which keeps the merchants happy.

3. PG Commision: PG requires to earn right! So, it charges commission on the amount paid by the customer.

Deeper info:
Till now, the customer has paid, fund has entered the escrow account. When's the PG getting its share? When the settlement day comes, the money needs to be sent to the beneficiaries. When these payouts processed, PGs deduct their commission.

In India, the commission charged is around 1.95% to 2%. Companies may get a better deal (lower commissions) if they have high volume transactions. In simple terms, they get volume discounts.

Let's come to our example of Planet.
The customer pays: ₹400
Money received by PG: ₹400
Commission Rate: 2%
Commission Amount: 2% of ₹400 = ₹8
Amount sent to beneficiary: ₹400 - ₹8 = ₹392

4. Payouts: Payouts in itself is a big deal, it simply means the money is disbursed. On the day of settlement PG deducts its fees and the amount is sent to the beneficiaries.

Deeper info:
There are companies just to solve for the payouts. Don't worry, PGs have a solution for payouts too. Planet or companies need to implement an excellent reconciliation mechanism. Which means they need to implement a solid backend which records the incoming customer payments with the outgoing merchant payouts along with the accurate merchant info.

Why is reconciliation required? Planet has got a decent business; thousands of people buy tickets on the platform. A lot of funds accumulate in its account. How will it know which customer has paid to which organizer and what amount? So, a mechanism is required in-place to track these, called reconciliation.

Interesting Scenario (Zomato)

Zomato is a huge food delivery business based in India. It's a big company, it's obvious to have multiple modes of revenue. Here, we will be discussing about its Platform Fee, i.e., ₹10 as of now. When paying for an order, it charges this amount along with a bunch of other fees.

How does this amount reach Zomato's account?
This is a situation when there are multiple beneficiaries, PG and Zomato both. PG will receive its PG Fees and Zomato will receive its Platform Fees (PF).

There are two primary methods to implement this fee deduction

A) Split Settlements - Many modern PGs offer this method for specific solutions like these. Remember, funds in Escrow Account never reaches savings or current account! Funds are automatically split based on the set configurations and payouts are made. Near to no intervention needed (except for critical times).

• Customer pays ₹400 to Zomato

• PG receives ₹400 in its Escrow Account

• During settlements, PG deducts its own fees

  • Let's say it is 2%

  • PG Fees deducted (2% * 400) ₹8

  • Amount left ₹392

• Zomato's PF is also deducted in this step

  • It depends on Zomato, the kind of configuration they have put in place. They could have implemented direct deduction of ₹10 from the original amount paid (₹400).

  • After the PG Fee is deducted, Zomato's PF is deducted as well and sent to its current account.

  • Amount After PG Fee ₹392

  • Amount sent to Zomato is ₹10

  • Amount after deduction ₹382

  • ₹382 is sent to the restaurant/merchant

  Note: In reality there are a number of beneficiaries like PG, Zomato, Delivery Guys, Coupon Providers (in some cases).

B) Receive the gross amount after PG Fee deduction - Unlikely scenario and probably not legally allowed by RBI. So, we won't discuss this.

If there is some error or if you think I've explained something wrong, please mention them. Thank you for reading this.