The agenda didn’t seem anything out of the ordinary, said an executive who went to the meeting at New Delhi’s North Block. A discussion was expected on various banking sector issues, including strategies to popularize digital banking.
Everyone was in for a surprise.
Government officials at the meeting said that from January 2020, they would do away with payments merchants need to make for transactions using two of India’s home-grown payments systems: the unified payments interface, or UPI, and RuPay debit cards. The idea—place India’s digital payments story on steroids.
Until January 2020, merchants paid up to 0.9% of the transaction value as merchant discount rate (MDR) on RuPay debit cards and 0.3% for UPI transactions.
MDR is the charge paid by the merchant to the bank, card network and the point-of-sale provider for offline transactions and to the payment gateways for online purchases.
This policy, while benefiting merchants, would effectively disallow banks and payment companies from making money through MDR any longer. The RBI executives opposed the idea but to their surprise, bank officials present at the meeting didn’t utter a word—they nodded in agreement, said the executive cited earlier. They probably did not realize the costs they would incur when such transactions became free.
The RBI, nevertheless, persisted with its opposition to the free regime, requesting the government to re-introduce the fees after six months, citing harm to innovation and future investments.
Even after two years, the government isn’t in a mood to relent—it’s a battle the RBI fought and lost.
On 21 August, the ministry of finance tweeted: “UPI is a digital public good with immense convenience for the public & productivity gains for the economy. There is no consideration in Govt to levy any charges for UPI services. The concerns of the service providers for cost recovery have to be met through other means".
A second tweet added: “The Govt had provided financial support for #DigitalPayment ecosystem last year and has announced the same this year as well to encourage further adoption of #DigitalPayments and promotion of payment platforms that are economical and user-friendly".
The Indian government had announced it would pay ₹1,300 crore to reimburse banks in December last year for the costs they incurred in doing away with MDR. The payments industry, however, said the money is a pittance and should be at least four times that amount.
Responding to the tweets, Vishwas Patel, chairman of the Payments Council Of India, an industry body, said that “all the support money provided by the finance ministry has been appropriated by the banks only… none of the payment aggregators or facility provider received anything".
Whatever the case may be, the government’s position that a free regime would turbo charge digital payments stands validated. Between January 2020 and now, monthly UPI payments have near-quintupled, both in terms of value as well as volume. Since May, UPI has been processing transactions worth over ₹10 trillion every month. In comparison, Immediate Payment Service (IMPS), an instant interbank electronic fund transfer service, clocked payments worth ₹4.5 trillion in May.
The RBI did not respond to clarifications sought by Mint.
We will revisit and deep dive into the costs the banking system incurs. But first, here’s a bit of the backstory.
The backstory
Prior to July 2012, Indian merchants paid equal MDR for credit as well as debit card transactions. Then, the RBI pointed to an anomaly in equating the risk between the two kinds of cards. While debit cards were linked to bank accounts and had some certainty with regard to the payment, credit cards were a riskier and unsecured instrument.
The MDR on debit cards was next capped at 1% of the transaction value. This was revised for smaller transactions in December 2016, albeit temporarily following demonetization, and then again in December 2017 when it became more targeted, depending on the revenue of the seller of goods and services.
In his budget speech in February 2017, Arun Jaitley, the former finance minister, announced a target of 25 billion digital payment transactions in 2017-18. People aware of the matter said that this push laid the ground for abolishing MDR a couple of years down the line.
In her budget speech, in July 2019, finance minister Nirmala Sitharaman made it more specific. “There are low-cost digital modes of payment such as BHIM UPI, UPI-QR Code, Aadhaar Pay, certain debit cards, NEFT, RTGS, etc., which can be used to promote less cash economy. I, therefore, propose that the business establishments with annual turnover more than ₹50 crore shall offer such low-cost digital modes of payment to their customers and no charges or merchant discount rate shall be imposed on customers as well as merchants. RBI and banks will absorb these costs from the savings that will accrue to them on account of handling less cash as people move to these digital modes of payment," she said.
So, an MDR-free regime was in the offing—the RBI, bankers, and everyone else in the fintech ecosystem just didn’t know how soon.
The Finance Bill of 2019 introduced Section 269SU into the Income Tax Act, making it mandatory for every business with a turnover of more than ₹50 crore to provide the facility for accepting payments through “prescribed electronic modes". The government also amended the Payment and Settlement Systems Act, 2007, to prohibit banks or system providers from imposing any charge on a person making or receiving a payment by using the electronic modes of payment prescribed under Section 269SU of the Income-tax Act, 1961.
The costs
There is a perception that service providers do not incur any cost for UPI payments, experts said. While the cost is lower than when a debit or a credit card is used, it is not quite free since the retail payments umbrella body, the National Payments Corp. of India (NPCI), charges a switching fee. Besides, there are infrastructure costs.
“There are costs attached to these payment systems (UPI and RuPay). It is not funded by the RBI or the government. Banks and fintech players are splitting the costs at the moment. Given that sophisticated infrastructure is needed, it is an actual cost being incurred by the financial services ecosystem," said Jaikrishnan G., partner (financial services consulting) at Grant Thornton Bharat, an advisory firm.
For debit card payments—except for RuPay cards— MDR is capped at 0.9% of the transaction value. This is divided broadly among the issuing bank (whose card is being used), the acquiring bank (whose point-of-sale terminal is being used), and card networks such as Mastercard and Visa. On credit cards, MDR ranges between 2-3% of every transaction value and is somewhat similarly split between participants.
On UPI, MDR used to be capped at 0.3% of every transaction, or ₹100, whichever was lower, and was divided among the payer’s bank (someone purchasing using UPI), the payee bank (where the seller has his/her bank account), the QR code deploying fintech, and NPCI.
The total cost incurred to process a debit card transaction is 0.72% of the value, while for UPI it is lower, at 0.25%, as per estimates from the RBI.
The other cost in rolling out digital payments, apart from maintaining the infrastructure, is in acquiring merchants. This involves sending officials to various merchant establishments to help them onboard and ensure the know-your-customer (KYC) process.
The payments business has never been very profitable for banks but the lack of MDR has made it even harder now.
The fightback
There is no free lunch, and the RBI knows it well enough. The regulator believes that if a system has to be sustainable, it needs to make money, a person aware of the ongoing discussions with the government said. He did not want to be identified.
Apart from the central bank, different industry bodies have made representations—to the bureaucrats in the commerce department and the finance ministry.
Industry participants have been arguing that the free regime is pushing some fintech companies to pivot to alternative revenue generation channels. According to one industry executive, many fintechs have been turning to lending to survive. Often, they tie up with providers of ‘buy now pay later’ products, where even small value payments, such as groceries, can be made in a couple of instalments within a stipulated deadline. Such tie-ups could become a regulatory nightmare for the central bank—there’s a view some under-regulated products can increase risk in the system.
“It is almost like the licence era, where you would put certain cess and controls on global and private companies while government players would function freely. This time around, it is a quasi-licence era policy as you are discounting the MDR," Parijat Garg, an independent fintech expert, said.
Bankers present at the 2019 meeting with the government could have nodded in agreement but they are no longer in favour of a free regime.
In a submission to the Rajya Sabha’s standing committee on commerce, banks sought reintroduction of MDR on UPI transactions and a recast of various payment service fees. In fact, the committee, in its report tabled on 21 July, suggested a relook at MDR on UPI transactions and the overall structure of payment service provider fees, given that financial transactions through UPI are expected to increase further.
Following the parliamentary committee report, the buzz around bringing back MDR gained momentum. But the tweets from the ministry of finance on 21 August have poured cold water on the idea.
The RuPay resistance
While the free regime has super-charged UPI transactions, it has had serious consequences on RuPay debit card issuances.
Introduced in 2012 by the NPCI, RuPay was positioned as India’s answer to global card networks—Visa and Mastercard. As of 30 November 2020, banks had issued 603.6 million RuPay cards. This was largely driven by a government scheme on financial inclusion. Experts said that there has been a steady decline in banks issuing new RuPay cards after the zero-MDR regime kicked in.
Banks have now slowed issuing new RuPay cards to financial inclusion beneficiaries. According to public data on the government’s flagship financial inclusion programme, the Pradhan Mantri Jan Dhan Yojana, the number of RuPay debit cards issued—the only available option for these accounts—trails the number of accounts opened.
While the total number of RuPay cards trailed aggregate Jan Dhan accounts by about 80 million on 1 January 2020, the gap has widened to 142 million as on 3 August this year. Ideally, every account should have one RuPay debit card.
Experts pointed out that while state-owned banks cannot stop issuing RuPay debit cards because of the push from their promoter, private banks are quite reluctant to let go of revenue.
The payments industry sees potential in RuPay, but believes it must be freed from the clutches of the zero MDR policy. Even when MDR is allowed, the RuPay scheme will take time to succeed because of the head start Mastercard and Visa have.
“It will take at least another five years for RuPay to make it big as the acceptance infrastructure needs to be built around it," said Jaikrishnan of Grant Thornton Bharat.
But the larger question lingers: What could the government do, going ahead?
Some opine that the government could use its goods and services tax (GST) database to exempt some merchants—the smaller ones—from MDR, while mandating it for the rest.
“The government could explore the model they used to do away with gas cylinder subsidies. This would be beneficial to the system as a whole because banks and payment companies would not have a blanket ban on collecting MDR," Naveen Surya, chairman of the Fintech Convergence Council, and chairman emeritus of the Payments Council of India, said.
