By Monisha Purwar
Over the last 5 years, digital payments in India have seen a steep increase from 2071 crore transactions in FY 2017-18 to 8,193 crore transactions in FY 2021-22 (till March 2022). According to an estimate by Boston Consulting Group, as of June 2022 digital payments constituted about 40% of all payment transactions in India and it is estimated that by 2026 around 67 % i.e., every 2 out of every 3 payment transactions will be digital. Amongst all modes of online payments, UPI has shown the steepest adoption rate amongst consumers.
Since 2020, the number of UPI transactions has been doubling year on year, clocking 14.55 billion transactions in Q1 of 2022 with UPI Peer to Merchant (P2M) transactions having a market share of 64% by volume and 50% by value. Its ubiquity amongst smartphone users makes it the closest replacement to cash in terms of ease and scale. UPI offers a very convenient design to make online transfers, both for payers as well as merchants, unlike net banking and credit/ debit cards that require entering multiple data points like bank account details, login credentials or card numbers to complete a transaction.
Moreover, the Government has mandated a zero-MDR framework for UPI since 2020, which means that charges for UPI are nil for its users and merchants alike, further increasing its market share vis-a-vis other payment modes that carry a charge. Attempts by banks to charge users for UPI Peer to Peer (P2P) transactions upon reaching a certain threshold limit have also been thwarted by the Central Board of Direct Tax in the past.
MDR or Merchant Discount Rate is a fee charged by the bank to the merchant for facilitating an online transaction. This fee is capped at 0.9% of transaction value for payment methods other than credit cards. Acquiring banks share MDR with other players facilitating a transaction such as Payment Service Providers (PSPs) and the issuer’s bank. The Reserve Bank of India (RBI), in its Discussion Paper on Charges in Payment Systems released recently, sought feedback on the fee structure of a range of digital payment services. Its feedback questions for reintroducing MDR charges for UPI payments caught quite a public stir which was quickly placated by the Finance Ministry’s assurance that UPI being a public good, the cost recovery concerns of the service providers shall be met by other means.
Also read: RBI wants stakeholders’ feedback on UPI MDR
Earlier, in 2020, while announcing zero-MDR on UPI, the finance minister had stated that RBI and banks will absorb costs of zero-MDR from the savings that will accrue to them on account of handling less cash as people move to these digital modes of payment. Details of any such arrangement between the RBI and the Government are unknown but the Government has been making budgetary allocations every year to incentivise banks and PSPs to grow their UPI user base. However, these incentives do not cover the operational cost of banks and PSPs.
The Committee on Deepening Digital Payments constituted by RBI in 2019 under the chairmanship of Shri Nandan Nilekani had opined that a viable UPI ecosystem requires that market forces dictate the transaction pricing and regulators should let the market compete on MDR and only regulate the interchange rate. With RBI’s Discussion Paper bringing the issue of zero-MDR to the fore, an analysis of the “public good” metric of the Government as well as UPI’s cost-related implications on market players within and outside the UPI ecosystem is overdue, to map the ideal way forward for the market.
Cost to the market and the Government subsidies
The UPI apps market is dominated by Google Pay, Phonepe and PayTM with over ~90% market share, but despite their massive market share, their revenue model for purely UPI-based payments services is unsustainable. The Payment Council of India- the largest industry body for digital payment aggregators, seeking a roll-back of zero-MDR discount rate, in January, 2022 announced that the payments industry expects a loss of Rs 5,500 crores due to zero MDR. In absence of public visibility of NPCI’s circulars on the structure of Switching Fees, PSP Fees and Interchange Fees levied on banks and UPI apps for transactions, the exact losses suffered by UPI apps and banks on UPI transactions cannot be estimated.
According to RBI’s Discussion Paper, the collective cost borne by all stakeholders for a Peer to Merchant (P2M) UPI transaction ticket-valued at Rs 800 is roughly Rs. 2 i.e., ~0.25% of transaction value. Added to this is the unknown cost of UPI P2P transactions on the system. The value of all UPI transactions in FY 2021-22 was ~ Rs 84 lakh crores, according to data from NPCI. Even if we assume the overall cost percentage for all UPI transactions to be as less as 0.1 % of transaction value, the total cost will still be ~8400 crores. Against this, the allocated Government incentives tuning to ~1300 crores for FY 2021-22 are minuscule. The Government only offers incentives on UPI P2M transactions of ticket size less than Rs 2,000 leaving out all other transactions. In July, 2022, these transactions constituted about 7% of the total UPI transactions by value.
In absence of a system where the costs incurred by the system are reasonably passed on to merchants or subsidized, UPI payments alone do not make a profitable business model. Vishwas Patel, Chairman of the Payments Council of India has also alleged that UPI apps have not been receiving any Government incentives and that the entire incentive amount is being appropriated by banks. This is contrary to the text of the incentive scheme of the Government for FY 2021-22 which provides that incentives received by acquiring banks are to be shared amongst UPI providers and issuer banks. At present, UPI apps are relying on diversification of their business model such as facilitating other payment methods and services on their apps to be profitable in the long run. But UPI’s core model of payments makes it an unsustainable business for small players who do not have other means of revenue like the big players, resulting in skewed competition and innovation in the sector.
Pricing or subsidy for the “Digital Public Good”
Going cashless has economy-wide benefits and UPI is our best bet to achieve that. Despite a meteoric rise, UPI still has a long way to go to replace cash and penetrate the rural and semi-urban areas. According to research by 1Bridge, only 3-7% of rural consumers are actively using UPI, with many even unaware of its existence. Bringing the rural masses to adopt digital payments can lead to productivity gains for the economy far outweighing the costs of a free UPI, so from the digital public good perspective, it is probably not the right time to levy charges on UPI for merchants or consumers. But for UPI enablers like PSPs and banks, a revenue model that meets their operational costs and offers them the width to invest in new technologies and upgrade their systems is the bare minimum for sustainability.
Rising UPI transactions also need to be matched by a robust scaling of the current systems, and banks and PSPs might not have the incentive to invest further in their UPI infrastructures in absence of revenue clarity from the stream. The Technical Decline rate of SBI for UPI transactions was 5.06% in June 2022. A fluctuating rate of technical declines by banks can lead to a loss of trust amongst consumers. In times when consumers are rapidly transforming their digital spending habits and showing complete reliance on UPI over cash use, a lack of seamless transacting can be a major pushback to the growing digital adoption trend.
What the UPI ecosystem needs is a balancing act between digital payments growth and incentivizing of the system. One way to strike this balance is by re-introducing MDR as a revenue stream for the banks and PSPs and also subsidising it for merchants to ensure that they incur no charges. But using taxpayers’ money to subsidize the costs for big merchants like Flipkart and Amazon serves zero welfare and can be avoided.
Protecting the interests of smaller merchants and encouraging small-value transactions should be paramount to any future policy on UPI. If MDR is levied on all merchants, then the major target of the digital inclusion drive of UPI – small merchants who deal with petty cash daily – will not accept digital payments. Here, a tiered structure for charges based on merchant size might be a good way to go forward. Size assessment of small merchants can be linked to the aggregate value of their UPI transactions.
On the question of regulation of MDR by the Government, there is no downfall in leaving the determination of MDR to the market forces as long as the Government secures these charges from monopolistic trends. For this, RBI may cap MDR and also lay down clear standards for its cost-based calculation by banks. With the linkage of Rupay credit cards to UPI, the launch of the UPI Autopay feature, and the enablement of UPI for feature phones, UPI is set to achieve monumental growth in the future. Promoting digital adoption, ensuring an optimal revenue stream for intermediaries, securing the interests of small merchants, and helping laymen with a transparent picture of charges to be paid by them are ideal considerations going forward.
(The author is a Delhi-based lawyer who consults on fintech policy. Views are personal.)