In January 2020, the government mandated that the Merchant Discount Rate (MDR) on UPI and RuPay debit card transactions be set to zero. This meant that when a payment was made using either of the two mechanisms, no charge was levied on the merchants for the transaction. A recent amendment has lifted this statutory prohibition, reversing a policy that has defined Indian digital payments for six years. While the zero-MDR mandate engineered unprecedented digital adoption, its reversal forces the ecosystem to finally confront the true cost of moving money.
The economics of the MDR
Consider a customer buying a toy. On the surface, money moves from her to the shopkeeper (merchant). Underneath, a message travels from her bank – call it Bank A, the issuer through a switching network such as UPI, to the merchant’s bank, Bank B, the acquirer, and then settles between them.
This movement is not free. The issuer bank has to authenticate the customer, bear the risk of fraud if the credentials are compromised, absorb the chargebacks if the transaction gets disputed, and provide customer service if the transaction goes wrong. The merchant’s bank (or the acquirer) has to bear the cost of providing a QR code and handling disputes from the merchant’s side. The network (such as Visa, Mastercard, UPI) runs the routing and the settlement. All these entities also run the fraud prevention infrastructure.
The question is who is best placed to bear the cost? There are effectively two realistic candidates.
The first is the merchant. In the world of cards, the merchant pays a fee, known as the MDR on every transaction. The bulk of this fee goes to the issuer bank, with the network and the acquirer bank getting the rest. Why was it in the merchant’s interest to accept this fee? Because it allowed the merchant to serve more customers. Earlier, the merchant was restricted to selling only to those carrying cash in their pockets, spending time, counting notes, finding change, and managing cash. Further, refusing a card could mean losing the sale outright. The margins lost on that sale were probably higher than the fee. The merchant was the entity capturing the most benefit from the transaction, and hence was the most suitable party to bear the cost.
The second is the government, which could choose to underwrite the costs because it is interested in formalising the economy and accelerating digitalisation.
How Zero MDR reshaped UPI
In 2016, when UPI came about, the MDR was permitted. This meant that the merchants would bear the cost in the same manner they did when payments were made through card networks. Like with the card network, the economics played out differently for different merchants in India: some micro-merchants opted out entirely to protect razor-thin margins, some passed the surcharge onto customers, while others absorbed it as the cost of doing business.
In 2019, the government of India set the MDR to zero through an amendment to the Payment and Settlement Systems (PSS) Act, which came into effect from 1 January 2020. This made UPI transactions cheaper than card payments and played an important role in the acceptance of QR-code-based UPI payments across the value chain – from vegetable vendors to five-star restaurants. Even those vendors who had shunned cards because of the MDR fee were happy to onboard UPI transactions.
But when the entity best placed to bear the cost does not, someone else has to. In the case of UPI, much of that cost fell on the issuer banks. The government compensated them through an annual incentive scheme, but the payments covered only a fraction of the actual cost and were decided afresh, budget to budget, making them difficult for banks to predict. With no reliable transaction revenue to offset these costs, UPI transactions were effectively loss-making for banks. Over time, the result was not surprising – banks began to underinvest in important functions like fraud monitoring and dispute resolution.
On the customer-facing side, Third-Party App Providers (TPAPs) with deep pockets and alternative revenue streams (like PhonePe or Google Pay) could afford to absorb operational losses to acquire users and data, resulting in just two players in the market today.
On the network side, zero MDR eliminated the possibility of a competitor challenging the National Payments Corporation of India (NPCI), resulting in an effective monopoly over the country’s payment infrastructure.
This is the legacy of zero-MDR: unprecedented financial inclusion, but at the cost of rising systemic fraud and severe market concentration.
Restoring economic reality
The recent announcement begins to reverse some of this. The Taxation and Other Laws (Amendment) Bill, 2026 removes the legal bar that prevented banks and payment service providers from levying MDR on notified payment modes. While the Union government retains the authority to designate fee-bearing channels, immediate pricing power now reverts to the NPCI’s steering committee.
One may sympathise with the government’s intention of wanting to increase digital payments. But any aspiration has to meet economic reality. If financial inclusion via free transactions was the ultimate goal, the government should have fully paid for the underlying infrastructure. By instead enforcing a blunt statutory ban, the state distorted the market. Unwinding this policy is a welcome correction. Depending on what pricing structure is adopted, commercial sanity may finally be restored to India’s digital payment rails, allowing the market to accurately price risk, fund critical infrastructure, and build a resilient payments ecosystem.
Renuka Sane is managing director at TrustBridge, which works on improving the rule of law for better economic outcomes for India. She tweets @resanering.
(Edited by Maryam Hassan)