On 17 August 2022, the Reserve Bank of India released a discussion paper on charges in payment systems. It sought feedback on charges levied on transactions using payment instruments such as credit and debit cards, as well as the Unified Payments Interface (UPI). The focus on UPI, which is cross-subsidised by the exchequer as part of a high-visibility digital adoption initiative of the government, drew a lot of eyeballs. Therefore the Ministry of Finance was quick to clarify that UPI is a digital public good and would continue to remain free of any charges.
In just over five years, this fast payment system has made India an undisputed leader in digital payments. Digital payment volumes in India are 3X that of the nearest competitor – China, and roughly two out of every three digital payments in India are made through UPI. There are several reasons behind this growth. As an open network, UPI forms the bedrock of several innovative fintech products. High smartphone adoption, low data charges, and pandemic-accelerated digitisation are other factors.
The Indian government has implemented a zero-charge regime to encourage the adoption of UPI. However, banks and payment intermediaries alike have questioned the sustainability of such a regime. Recently, the Parliamentary Standing Committee on Finance in its report highlighted the need to relook the current practice of zero-charge.
Paying for our payments
UPI enables instant payments. Payments flow from one bank account to another bank account via the National Payments Corporation of India (NPCI) platform. Payment intermediaries (like PhonePe and PayTM) play a key role in offering seamless payment experiences to consumers and helping sellers set up digital payment acceptance solutions.
Each bank and payment intermediary, apart from the NPCI itself, incurs expenses to grow, and keep the UPI network up and running. The RBI estimates that these network enablers spend about Rs two each time an online shopper spends approximately Rs 800 through UPI.
Imagine the back-end tech infrastructure of a payment system as a digital highway. The operators of such tech infrastructure typically exact a highway toll over the payments that pass through. As with physical highways, the toll ensures that the tech infrastructure is maintained and periodically upgraded. Since online sellers rely on these digital highways for their business, the highway toll –merchant discount rate (MDR) in case of digital payments – is typically collected from them, and distributed among the network enablers. MDR is imposed on various payment instruments around the world.
Budgeting for upkeep
Now if a physical highway were to waive all tolls, it would likely see a concentration of traffic, and would hence need more upkeep. Similarly, if MDR is zero for a particular mode of digital payment, both users and sellers would be incentivised to adopt it over other modes. However, those who operate the back-end tech infrastructure would get squeezed as transaction volumes and running costs would rise in the absence of any revenue generation. This is exactly what is happening with UPI.
As per the Finance (No. 2) Act of 2019, UPI network enablers are prohibited from imposing any charges, including MDR, over UPI transactions after 1 January 2020. To support costs incurred by the digital payments ecosystem, the central government earmarked Rs 1,500 crore in the 2021-22 budget, which was disbursed through a Rs 1,300 crore reimbursement scheme. This financial support has been continued for FY 2022-23. No other comparable jurisdiction adopts a similar zero MDR framework.
The reimbursement scheme was designed to incentivise banks to accept low-value (up to Rs 2000) UPI payments. Banks can claim a percentage of each transaction on a quarterly basis. However, industry bodies argue that the UPI ecosystem needs about 4X the current annual allocation.
Need to revisit the zero–toll framework
As traffic builds on the highway and UPI volumes rise, the gap between the operational costs incurred and budgetary support received widens. To put this in context, UPI payment volumes have risen ~ 5X since 1 January 2020. UPI clocked over 12 billion payments over the last 2 months alone, which is roughly 1.2X the total UPI payments in all of 2019.
From a long-term growth perspective, a serious rethink of the zero-toll framework is necessary not only for recouping infrastructure running and merchant acquisition (i.e. the setup costs in enabling a seller to go digital through UPI) costs, but also for ensuring that investments in fraud monitoring, security, and error handling mechanisms are done.
Technical glitches and failures are indeed an ongoing problem for the UPI ecosystem. Experts identify the limited load-handling capacity of back-end systems, particularly during peak hour traffic, as a probable cause here. The absence of a revenue stream directly affects the ability of UPI ecosystem enablers to upgrade this infrastructure. A zero MDR framework distorts incentive structures for highway upkeep, and can ultimately hamper the growth of the payments industry. Expert committees chaired by Ratan Watal and Nandan Nilekani have each recommended that MDR should be market-driven to enable ecosystem growth.
The government may explore a tiered approach to introducing MDR on UPI transactions. Under such an approach, it can consider introducing charges on transactions above Rs 2,000. The scope of such charges can also be limited to certain categories of critical public needs such as mutual funds, petroleum products, and debt collection. This can ensure that small merchants are not discouraged from offering UPI payment options and India moves towards the Prime Minister’s goal of ‘ease of living’. Simultaneously, differentiated charges will allow market participants to recoup costs and continually upgrade quality of service.
The authors work at Koan Advisory Group, a technology policy consulting firm in New Delhi. Views are personal.
This article is part of ThePrint-Koan Advisory series that analyses emerging policies, laws and regulations in India’s technology sector. Read all the articles here.