The crucial question no one is asking about MDR on UPI transactions
As soon as the MDR news flashed, the champions of socialism and capitalism raced to express their opinion on the decision. Primary arguments were:
“It has been costing our government a fortune. They cannot subsidize the system till eternity. At some point of time the torch has to be passed on to the consumers.”
“Our dear government is already blindly funding revdi schemes. The size of subsidy is peanuts compared to the size of spend on useless welfare schemes. Is our government willing to sabotage the only piece of technology that is working in our favor?”
“People will start shifting to cash…”
“The charge is only on merchants not consumers…”
“The charge trickles down to consumers with increased cost…”
With all these debate points I was hoping some sane voices will ask the right question! From where did the government pull 0.4% out of? Every time the government comes up with a number like this I roll my eyes and imagine a conversation among the elected office bearers and the bureaucrats:
Bureaucrats: “Sir if we levy a 0.3% charge on transactions, we can overcome the subsidy bill we are footing.”
“And 67% of the total value transactions are the transactions above rs. 2000. So if we slightly increase the charge and only bill the merchant transactions above 2000, we can recover most of our money.”
Nirmala ji and Modi ji: “Go ahead as you please!”
What is the economic basis for 0.4%? Why not 0.2%? Why not 50%? Why not 500%? Why not zero?
To understand why 0.4% is ridiculous we need to look at the list of stakeholders in the transaction. (Any number that government comes up between 0 to infinity is ridiculous as a matter of fact).
There are four primary stakeholders in the MDR transaction.
- Issuing bank: Account holder bank like HDFC, SBI, etc.
- Acquiring bank: Merchants that provide QR like Bharat Pe, Paytm Payment bank, HDFC Merchant, Axis etc.
- TPAP: Apps provider like Google pay, phone pe, etc.
- Payer PSP (Payment Service Provider): UPI Backend infrastructure provider like AXIS, HDFC, ICICI (provides UPI ID like etc.)
It doesn’t take a genius to observe that all the stakeholders are competitors in a free market, consumers are their customers and there is a interdependent financial ecosystem not just limited to UPI transactions. In this efficient market, why should the government be performing this price discovery at all? And it becomes even stranger when the regulatory structure also determines how the MDR revenue should be divided among different participants.
The government has no job in deciding what the consumer must pay. Markets will decide who will pay what. Each participant has the right to decide what they can charge. Eventual competition will ensure a much lower cost and will be more efficient for the consumers.
If that statement alone is not satisfying, let me help you with a dry run what will happen if the cost of transactions were to be left to the market.
- The issuing bank wants your banking relationship.
- The acquiring institution wants the merchant relationship.
- The payment app wants your transactions, engagement and data because those relationships may later allow it to distribute loans, insurance, investments and other financial products.
- The PSP bank wants transaction volume, customer relationships and a stronger position within the financial ecosystem.
All four components have an incentive to absorb the cost in return of the potential additional business they get. Loans, Credit, Investments and countless other instruments can be sold to the consumers.
Therefore, every participant has an economic incentive to absorb at least some part of the transaction cost if doing so helps it acquire more profitable business elsewhere.
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Servers cost money.
Cybersecurity costs money.
Fraud prevention, Technology teams, Customer support and Banking infrastructure costs money.
The argument is not that these costs magically disappear.
The argument is that the explicit price charged for the transaction itself could naturally move towards zero because competing firms may prefer to recover those costs from the broader customer relationship.
That distinction is extremely important.
Moreover, even in situations where market decides to put a higher price than 0.4% it is not a wise decision to fix prices and an incentive structure on the participant entities. The technology is always evolving, financial markets get more efficient day by day and every financial entity is after your liquidity to squeeze out every arbitrage opportunity they get. It is only natural that there is a high tendancy over some time that the price may converge to near zero!
Suppose processing a customer’s UPI transactions costs a bank ₹100 over a certain period.
The bank may still happily charge that customer ₹0 for UPI because the same customer generates ₹5,000 of profit through a home loan, credit card, current account, wealth product or some other financial service.
For the bank, the relevant equation is not necessarily:
UPI revenue > UPI cost
It may instead be:
Total lifetime value of customer > Total cost of acquiring and servicing customer
UPI can simply become part of the customer-acquisition cost.
What happens when you fix structures?
What happens when a new App provider with a sleek and optimized technology enters the market? What happens when a more efficient bank comes up with a net reduced cost strategy? What happens when merchants come up with better selling strategy? In free markets the latest competitor gets the benefit of acquiring more customers through reduced prices, as price-demand elasticity works in their favor. Now since the prices are fixed, consumers don’t move, innovation isn’t rewarded and the innovator cannot compete with pre-existing giants.
With rigid structures like these there is no wiggle room for anyone to experiment and innovate. Fixing prices creates Oligopolies (Monopolies/Duopolies in worst cases). It fixes incentives which results in destruction of competition. These structures do not evolve with evolving situations. They will get buried in a pool of arbitrary numbers like 5%, 18%, 12.5%, 20%, 30% etc.
The most interesting question in the entire MDR debate is not:
“Should merchants pay 0.4%?”
or
“Should the government continue subsidising UPI forever?”
The more fundamental question is:
Why is the government determining the price at all?
If the subsidy has become unsustainable, withdraw the subsidy. Make the actual economic costs transparent. Maintain inter-operability and competition. Let banks, acquirers, fintech companies, payment apps and merchants negotiate among themselves. Perhaps the resulting market price will be 0.4%. Perhaps it will be 0.2%. Perhaps some companies will charge ₹5 per transaction. Perhaps others will charge nothing because they make their money elsewhere.
That is precisely the point.
Nobody sitting in an office should decide the “correct” price beforehand.
The market discovers it. State deciding the prices creates more problems than it solves. Read this post by Nithin Kamath: Post
Each sector comes with its unique challenges. It is better that each one of them deals with their own problems instead of a higher entity forcing down a cost upon them.
