The Incentive Problem with MDR
Banks want MDR (merchant discount rate) reinstated for RuPay and UPI transactions. The only problem — Most people still don’t fully understand the issue. So in today’s Finshots, we discuss MDR, its abolition and more.
The Story
Think of MDR as a charge on the total transaction value when you buy something using a credit/debit card. It usually tallies up to 1-3% and it is perhaps best illustrated using an example. Let’s suppose you buy a box of chocolates for ₹100. You don’t have cash on you. So you decide to pay using your SBI debit card. This sets off an elaborate tango that involves multiple stakeholders. The moment you swipe your card, the store owner’s bank will receive the transaction information associated with your purchase. The bank will now have to verify with SBI if you’ve got enough money to pay for the purchase. And they’ll also have to see if all your information checks out.
However, they can’t do it on their own. Instead, they’ll have to rely on a payment network operated by Visa, Mastercard or RuPay. Once these guys enter the fray, they’ll relay the information to SBI and after everything checks out, the money will finally be credited to the store owner’s account. That is after everyone has taken their cut. Your bank will take a small piece of the pie. The merchant’s bank will take its cut and the likes of Visa and Mastercard will take their share. And the store owner will only receive what’s left. In essence, if the MDR stood at 1%, he will receive ₹99 from your purchase.
But here’s the problem. For a government that is trying to push the digital payments initiative, this is a bottleneck. Remember, if the merchant is facilitating a digital transaction, he loses the ₹1 and he will be more inclined to simply accept payment in cash. So in a bid to encourage people to adopt digital payments the Finance Ministry simply decided to waive MDR on all transactions made through UPI and RuPay debit cards in 2019.
And while you could argue that this did, in fact, promote digital payments, it also did something else. Remember, the banks still have to process digital transactions. They still have to do the tango. The only difference — They have to bear the cost themselves. So they did the only thing they could. They lobbied. The Indian Banks’ Association (IBA) sought compensation to the tune of ₹2000 crore a year, to run the RuPay/UPI infrastructure. They wanted to make up for the lost revenue through MDR. The finance ministry however politely declined. Their contention was simple.
They believed the promotion of digital transactions would allow banks to save money elsewhere. For instance, the ministry estimated that banks could save up to ₹21,000 crores from not having to handle and process cash. They asserted that this money could easily help banks operate the digital ecosystem supporting UPI. But soon enough, cracks began to appear.
The banks lobbied once again. This time they wanted a waiver. A waiver of the PSP fee. Now bear in mind we haven’t yet discussed third party app providers. These are intermediaries in the digital ecosystem that also help facilitate UPI and RuPay transactions. Think Google Pay. And while most of them are loss-making as it stands, they did levy a small charge on banks (called the PSP fee) for helping them process digital transactions. But since banks were already cracking under the pressure, they wanted the PSP fee waived off as well. And once that happened, more players in the digital ecosystem had to suffer.
Meanwhile, banks were also becoming increasingly reluctant to issue new RuPay cards. After all, processing a RuPay card transaction had no upside. They simply had no incentive. So they went slow and pushed it on the backburner. Customers also reported frequent failures with these indigenous cards and the banks now contest that this problem will likely persist unless MDR charges are reinstated.
And that’s why the IBA and payment forums recently approached the government to reverse its stand on MDR. As reported in an Economic Times article—
“While the aim was to promote digital payments, the financial inclusion agenda has taken a severe beating; as part of the budget consultation process a representation has been made to the finance ministry to bring back MDR on RuPay cards”—An industry executive
So we will just have to wait and see what happens.
Until next time…