Among the many public policy options available to the state (do nothing, indulge in rhetoric, do very little etc), my favourite is the ban. Afterall, who in India doesn’t like a bit of banned-baaja at above 45 dB (that’s the permissible noise limit set by the state for residential areas at night). So, my heart did the Wordsworth-ian leap up when I beheld the news report that the Government has banned the MDR (Merchant Discount Rate) charges for transactions through homegrown RuPay and UPI platforms. Further, I read breathlessly, the Government through the Department of Revenue will make it mandatory for all companies with more than Rs 50 Crs in annual sales to provide for the facility of payment through RuPay debit card and UPI QR code to their customers. This was to be done within 30 days of the notification failing which a fine of Rs 5000 per day will be charged on these companies. A ban and a good fine all in a single elegant move!
For those of you who share with me a literary bent of mind, I have provided the text of Section 10A of the Payment and Settlement Systems Act 2007 which came into effect on January 1, 2020 on payments made through RuPay debit cards or BHIM-UPI. This is how the lyrical provision reads:
“Notwithstanding anything contained in this Act, no bank or system provider shall impose any charge upon anyone, either directly or indirectly, for using the electronic modes of payment prescribed under section 269SU of the Income-tax Act, 1961.”
Let me back up a bit and give you, dear reader, a quick run through of how cash and payments work. First thing you must know is payment is the highest used financial transaction. You earn money in (hopefully) big, chunky transactions (salary, bonuses, payouts for trolling etc) and you spend them in a multitude of transactions of varying value. Now, the traditional method of payment in India was cash. Cash has many advantages – you settle the transaction immediately, it leaves no trail so your privacy is protected (useful for blackmailers, of course but also for ordinary reticent people like me) and it doesn’t require any investment in a device or tool to use it except a wallet.
However, it has its drawbacks. It is costly to print cash, to manage its circulation and to reconcile it in a country as large as ours. Rough estimates indicate it could be costing the RBI as much as Rs 26,000 Crs to run the cash economy. Also, cash is often used to evade taxes and avoid formal accounting trail (do number ka khata) by businesses leading to loss of revenues for the Government. Besides, cash has other transaction costs – of carrying it, of having the right denomination to transact (the bhai saab, chhuttey hain kya, problem of India) and safety issues (the famous India public service message – beware of pickpockets). You can’t blame any government to encourage digital transactions over cash. Having said this, beyond a point, the government shouldn’t intervene to tilt the balance away from cash. The question is whether a ban on a charge the right policy intervention to support digital payments. Let’s figure this out for ourselves.
Now, what happens when you go to a shop (also called a Merchant) and purchase that slim-fit shirt that’s not meant for you using your debit card from a bank which we will call the Issuing Bank. You will notice there’s a POS (point of sale) machine that’s used to swipe your card. This POS machine is often provided by a Bank (let’s call it the Acquiring Bank) or a payment service provider (or Aggregator) and its installation, maintenance, the paper roll etc is provided by that provider. This is a real cost. India has over 65 million merchant establishments and only 4 million have a POS machine. These 4 million have been provided by these Banks or these providers to these merchants without any charge. Once you swipe and you authenticate yourself, the transaction is successful, and you are invoiced.
Here’s what happens in the background. The information that you have done an authentic transaction will mean the Issuing Bank will be debited that amount and it will go to the Acquiring Bank’s or Aggregator’s nodal account. This is like a central account and then the Acquiring Bank or Aggregator will transfer that information to a Merchant Account that’s with the Bank or the Aggregator. Once this information is with the Merchant Account, the Merchant receives the information that the money has reached them from that transaction. All of this happens in real time in terms of information flow. There are payment networks like Visa, Mastercard and the homegrown RuPay that facilitate this information flow. The actual money transfer happens over the next 2-3 days and the Merchant receives the money in their Bank Account.
This whole process requires physical and technology infrastructure, network, authentication services, security, multiple players who specialise in different parts of this chain and atleast 2 banks (Issuing and Acquiring Banks) involved who transfer money among themselves at a rate called Interchange rates. Plus, there are other costs in case there are wrong transactions, refunds or chargebacks etc. In India, we decided a few years back, the cost of these transactions as a charge can’t be levied on the customer. So, the Acquiring Bank (or an Aggregator working on its behalf) started charging a fee to the Merchant called the Merchant Discount Rate (MDR) for all the services it provides. Typically, it ranged between 1-3% for a transaction. The Merchants were fine with it since it reduced the ‘friction’ in dealing with customer, reduced their cash carrying costs, improved security and brought down cash pilferage. Of course, there were merchants who wouldn’t want to go digital because of their aversion to being in the formal economy that’s transparent. That aside, this seems like a win-win and so long as market forces played out on the MDR charges you could apply, no single Bank could keep hiking MDR rates. This is how it plays out in most of the world.
So what’s the issue? How did this ban come about? Well, bade bade deshon mein chhote chhote bans lag jaate hain. We will cover that in the next post.