What we have established so far is there are costs of running the digital payment ecosystem. These costs are borne by multiple specialists who participate and play specific role in the information and the money flow. The MDR is a charge levied to the merchant by the Acquiring Bank for these services. The Acquiring Bank then splits this MDR charge among these players to keep them viable and interested in delivering these services. God’s in his heaven and all’s well with world like Browning would have said. Right? Wrong.
There was this growing feeling among many that MDR rates are being baked in by the merchant into the price of their products. There’s no way to know this. And, surely a lot of us as customer don’t really make out if there is a higher price to pay because of digital payment in most cases (barring those small merchants who charge an extra fee for usage of a card). Also, there was a view that the MDR charge was huge for a merchant and discouraged him from pushing a customer towards a digital transaction. So, there was enough momentum to the idea that if you take out MDR, the merchant will have greater incentive to go digital and he will pass the savings to the customer in terms of lower price who will then happily do more digital transactions.
The government therefore has done 2 things in parallel. Firstly, they have made it mandatory for any merchant with more than Rs 50 Crores in revenue to have RuPay or BHIM UPI as a platform which they must have with them. RuPay is a government owned payment network owned by NPCI (a government body) while BHIM UPI is a government created utility. Secondly, they have abolished MDR for RuPay and BHIM UPI since they own or control it. Now, it will be useful to conjecture how will this all play out in the future from all perspectives.
MDR charges were bringing RuPay and Bhim UPI (more specifically, their creator RBI and a bunch of Banks) almost Rs 1800 Crs of revenues. This will now disappear. The FM’s view was “RBI and banks will absorb these costs from the savings that will accrue to them on account of handling less cash as people move to these digital modes of payment.” This will be true in the longer run if this move truly pushes digital transactions significantly higher. We will come to that later. But in the short run Rs 1800 Crs is lost.
Merchants will now have an incentive to push RuPay card usage to the customer over other cards. Visa and Mastercard can’t make their charge to zero since this is their primary source of revenue. It is very difficult to show if the merchants pass on this benefit of zero MDR to customers by reducing the price of their products. So, the end customer benefits remain dubious. The merchants pushing RuPay would mean the Acquiring Bank will make no money since there’s zero MDR. The Acquiring Banks (or Aggregators and Payment Service Providers) have been primarily responsible for making the merchants go digital by installing the POS machines and running them. This requires a large team that goes to thousands of shop in small town India daily and convinces them to go digital with POS machines, QR codes, app downloads etc. RuPay doesn’t do this. It is not in this business.
So, in the absence of any incentive, who will do this now? Who will even maintain the 4 million POS machines in the market already if there’s no money to be made running them? How will we go from 4 million to 65 million shops becoming digital? Who will continue to innovate on the payment ecosystem and make it more frictionless and easier for customers and merchants? What’s the incentive for fintech players to help SMEs and MSMEs to go digital and manage their financial and treasury operations?
Here’s what will most likely happen. Banks will make up the loss in revenues through some other charges that they will add to their services elsewhere which will be higher than MDR and which will be borne directly by customers. Or, they will withdraw rewards scheme, free services etc to recover the revenues. The impact will be on end customer directly. There won’t be any incentive to add new POS across the country. The attractiveness of the payment ecosystem for innovative entrepreneurs will wane.
It is useful at this point to see how a similar move played out in the USA. Right after the 2009 financial crisis, the US enacted the Dodd-Frank law that laid out various new regulations to rein in the financial services sector. The Durbin amendment was part of the this law which aimed to lower the interchange fees (the charges that merchants pay to banks when a customer makes a purchase; basically their version of MDR) with a view that this would lead to merchants passing the savings to the customers in lower prices and reduce the money the big Banks made. So, there was an upper cap fixed for the interchange rate that a Bank could charge the merchant. After 8 years of this amendment, it is instructive to see how this played out based on various studies done. First, the big banks recouped their loss in revenues by increasing customer fees and reducing rewards elsewhere. A study by George Mason University found the retail prices haven’t come down at all. So, merchants didn’t really pass on the benefits to customers.
Most interesting though was the impact of this on small retailers like coffee shops, delis, small merchants. In the earlier regime when there was no price cap, the Bank would charge a much lower rate for smaller value transaction while charging full rates for a high value transaction. This was a form of price discrimination to maximise the full potential of digital payment. So, for example, in the pre-Durbin regime, the charge would be 44 cents for a typical $ 44 transaction while they would charge 3 cents for a $ 4 transaction. In the post Durbin world, the interchange charge on a $ 44 transaction was capped at 26 cents (losing 18 cents from pre-Durbin era). This meant that the Bank would charge the $ 4 transaction now at 21 cents (recouping the 18 cents lost). So, the smaller retailers were left with a distinct disadvantage and they started discouraging digital payments. In summary, no one was left wiser if the Durbin amendment helped anyone.
The Indian MDR rates were already among the lowest already in the world. The MDR rates might not be necessarily be the only reason for lower digital adoption. We need to increase the coverage of POS machines to more merchants and we need to strengthen GST and tax compliance practices to have more merchants adapt digital payments. Possibly, a better policy alternative would have been to have a slab based MDR that was lower than the current rates and provided a tax incentive for the digital part of revenues declared by the merchants. That would have kept the incentive for payment players to continue building payment infrastructure across the country while giving a direct benefit to merchants to go digital.
The current approach reduces choice for the merchants and skews them towards a particular player (RuPay), increases the market concentration risk and associated risks of systemic impact in case of security failure or large outage at RuPay and provides no incentive to anyone who wants to pound the streets of Bharat to get merchants on the digital train and provide innovative products and solutions for them. Like most bans, this might deliver a few short-term gains while leading us away from our long-term objectives.