How UPI MDR could undermine the economics of low-cost investing

The argument that the cost of innovation needs money doesn't really warrant a percentage of transaction. Technology costs should come down as transactions grow.

You will start to see merchants paying a fee (merchant discount rate, MDR) to receive money in transactions above ₹2,000 from 15 October.

Merchants will pay 0.40% of a transaction. But certain merchants will pay less. Insurance, for example, pays a flat ₹5 per transaction. Lumpsum investments into mutual funds made through UPI will be charged 0.02% (2 basis points, bps), which the fund house might need to bear. Brokers too will pay a similar 0.02% on inflows that use UPI.

Fair disclosure: we run a mutual fund, so assume bias. The problem isn't that asset management companies must bear this cost—it's that the cost of incremental investment in a fund is very high for a low-cost fund. Many low-cost index funds charge 10 to 20 bps as management fees, and 2 bps is a very high fee to bear for these transactions. The larger funds will be fine since their incremental flows are tiny compared to the fund itself, but for smaller funds, the burden is greater.

Now take a stockbroker. If you have a balance with them in cash, they will send it back to you (by regulation) every three months. You send that money back to them via UPI and it will cost them ₹20 per lakh. If you don't transact or just do a few transactions where the brokerage (now typically a flat rate fee) adds up to ₹20 or less, the broker doesn't see a profit.

So, regardless of UPI regulations, brokers might have to charge an extra fee to use UPI, as will mutual funds, eventually. Investors will (and even now, can) move to other electronic payment systems such as NEFT or RTGS, which typically take a couple of hours and cost nothing, as mandated by the Reserve Bank of India.

It would be better to keep the fee lower, at ₹2 per transaction, which is around what fund houses absorb right now. This will ensure that fund houses do not pass the costs to the fund investor. Sebi's limits on fees do not cover these other costs, so this fee is chargeable to investors without any limits. (Management fees have lower ceilings as assets under management increase.)

Am I against MDR completely? Philosophically, I am because UPI discourages cash, creates bank account history for formal credit, and has high trust. And banks earn the biggest amount from this money by having larger current account balances than usual and have the ability to do far better credit underwriting for merchants.

If anything, the banks should pay part of the profits they earn to the app ecosystem (which currently earns little directly, but does also earn income from sources like lending, selling other investments and so on—the UPI payment is a loss leader). But let me give in to say, alright, charge a little for a relatively small subset.

The argument that the cost of innovation needs money doesn't really warrant a percentage of transaction. Technology costs should come down as transactions grow. A flat fee— ₹2 per transaction—is a better way to encourage UPI in investments, just as a flat brokerage has improved transactions in the stock markets.

Compare the credit card players, where typical charges are 2% to merchants – but this comes with an underwriting risk that the end-user doesn't pay (the issuing bank takes that risk). There is no such risk underwritten in UPI—it's an instant movement from one account to another. And then, in credit cards, the underlying infrastructure is built by the card networks, who charge part of the fee.

NPCI, which runs the entire system of UPI, IMPS, NACH, Fastag and so on, has built that infrastructure for the banks and the apps themselves, which comes in at a much lower fee to the industry. Plus, the economies of scale need to be passed to the consumer.

Investors in mutual funds might not see much of a difference as today, UPI forms a very small part of the transactions made. (Retail inflows are usually substantially net banking, UPI Autopay, which is not under MDR at all, NEFT/RTGS or bank mandates).

Stockbrokers, however, seem to have a much larger share of UPI-based inflows and they will likely add charges. If we don't want to see “additional charges to use UPI,” we should keep the costs a fixed amount, not a percentage of transaction.

Deepak Shenoy is CEO, Capitalmind Mutual Fund, which is based in Bengaluru, with about ₹650 crore of assets under management.