Mint Explainer | Will MDR hit UPI payment transaction volumes?

The National Payments Corporation of India (NPCI), on Tuesday, reintroduced merchant discount rate (MDR) on some person-to-merchant (P2M) transactions made via the unified payments interface (UPI) platform. The MDR is expected to be split between ecosystem players. However, the charge has created a lot of noise around its potential impact on UPI usage. Mint takes a look

Will MDR hit UPI transaction volumes?

MDR on UPI payments is not expected to significantly impact overall transaction volumes, given that only 4% of total UPI transactions are expected to be eligible for such a charge, as per the finance ministry. All person-to-person (P2P) UPI transactions and P2M transactions of upto ₹2,000 will continue to be free.

MDR is being reintroduced selectively and the next key question will be how these charges are absorbed across different sectors, said Sridhar Guntuku, VP, alliances and oartnerships at payments aggregator platform Decentro.

Vivek Mandhata, managing director & partner, BCG said a threshold-based approach protects retail and small-merchant transactions, so that ordinary users and neighbourhood shops feel no impact.

“What matters now is how the industry calibrates the actual rate and threshold. Set too low, and it barely moves the needle on investment; set too high, and it risks pushing volumes back toward cash for high-value merchant transactions,” he said.

What other payments are subsidised under the new structure?

P2M transactions comprised 30% of total UPI transactions in terms of value in August, and 63% in terms of the volume of transactions. Of the P2M transactions, around 33% were below ₹2,000 in value terms and 96% in volume terms.

Within P2M transactions, on which MDR is applicable, small merchants such as street vendors and neighborhood shops, receiving up to ₹1 lakh a month through UPI QR codes, will be protected under the person-to-person-merchant (P2PM) framework and will be charged no MDR. Auto-debit recurring payments like utility bills or mutual fund subscriptions, known as UPI Mandates or AutoPay, will also not carry the prescribed MDR transaction charges.

Transactions of over ₹2,000 in essential and thin-margin sectors, including railways, telecommunications, insurance, fuel, utility-bill payments, educational fees and agricultural inputs, will attract a flat MDR of ₹5 per transaction. Payments relating to mutual funds, securities, stockbrokers and dealers will attract a lower MDR of 0.02%, capped at ₹300.

“Our estimates suggest 60-70% of UPI P2M payment value above ₹2,000 (which itself accounts for 67% of total UPI P2M payments) will ultimately fall within categories subject to regular MDR, translating into 40-50% of transaction value being subject to the 40 bps MDR,” Bernstein Research said in a note.

How will it support the UPI ecosystem?

MDR will be distributed between payment ecosystem players, with banks seen as benefiting the most, and will help the industry invest in the growth and security of the UPI network. The government has also recommended carving out a pool equivalent to 5% of MDR collections to support infrastructure for smaller merchants and in remote parts of the country.

These measures are seen supporting the expansion and growth of the UPI network to newer market segments and facilitating higher load-carrying capabilities as usage and transaction volumes increase on the platform. It will also support investments in strengthening the infrastructure, tighten fraud prevention and push innovation.

Brokerage firm Jefferies expects the industry to earn around ₹15,000-18,000 crore through these MDR charges.

“The next stretch towards 90% digitisation is about bringing the merchants and buyers who are still outside the digital economy into the fold. Achieving this at scale will require a self-sustaining platform that can continue to invest in reliability, security, technology and innovation,” said Anirban Mukherjee, chief executive officer, PayU, adding that the return of MDR is an important step in creating that sustainable foundation.

Could merchants and users shift to other channels?

With majority of transactions still being protected under zero MDR, transaction volumes are likely to be largely steady. Minor dips may occur in high-value, active commercial trades, especially as banks and payment service providers (PSPs) calibrate their back-end processes, but long-term growth should be on track, as per industry experts.

Others believe some merchants could also revert to cash, whereas users should drift to other channels of payments such as digital wallets or central bank digital currency (e-rupee) which continue to be free modes of payments.

“The bigger opportunity here is for banks and fintechs to use this new headroom to compete on service quality rather than just cost, whether that is faster settlement, better fraud cover, or richer merchant analytics. Done right, this could be the catalyst that finally makes UPI infrastructure commercially self-sustaining rather than reliant on subsidy or scale alone,” BCG’s Mandhata said.

Will users have to pay more now?

Not as yet. MDR is a fee that is charged to merchants and not users. Banks have been advised to ensure that merchants do not pass MDR charges on to customers, and UPI application providers have been “expressly prohibited” from imposing platform fees or hidden charges.

NPCI said that market dynamics and historical payment trends show that merchants absorb nominal digital processing costs as standard operational overheads to drive higher business volume. The overhead tends to be offset by increased footfall, higher average ticket values and reduced cash-handling risks, giving shopkeepers no economic incentive to inflate retail shelf prices.

However, historically, merchants tend to pass on at least part of the higher cost incurred due to MDR to end use customers, especially for large value purchases. This is reflective of extra charges that customers may today pay on credit card transactions or online platforms in the form of surcharge or categorised as a ‘booking’, ‘platform’ or ‘convenience’ fees. It now remains to be seen whether merchants could adopt a similar approach for UPI transactions.