UPI’s ₹16,000 crore MDR windfall could change the economics of digital payments

Historically, UPI generated negligible direct revenue for payment apps; however, potential MDR of ₹16,000 crore is reshaping the landscape. This revenue could enhance bank capacities and provide UPI apps new resources to attract consumers and merchants, helping evolving the payment ecosystem.

For years, the UPI (unified payments interface) has had an unusual economic model. Banks invested in the underlying infrastructure, while companies such as PhonePe, Google Pay and Paytm spent billions acquiring consumers and merchants, distributing QR (quick response) codes and soundboxes, improving payment experiences and fighting for market share. Yet, the transaction at the centre of all this generated virtually no direct revenue for most of them.

UPI processed ₹29.8 trillion worth of transaction in August, with merchant (person to merchant or P2M) payments accounting for roughly ₹9 trillion. Annualised, that is about ₹107 trillion of P2M value, of which roughly ₹72 trillion comes from transactions above ₹2,000. A 0.4% merchant discount rate (MDR) on transactions above ₹2,000 could theoretically generate nearly ₹28,000 crore. But after accounting for small-merchant exemptions, the ₹300 cap and concessional rates for categories such as fuel, telecom, insurance, railways and capital markets, industry estimates put the actual annual MDR pool closer to ₹16,000 crore.

In simple terms, this ₹16,000 crore gets divided almost equally into two parts. Around ₹8,000 crore goes to the banking system that provides the rails. The other ₹8,000 crore goes towards the consumer and merchant distribution that brings transactions onto those rails.

The first ₹8,000 crore should help banks continue investing in UPI capacity, cybersecurity, fraud prevention and transaction success rates. Technical failures are already quite low across the larger banks, so I would particularly like to see some of this incremental revenue being invested proactively in curbing UPI fraud, which remains a serious problem.

But I find the other ₹8,000 crore more interesting.

As much as ₹3,200 crore goes directly to UPI apps, while another ₹4,800 crore goes to the merchant-acquiring side. This is effectively the first meaningful direct revenue pool rewarding companies for distributing UPI.

At current transaction market shares, the ₹3,200 crore app pool could translate into roughly ₹1,000-1,200 crore for PhonePe, ₹800-900 crore for Google Pay and ₹200-300 crore for Paytm, with the remainder going to other UPI apps.

Until now, gaining another percentage point of UPI market share gave an app more engagement and more customers to cross-sell financial services to. It did not materially increase transaction revenue. Now it does.

The merchant side makes the economics even more interesting. Assume, illustratively, that Paytm accounts for 30% of merchant acquisition, PhonePe 25% and Google Pay 5%, while banks and payment aggregators collectively account for the remaining 40%.

The ₹4,800 crore merchant-acquiring pool would then put approximately ₹1,200-1,400 crore against Paytm’s merchant footprint, ₹1,000-1,200 crore against PhonePe’s and roughly ₹250 crore against Google Pay’s.

There is an important qualification here. The merchant-acquiring side receives 12 basis points (bps) out of the 40 bps, or 0.4%, MDR. Paytm, PhonePe and other merchant acquirers participate in this pool, but their net economics will depend on their commercial revenue-sharing arrangements with acquiring-bank partners. The entire 12 bps should, therefore, not be read as revenue accruing to the UPI app.

Even after allowing for that, these are meaningful numbers. Under these assumptions, PhonePe sits against roughly ₹2,000-2,400 crore of annual consumer and merchant-side MDR, Paytm around ₹1,200-1,500 crore and Google Pay around ₹1,000-1,200 crore.

What happens next is what interests me.

There is now more money to compete for consumers and merchants, improve checkout experiences, experiment with rewards and loyalty programmes, develop better fraud products, and invest further in offline acceptance. We should also see new UPI use cases that were difficult to justify when every incremental transaction generated zero direct revenue.

It also changes the incentive for smaller UPI apps. A percentage point of UPI market share is no longer merely distribution. It now has a value attached to it. Can we now see Super Money, Navi, Cred pushing to acquire more customers and merchants? Will this make it easier for the National Payments Corporation of India (NPCI) to enforce its 33% market share cap by encouraging smaller UPI apps to compete for market share?

Personally, I would still prefer UPI to remain at 0% MDR. I believe the economic value created by a free UPI is far greater than the ₹16,000 crore that MDR might generate—lower cash-handling costs, greater formalisation of commerce, digital trails that improve access to credit, lower payment costs for small businesses and the broader efficiency created by moving billions of transactions digitally.

But that debate is now behind us, at least for the moment. If MDR is here, I hope a meaningful part of this new revenue gets reinvested rather than simply absorbed into existing profit and loss accounts.

UPI's first phase was about distribution: getting hundreds of millions of Indians and merchants onto the network. This new economic incentive could make its second phase about what companies build on top of that distribution.

₹8,000 crore to make the rails stronger. Another ₹8,000 crore to get more people to use them—and to give them more reasons to do so.

Deepak Abbot is co-founder of gold lending NBFC indiagold and a former Paytm head of product & growth.