Payments problem

The National Payments Corporation of India (NPCI) last week revised bank interchange fees for the Unified Payments Interface (UPI) to zero for all domestic transactions with retrospective effect from January 1, 2020. This is a “pilot” programme, which will stay in effect till April 30, 2020. This cut is the inevitable consequence of the finance ministry’s decision to cut the merchant discount rate (MDR) to zero on the UPI and RuPay transactions from January 1. Banks cannot pay interchange fees on these transactions, since they are no longer receiving fees from the MDR. The decision assumed that the removal of the MDR will lead to a further upsurge of digital transactions. While it is mandatory for any establishment with a turnover of greater than Rs 50 crore to offer digital payment options, the removal of the MDR is expected to encourage smaller merchants to adopt digital payment systems, since they will not have to pay charges to banks or fintech service providers. But the MDR was a key revenue stream and its removal has hit the industry hard. There will be negative consequences in terms of the growth of the digital payments ecosystem. The MDR contributed about Rs 1,800 crore to industry revenues in 2019.

But despite that income stream, the major fintech players are all incurring losses because their expenditures on both creating front-end and back-end infrastructure are high and they also have to offer cashback and other incentives in a competitive space. There are substantial costs to setting up infrastructure for digital payments. It is estimated that payment app providers spent over $1 billion in 2019 to boost e-payments on the UPI. Transactions on digital platforms run at over 1 billion per month and continue to grow. Merchants paid the MDR to their respective banks as a fee for accepting digital payments via the UPI, RuPay cards, and other instruments. (Both the UPI and RuPay platforms are managed by the NPCI.) The banks pay interchange fees, network fees, and payments service provider fees to other banks, fintech players, and stakeholders in the ecosystem. The NPCI also takes a fee for enabling UPI and RuPay transactions. 

Hence, the MDR was a source of revenue for many entities and a major one for some businesses in the digital value chain. In the absence of the MDR, there will be very little incentive for fintech players to expand their network by registering new merchants and users. Investors will also be unwilling to spend more on maintaining and strengthening existing networks, leading to higher transaction failure rates and probable frustration among users. Finding alternative revenue streams will be difficult, and may be legally problematic for the industry; many businesses may end up monetising customer data and possibly infringing the provisions of the proposed data protection law. 

Building an inclusionary digital network is a reasonable goal. But it is debatable if the elimination of the MDR, with retrospective effect, is the ideal way to encourage the uptake of digital transactions. Players in the ecosystem must be compensated for their investments, and the MDR was the natural way. Alternative modes of direct compensation by the government, which fintech players are now attempting to negotiate, would be a much more convoluted exercise. The digital finance industry is still in a nascent phase and the government should reconsider this policy.

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