The future of UPI depends on getting MDR formula right

India’s digital payment infrastructure, led by the Unified Payments Interface (UPI), is a model that many countries aspire to have. What began as a payments protocol is now the backbone of everyday commerce with transaction value having grown 4000-fold in the past decade from Rs 0.07 lakh crore to Rs 314 lakh crore. Its growth has been shaped by deliberate policy choices, including an interoperable public payments infrastructure, incentives for digital adoption and the abolition of Merchant Discount Rate (MDR) in 2020.

The recent amendment to the Payment and Settlement Systems Act has reopened the debate on how much merchants should pay. A pertinent question that also sits beneath is where that money should ultimately go. The way the MDR pool will be distributed by the NPCI Steering Committee in the coming weeks will determine whether it simply funds the existing UPI infrastructure or helps finance the next phase of its growth.

Applying a threshold of Rs 2,000 to peer-to-merchant (P2M) transactions, will make about 67% of this value chargeable. Extrapolated annually, a modest 0.25% MDR would yield over Rs 15,000 to Rs 17,000 crore for the UPI industry.

Banks have undoubtedly played a central role in building and maintaining UPI infrastructure, however, the distribution of the proceeds of MDR should also take into account the players who are to incur the costs of UPI’s future growth. Instead of directing a large part of the MDR to banks, 50-60% share should ideally go to the apps and platforms driving merchant acquisition and the next phase of UPI growth.

The next phase of UPI growth will depend increasingly on merchant acceptance. Nearly every incremental cost associated with that expansion sits on the acquiring side, including merchant verification, QR code deployment and servicing, per-merchant fixed costs, reconciliation, chargebacks, grievance redressal, and the fraud-prevention systems that protect the network’s integrity. By contrast, the banking ecosystem largely authenticates a customer it already serves, using infrastructure built long ago, at negligible incremental cost. If the MDR sharing formula does not adequately reflect this difference in cost and investment, it risks rewarding participants for maintaining the existing system while leaving the players responsible for expanding its reach with insufficient resources.

The broader economics of UPI also need to be considered. A 2022 discussion paper of the RBI estimated the total cost incurred by banks, app providers and NPCI for each P2M transaction at 0.25% of value. However, banks have also benefited from higher savings account balances maintained by customers to service UPI payments, as well as from the sharp reduction in cash-handling costs that digital migration brings. The UPI has reduced the cash handing cost and immensely benefited consumers.

As India continues to deepen the adoption of UPI, its digital public infrastructure, the fintech sector needs capital to fuel the next phase of UPI growth. This will require investment in technology, advanced fraud detection, and the merchant-acquiring infrastructure needed to extend digital payments to India’s remaining cash-dependent segments. Onboarding merchants, deploying and servicing QR and POS infrastructure, and providing technology and support to smaller merchants are not simply costs to be recovered. They are investments in expanding UPI’s acceptance and, therefore, its future transaction base. That is precisely why MDR needs to leave enough margin for the players investing in expanding merchant acceptance.

The answer, therefore, cannot simply be to redistribute MDR mechanically. The framework needs to be designed to support both investment and sustenance of the existing ecosystem. Further, the Steering Committee’s methodology should be published, cost-based and periodically reviewed.

The future growth of UPI depends on investment in domestic payments infrastructure and cross-border expansion. NPCI therefore has a responsibility to ensure that the MDR pie is distributed towards investing in extending UPI’s reach.

The author is a professor at ICRIER.

Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.