The case for pricing UPI transactions and what's at stake for banks

Banks pay a switching fee running into hundreds of crores every year for UPI, but have to offer the service for free

Last Sunday, the finance ministry tweeted that UPI (Unified Public Interface) is a digital public good with immense convenience for the public and productivity gains for the economy. And, therefore, “there is no consideration in the government to levy any charges for UPI services. The concerns of the service providers for cost recovery have to be met through other means”, it said.

The ministry’s stance came days after Mint Road came out with a “Discussion Paper on Charges in Payment Systems” broadly making the case for a transaction fee for these services.

“In any economic activity, including payment systems, there does not seem to be any justification for a free service, unless there is an element of public good and dedication of the infrastructure for the welfare of the nation. But who should bear the cost of setting up and operating such an infrastructure is a moot point,” the paper observed.

The paper’s contention has been engaging the payments industry for years now and figured in talks with the Reserve Bank of India (RBI). Without correct pricing, just about everybody in the payments ecosystem is under pressure.

Take the issue of the merchant discount rate (MDR) — the structure that decides what each entity in the payment services loop gets to pocket on a transaction.

A zero-MDR regime was introduced on RuPay-UPI debit cards in the July 2019 Union Budget on transactions of up to Rs 2,000. It would have been much better to link this to merchant turnover of up to Rs 20,00,000 (that is, merchants outside the goods and services tax loop) instead of giving a flat exemption of up to Rs 2,000 — at all outlets. This would have given relief to smaller merchants; larger outlets should have been made to absorb the MDR — they can afford to do so. On the specific issue of MDR, it may be recalled that neither the Nandan Nilekani Committee Report (2019) nor the Watal Committee (2016) made a case for zero-MDR, but said that market forces should decide it.

The crucial point is that the government picks up the tab for this freebie. The Union Cabinet had last December approved a Rs 1,300-crore package as compensation for this zero-MDR, and to give a fillip to digital payments. The zero-MDR cost is now being borne by taxpayers (for the MDR foregone) when you order up to Rs 2,000 on Amazon, Flipkart, or a Swiggy (the latter two are funded by private equity capital) at an eatery or a fancy retail outlet. Worse, banks and acquirers on the Visa and Mastercard networks get to make more money as there is a healthy MDR to be carved out.

The fact that everything linked to UPI can never be free — or under-priced — is borne out by the in-the-works pricing on RuPay-UPI credit cards. The National Payments Corporation of India (NPCI) and banks have arrived at a consensus for an MDR of 2 per cent. Of this, 1.5 per cent will go towards the issuing bank as interchange with the rest (50 basis points) being shared as fees with RuPay, and the acquiring entities — be it banks, or non-banks such as Mswipe Technologies and Paytm. This intended pricing arrangement, incidentally, is largely aligned with the MDR structure for credit card transactions on Visa and Mastercard. The only exception, which could be on offer, is at outlets with an annual turnover of up to Rs 20,00,000. These transactions will be free with the ticket size capped at around Rs 2,000-5,000 with no limits on the number of daily transactions.

The finance ministry’s view on UPI pricing comes even as there is a public debate over freebies in electoral politics. What’s lost in the din is that banks pay a switching fee to the NPCI — a not-for-profit entity — running into hundreds of crores every year for UPI, but they have to offer the service for free — whether it is for peer-to-peer transactions, or peer-to-merchant.

The ministry’s stand that “the concerns of the service providers for cost recovery have to be met through other means” is of particular importance. Just what are those “other means”? Simply put, think of it: if those who can afford gas cylinders at market rates have no business to avail of it in a subsidised manner, why can’t the same logic be extended to UPI transactions? Likewise free UPI should be targeted at income groups and merchant outlets that can’t be burdened by free-market pricing. The rest should pay — in national interest. This is an aspect which the RBI itself has highlighted: “… there does not seem to be any justification for a free service, unless there is an element of public good and dedication of the infrastructure for the welfare of the nation.”

The pricing rationale

·         Payment systems operators incur expenditure to create and operate safe and secure payment systems, comply with statutes and generate public awareness

·         The objective of promoters includes recovery of costs and generation of sufficient returns to ensure continued operations

·         It is important to ensure that payment services are priced in a manner that retains incentives for both — users to access the services and service providers to offer them

·         There has to be justification for a free service — public good and dedication of the infrastructure for the welfare of the nation