NPCI will incur revenue losses of 200 crores annually.

Bankers claim they would incur a loss of Rs. 5,000 crore.

What am I talking about here?

In the budget speech of July 2019, the Union Finance Minister announced that businesses with an annual turnover exceeding INR 50 crore must offer digital payment options such as BHIM UPI, UPI QR Code, and Aadhaar Pay to their customers.

The Minister said that no Merchant Discount Rate (MDR) could be charged for providing these digital payment options.

The products subject to the Zero MDR regime include RuPay Debit Cards, BHIM UPI, UPI QR Code, and Aadhaar Pay, all of which are offered by the National Payments Corporation of India. The idea is to promote NPCI's products over other digital payment products through zero MDR.

However, would it be successful in doing so?

NPCI will face revenue losses, and the policy disincentivizes banks from adopting NPCI's payment instruments. The banks do all the heavy lifting in processing NPCI's product transactions. Banks incur several costs for the infrastructure needed to complete transactions, and MDR charges were their bread and butter. Removing that revenue stream does not remove the underlying costs. It simply transfers the burden without providing a replacement.

To understand the scale of the problem, consider what it takes for a bank to participate in the digital payment ecosystem at all.

Core banking systems need to be upgraded and maintained. Settlement infrastructure must be kept current with network requirements.

Customer-facing interfaces, mobile apps, internet banking, and USSD services require ongoing investment.

Every UPI transaction that a bank processes passes through infrastructure that was built and is maintained at real cost. The zero-MDR policy requires banks to absorb those costs without a corresponding revenue mechanism. For fintech companies operating payment infrastructure on behalf of banks, the pressure is no different. Payment fintech stress accumulates quietly when policy, rather than market dynamics, constrain revenue models.

How does this affect the expansion of digital payments?

Banks will not be too enthused about spending money on setting up acceptance or point-of-sale infrastructure. The underserved and unserved would continue to remain so.

UPI transactions can be processed through mobile applications, but even then, all the lifting is done by the banks, not by the app providers. App providers collect data and build customer relationships.

The banks carry the transaction cost. The banks' participation in the application space would go down. They might start charging customers, rather than merchants, for using the facility to make UPI transactions.

After a certain number of transactions per month, they may charge the customer a transaction fee. Some banks have already begun exploring tiered models where a limited number of free transactions are offered each month before fees apply.

A bank cannot run its business without transactional revenue, as infrastructure spending for the transactional environment is reasonably high.

Most banks in India are either publicly listed companies or government-owned institutions with balance sheet obligations.

Their participation in the digital payment ecosystem is not charitable but a commercial decision. When that logic breaks down due to revenue removal, participation weakens.

The most critical participant in the digital payment ecosystem is the bank. When banks reduce their investment in the infrastructure that enables digital payments, the growth of digital payments slows, regardless of how many government mandates or consumer incentives exist on top of that infrastructure. The fintech ecosystem challenges that follow are not always immediately visible. They show up months later in reduced product investment, slower merchant onboarding, and a gradual retreat from unprofitable segments.

There is also a point to be made about the merchants that the zero-MDR policy is intended to serve. Large merchants with turnovers above INR 50 crore are already digitally capable and have the resources to implement UPI and RuPay acceptance.

The merchants who genuinely need support to adopt digital payments, smaller retailers, kirana stores, and street vendors, are not covered by the mandate threshold. The policy, as structured, benefits the segment that needed the least help.

Should Zero MDR be the way forward?

MDR should be market-driven. Capping MDRs or removing them altogether will hinder growth in the digital payments industry. While the zero MDR policy is currently in place only for NPCI products, it may well extend to other products and even international card networks. The precedent set by removing MDR for one product category makes it harder to resist similar pressure in adjacent categories.

Forcing payment companies and banks to look for alternative revenue sources creates its own distortions. Fintech market pressures of this kind compound over time. When revenue models are constrained by regulation rather than competition, innovation slows. Companies that would otherwise invest in expanding acceptance infrastructure or improving transaction reliability instead focus on workarounds rather than building forward.

One likely outcome is that payment data becomes the product. Banks and payment providers use transaction data to cross-sell lending, insurance, and investment products to customers who did not expect that their payment behavior would be used in that way. The value exchange shifts from a transparent fee-for-service model to an opaque data-for-service arrangement. That is not necessarily better for consumers, even if it looks that way.

In essence, making digital payment provision commercially unviable reduces digital payment penetration. The paradox of the zero MDR policy is that it attempts to expand digital payments by removing the economic incentive for the participants who enable them.

A look back from 2020

Writing in June 2020, the zero-MDR debate was still relatively fresh. The policy had come into effect in January 2020, and its full consequences for bank participation and infrastructure investment were still playing out.

The years since have shown that UPI continued to grow at a fast pace, driven by feature smartphone penetration. The pandemic also accelerated the adoption of contactless payments and federally led initiatives to onboard new users.

But the question raised in 2020 about the long-term sustainability of zero MDR remains valid and unresolved.

The RBI and NPCI have periodically revisited the MDR debate, with banks continuing to flag the cost burden of processing zero-MDR transactions at scale. The question of how to fund the infrastructure that underpins the success of India's digital payment ecosystem, without taxing consumers or penalizing banks, has yet to find a definitive answer.

What is clear is that the commercial model underlying digital payments matters as much as the technology. Sustainable digital payment infrastructure requires participants who are fairly compensated for their roles. Zero MDR removes that compensation for some of the most critical participants in the chain. How that tension is resolved will shape the next phase of digital payments growth in India.