Context

• The recent discussion paper by the RBI on charges in payment systems has triggered widespread public debate, especially on the zero-charge framework for UPI transactions.

Know the basics- What is UPI?

• UPI is an instant real-time payment system developed by National Payments Corporation of India (NPCI) facilitating inter-bank transactions.
• The interface is regulated by the Reserve Bank of India and works by instantly transferring funds between two bank accounts on a mobile platform.

Why RBI wants to intervene?

• Two important reasons:

1. Goals of financial inclusion: Viewing digital payments as a public good and
2. Addressing market failures: Such as the presence of dominant firms or externalities that may arise due to the two-sided nature of this market.

• For both objectives, regulators might want to cap or set to zero the MDR or merchant discount rate (paid by merchants to their payments service provider) or the interchange fee (paid by the acquiring bank to the issuing bank), or both.

What is the present scenario of Pricing UPI?

• Subsidies on operational cost: In the case of UPI, the government subsidizes the operational costs of facilitating UPI transactions, which is reportedly inadequate. In January 2022, the Payments Council of India reported that the industry expected a loss of Rs 5,500 crore.
• Subsidies are inadequate: Even with a public good motive, in the absence of evidence, one cannot assume this to be the best allocation of limited government resources. As per the Indian Digital Payments Report (second quarter of 2022), the average ticket size of P2M transactions (person to merchant) on UPI is Rs 820. RBI’s estimated cost of Rs 2 for processing a Rs 800 transaction, is 0.25 per cent of the transaction value, much lower than the MDR cap set at 0.9 per cent for debit cards and an MDR of 2 per cent being pro- posed for RuPay credit cards on UPI.
• Presently MDR is Zero: A floor MDR of 0.25 per cent is, therefore, not unreasonable. Arguably, these are substitutable services competing for the same pool of merchants. Policymakers must also bear in mind behavioural challenges in moving from zero MDR to a positive MDR. Anchored at a zero MDR since January 2020, merchants, especially ones with thin margins, may hesitate to accept an increase in MDR, even if they benefit on net terms.

How RBI can regulate price?

• Understanding what to regulate: In order to understand how and what to regulate, we borrow from the rationale followed for other two-sided markets that exhibit cross-platform externalities. consumers benefit more if the size of the merchant network accepting a payment instrument (for example, debit cards) is larger and, at the same time, merchants benefit more if many consumers use debit cards.
• Recovering the cost from merchants: Card networks like Visa and Mastercard compete for banks, usually not too many, to issue their cards. Since the acquiring bank must pay the interchange fee, they recover these costs from merchants.
• Regulating the interchange fee: In most jurisdictions, the interchange fee is regulated to prevent banks from charging exploitative rates and the MDR is left to be commercially determined. This is also done for administrative ease, since banks are fewer, while monitoring bank-merchant contracts can be onerous.
• Charging the MDR: In the UPI parallel, involving payment service providers of payers and payees, the remitter and beneficiary banks as well as NPCI, RBI could either regulate the inter change fee between payment service providers or the merchant discount rate charged by them.
• Deciding between MDR and interchange fee: The market for merchant acquisition is usually more competitive and can be left unregulated, and if necessary, the interchange fee between the two payment service providers can be regulated. If both markets are sufficiently competitive, regulation could mean establishing a floor/ cap charge. The decision what to regulate is, therefore, crucial.
• Example of telecom industry: A related example is available in the telecom industry where facilities provision is regulated through the interconnection fee, while retail prices for the relatively competitive telecom services segment are left to the market. For externalities of the two-sided market to be internalized, the choice of instrument must be carefully evaluated.
• Determining the actual price: The next step is to determine the price level, which is a lot trickier. Drawing from economic theory, the optimal level would depend on whether the regulator cares only about consumer welfare (as op- posed to total welfare), and whether the issuing and acquiring banks make positive margins on each transaction.

How digital payment is charged around the world and India’s requirement?

• Example of PIX of Brazil: Pix, a two-year-old interoperable digital payments system in Brazil, provides a good comparison of how price setting might be considered in the UPI context. Pix does not regulate MDR, payment service providers have the freedom to set MDR, though in practice most banks currently don’t charge an MDR, largely to onboard more merchants on their platforms.
• MDR appears less attractive: The indicated cost is R$ 0.01 for each 10 transfers, or 16 paise in Indian rupees for every s10 transactions. This is substantially lower than the costs estimated for India and is also perhaps the reason why payment service providers are not immediately inclined to recover costs through MDR.
• Not hampering the innovation and investment: In general, benefits of regulatory intervention should outweigh the costs of intervening. The costs of intervening not only include the administrative costs, but also potential costs arising from setting the wrong interchange fee or cap, as well as any costs arising from the impact of the intervention on future investment and innovation in the market.

Do you know what is Merchant Discount Rate?

• Merchant Discount Rate (alternatively referred to as the Transaction Discount Rate or TDR) is the sum total of all the charges and taxes that a digital payment entails.
• Simply put, it is a charge to a merchant by a bank for accepting payment from their customers in credit and debit cards every time a card gets swiped in their stores.
• Similarly, MDR also includes the processing charges that a payments aggregator has to pay to online or mobile wallets or indeed to banks for their service.

Conclusion

• Policymakers must collect more data on costs of transfer, user preferences, both merchants and consumers, as well as undertake a thorough analysis of substitutability and competition in the digital payments sector, to put our best foot forward in helping achieve the potential of UPI in India.

Mains Question

Q. Explain the reasons for success of UPI in India? Analyze the Role of UPI in financial inclusion in India?

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