More Thoughts on MDR Debate

So much chatter going on in Indian market around MDR, short for Merchant Discount Rate, thanks to NPCI making MDR zero for RuPay debit card transaction based on instructions from Finance Ministry. I had touched upon this topic once before here. However now coronavirus pandemic putting extra pressure on most of the businesses including payment facilitators, this topic is again making rounds. I felt like I should put together one post explaining my views in other post where I have supported the move of zero MDR.

First thing let’s talk about what is MDR and why it has been there as a key source of revenue for payment providers. MDR is the money that is paid by the merchant to the payment ecosystem used in facilitating the transaction. All the parties involved in the value chain i.e. acquirer, interchange and issuer get their share from this MDR including the third party technology or operations service providers used by these parties. MDR is typically a small percentage of transaction value, somewhere between 0.8 percent to 3 percent. Essentially what it means is that when you pay a merchant 100 Rs using your American Express credit card, the merchant actually gets only 97 Rs, while the 3 Rs are used to pay everyone involved in facilitating this exchange.

Now why would a merchant agree to take a cut in his/her income to facilitate this after-all it’s the merchant who drives the mode of transaction and not other way round. How often have you refused to deal with a merchant because he did not accept your credit card? You find a way to pay that merchant accepts and move on with your purchase. Then what is the answer? In a credit card world card company is facilitating the purchase by offering an instant credit to the customer thus taking a risk on the transaction, this risk taken by the issuer enables the purchase to go through, which may not have happened in case the credit was not issued at the time of transaction. Now here is something for the merchant to gain, he is gaining a sale, which may not have happened otherwise. That is the reason merchant doesn’t mind paying that MDR. Now issuer alone cannot support this massive ecosystem, so parts of this MDR is distributed among other participants in the ecosystem.

If the MDR was for supporting the technology and operational cost for running the ecosystem, it would have been a flat fee and not a percentage of the transaction amount, because cost of processing a transaction remains more or less the same irrespective of the transaction amount. So primary reason a merchant agrees to pay an MDR is because issuer is taking a risk on the transaction by issuing an instant credit in order to facilitate the purchase. Bigger the amount, bigger the risk for the issuer.

Then industry launched debit cards in order for customers to access the funds parked in their savings and current accounts. Instead of reinventing the wheel, they decided to ride on the same infrastructure set-up for credit cards to facilitate debit card transactions as well but then they got too lazy and even copied the same MDR based business model. In case of debit cards customer has already parked funds in banks and banks are making more money from that money and it is responsibility of banks to facilitate access of funds in his/her bank account to its customer. Banks do not want customers to line up in the branches because that is the most expensive mode of transaction for banks, in order to save that cost banks have set up digital infrastructure to provide easy access to customers, this also includes POS/Payment Gateway infrastructure.

I am of the view that MDR model is fine for credit card universe however it does not make any logical sense for debit card transactions and issuer banks should bear the cost of these transactions instead of passing that cost to merchants or customers in anyway. Issuer banks should pay interchange and acquirers on fixed fees basis, then acquirers should compensate their technology and operations partners from their share. Interchanges as the bodies at the center of all this should facilitate working of a reasonable compensation mechanism for sustainable ecosystem growth.

Since the industry had been running on this illogical model for far too long everyone had gotten used to it; but zero MDR move by Government should work as a catalyst to drive this change and implement a more logical and sustainable business model, which is not designed to unreasonably favor the banks. Banks should not be allowed to only benefit from this entire ecosystem, while other partners share the entire burden of cost. I hope NPCI leads the way here with support from RBI and Finance Ministry to arrive at a agreeable solution that doesn’t ruin the payment facilitators and force them out of business. If that happens customer will be the biggest loser.

PS: This piece was originally published as my opinion piece on IBS Intelligence blog.

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