Even more thoughts on MDR debate

In my last post I had touched upon the entire authorization piece for card transactions and how it makes sense to have MDR for Credit Card transactions however it feels unreasonable when it come to Debit Card transactions. Today I will explain the settlement aspect of transaction and try to make sense of MDR charges based on settlement flow.

How settlement for a card transaction works?

After transaction is completed merchant claims money from the acquiring bank. Acquiring bank further sends a file to Interchange and Interchange gets the money from Issuer Bank. This entire cycle traditionally used to take days.

Acquiring bank is making a guarantee to the merchant and based on that guarantee, they process the transaction. Interchange is giving the guarantee to acquirers. Meaning in the event of an issuers inability to pay for a transaction done by its customer the interchange will ensure that the acquirer gets paid for the money they have paid to the merchant.

Above risk is high if you assume settlement cycle spread across many days. However in today’s fast paced world the settlement cycle is shrinking. We are practically settling the transaction with-in T+1 days. There are continuous attempts to shrink this cycle to make it even near real time. If that happens the risk by acquirers and interchange is going to be practically zero.

Many debit cards in the market even follow a single message settlement protocol similar to ATM transactions. In this case there is no need for merchant to process any batch settlement. The settlement is processed automatically by default.

This risk taken by acquirers and interchange on top of supporting the ecosystem with their technology and operations is additional justification for them getting a share of the transaction fee, however this still beats me, why the fee should be paid by the merchant and not by the issuer.

The merchant is the first one to go out of pocket (he has sold the goods without money in his/her account) hence contributes to zero risk in this entire ecosystem. Customer is using his debit card meaning he/she is using the money that he/she has parked in the his/her account already, hence not contributing to any risk. At the time of transaction the money is debited from customer’s account and parked in a payable account by the issuer bank. It is this account that is used to settle money with the interchange.

If a issuer bank has managed to get into a situation somehow (recent Yes Bank situation) that they are not able to settle with the interchange it is definitely not because of the customer and/or the merchant, hence in all fairness it is them who should fund the entire ecosystem from their income through deposits and not fleece the merchants.

If you want merchant to pay MDR, issue credit cards and give enough incentives to your customers to use them. If customer prefers to use his/her debit card instead, it is ideally his/her bank’s responsibility to offer necessary ecosystem to access his/her funds. Always remember the issuer banks are already making profits by investing this money parked by customers in their CASA.

Four years back RBI suggested some reforms in this consultation paper however no action has happened in that direction. What I am suggesting is not exactly the same but fundamentally both are using the base analogy that the benefits are currently unfairly tilted in favor of issuer banks and it is these issuer banks who should bear the most of the burden instead of expecting other players in the ecosystem to fund for the infrastructure needed for its customers to access funds parked in their accounts in these banks.

Recent growth in this ecosystem was fueled by VC/PE money, which may not be available in same proportion given the current global slowdown caused primarily by the Coronavirus pandemic. This means some key players will find it extremely difficult to survive and it will not be good for the overall digital payment ecosystem. It is in the interest of issuer banks to save this ecosystem by taking ownership of the costs involved. If that doesn’t happen, only players surviving will be the ones with deep pockets not the ones with better innovation. This will eventually kill the innovation in this space and steer entrepreneurs away from attempting new/innovative solutions in this space.

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