Who should pay MDR to compensate costs of banks & payment aggregator companies going forward?
When trying to identify who will pay MDR on UPI transactions in future, every bank should ask itself a fundamental question,
What would their presence in the payments space look like if NPCI had never introduced UPI in 2015-2016? What would have been their answer to the wallet revolution back then?
This question becomes critical as the industry faces mounting pressure to implement Merchant Discount Rate (MDR) charges to cover operational costs.
UPI is considered as cost center by banks
Banks face significant expenses in the UPI ecosystem:
- UPI software acquisition and licensing
- Operations costs including servers and staff
- Per-transaction fees for accessing the NPCI switch
These costs became particularly burdensome after the Indian government announced zero MDR in 2020, as banks, being essential conduits to NPCI’s UPI switch, find themselves without any opportunity to monetize these services.
Industry’s Response: The Move Toward MDR
Similar to how the National Highways Authority charges toll fees from four-wheelers while exempting two and three-wheelers, the banking industry is moving towards charging MDR to merchants (either directly or by levying fee on respective payment aggregator who facilitated that service) on UPI transactions. The move by ICICI Bank is third in recent months, which details can be found as referred to in news article references such as,
Banks are turning decisive to collect MDR, while Yes Bank and Axis Bank started charging in the past, ICICI Bank has announced their approach to charge payment aggregators for P2M transactions for merchants (who are not ICICI Bank customers) from August 01, 2025
Be it ICICI Bank or for that matter any other bank, there is no wrong with this idea of charging MDR to merchants, but is this in the best interest of,
- people (who use UPI to make payments in P2P & P2M scopes)?
- merchants (who collect payments on UPI)?
- banks (who facilitate P2P, P2M transactions)?
- payment aggregator companies (who connect to banks to facilitate P2P & P2M transactions)?
- NPCI (who manage UPI switch)?
- Indian government?
While UPI which used to predominantly be as payment method that works with value in the bank account, things got changed after advent of UPI credit as,
- people tend to choose between UPI debit / UPI credit / Credit card / Debit card / Cash when making payments using smartphone
- small merchants opted for UPI as it is convenient, comes without any transaction costs, less worry for currency change availability and credit score building opportunities
- large merchants adopted UPI as an additional payment option that offered convenience and zero MDR compared to other methods
- acquirer banks have control since all transactions that happen through their own co-branded BHIM apps or through connected payment aggregator companies are considered as theirs at NPCI (as long as the merchant’s VPA is created based upon bank’s VPA suffix) in P2M transaction scope
- payment aggregator companies who have burned cash on cashback offerings now seek sustainable revenue models. They face pressure to comply with RBI’s new payment aggregator licensing requirements while also managing operational costs
- NPCI aims to maintain healthy transaction share distribution among PSP participants (i.e., below 30%). However, new participants are reluctant to enter the market due to limited balance sheet value under the current zero MDR regime
- finally, Indian government, while they do encourage competitive value exchange, they need a means to control the odds and undue dominance by any external player in the payments sector, they tend to exercise diverse options as a leverage in strategic discussions with partners, friendly countries and adversaries
The Path Forward: Government-Funded MDR
The Rationale
The Indian government has clearly positioned UPI as a public good service. As suggested in this article, this positioning suggests a logical funding mechanism: government payment of MDR costs.
This approach is pragmatic because every Indian citizen and legal immigrant using UPI contributes to government revenue through either:
- Direct taxes (income tax)
- Indirect taxes (GST)
Implementation Framework
The specific MDR amount the government should pay requires comprehensive evaluation of:
- Actual operational costs across all stakeholders
- Viable profit margins of each in the value chain
- Value propositions for banks and payment aggregators
A reasonable MDR structure can then be negotiated with the Indian government based on these assessments.
Strategic Value of Investment
Just as national highway construction and infrastructure investments contribute to GDP growth, UPI’s economic impact is equally significant. The platform creates far-reaching opportunities for:
- Financial inclusion
- Digital economy growth
- International payments infrastructure creation through NPCI International Payments Limited (NIPL)
- Strategic partnerships with other countries for either INR acceptance or white-label UPI implementations
Summary
UPI represents critical digital infrastructure that deserves strategic investment and appropriate budget allocation. With proper government funding of MDR, all stakeholders—RBI, NPCI, NIPL, PSU banks, private banks, and payment aggregators—can continue expanding the UPI ecosystem while maintaining its accessibility as a public good.
The time has come for decisive government action to ensure the sustainability and continued growth of India’s digital payments infrastructure.