Reserve Bank of India lens on payment fintechs over misclassified merchants

The Reserve Bank of India is scrutinising payment fintechs for allegedly misclassifying merchants to exploit credit card fee structures, said people familiar with the matter. This, it’s been learnt, has already triggered adjustments in interchange rates by major card networks. 

Several payment aggregators are said to have misclassified merchants, typically in the retail category, under utility — a segment that traditionally draws lower interchange rates. Such a move allowed payment firms to allegedly pocket the difference between what merchants were charged and what issuing banks received. 

“For many, this is the business model,” said a senior executive of a private player, requesting anonymity. 

Interchange fees are paid to a card-issuing bank every time its customer uses a credit card to carry out a transaction. 

The people in the know said the value of transactions processed through such an underhand method may exceed ₹5,000 crore per month.  Furthermore, the sources confirmed that the financial regulator has taken cognizance of the matter. The RBI, however, did not respond to Business Standard’s queries regarding the probe into the matter.

 

After the practice was identified, major card network players -- Mastercard and RuPay -- responded by raising the interchange rates for utility merchant category codes (MCCs) from 0.85 per cent to 1.85 per cent. The interchange rates for retail MCCs is around 1.85 per cent.

 

Visa is expected to follow suit.

   

Mastercard, RuPay, and Visa did not respond to email queries about reasons for raising interchange fees for utilities.

 

The updated interchange structure brings the utility category in line with other MCCs to reduce arbitrage between higher- and lower-value segments. “Payment aggregators (PAs) started marking retail merchants as utilities,” said the executive quoted above. “They (retail merchants) are charged a higher fee, but in the background a lower interchange is processed. The difference is kept.”

 

Industry executives attributed the trend to thin margins in the payments business, growing competition, and pressure to justify valuations as several players eye public listing. There are currently 53 online payment aggregators registered with the RBI.

 

Some players said the interchange hike for utilities may weigh on consumers. “An interchange fee of 1.85 per cent is too high for a credit card transaction to pay for basic utility service,” said another person with knowledge of the matter. “At that level, card usage may drop in the future.”

 

Aggregators’ cost bases benefit from artificially low interchanges, creating a margin between what merchants are charged and what is passed to the issuing banks through misclassification. “Some players have acquired BINs (bank identification numbers) of their own. In such cases, banks have agreements where merchant onboarding and MCC assignments are handled by the private players directly,” one of the people said.

 

According to competing PAs, fintechs that misclassified MCCs were able to offer merchants lower fees than typical market rates, since they were processing the transactions at a much lower cost on the backend.

 

“If the retail category had a 1.8-1.9 per cent interchange, problematic players offered a 1.4-1.5 per cent rate just to attract business,” said an executive at a large payments aggregator. “Since their merchant was misclassified as utility, only 0.8 per cent interchange was processed behind the scenes. We can’t run a loss-making business by trying to match that.”