UPI vs cards: Why merchants pay MDR on cards but not on UPI payments

UPI payments are free for merchants, while card transactions carry MDR. Here's why the two digital payment systems have different costs and how a possible UPI charge could work

Unified Payments Interface (UPI) has become a key part of India’s digital payments system. From small shops and street vendors to large retailers and online businesses, millions of merchants now accept UPI. Yet, unlike most card transactions, ordinary bank-account-funded UPI payments currently carry no Merchant Discount Rate (MDR) for merchants.

 

So, why are the two systems treated differently?

 

What is MDR and who pays it?

 

MDR is the fee a merchant pays for accepting and processing certain digital payments. In the card ecosystem, it is borne by the merchant rather than the customer. The charge is not simply income for the merchant’s bank. The Reserve Bank of India (RBI) says MDR is divided among issuers, acquirers, card networks and other entities involved in the payment chain. It has also directed banks to keep different components of MDR unbundled for greater transparency.

 

How do UPI, debit cards and credit cards differ in costs?

 

The source of money is only one part of the difference. The payment rail, acceptance infrastructure and pricing framework also determine how transaction costs are recovered. 

Photo: AI-generated image

 

 

A UPI payment usually moves money directly from the customer’s bank account to the merchant’s bank account through an interoperable payment rail. The customer is not being passed credit for the transaction.

 

A debit card offers the closest comparison with ordinary UPI because it also typically uses money already available in the customer’s bank account. However, the transaction is processed through card-acceptance infrastructure and a card network, and operates under a different MDR framework.

 

Card payments connect the merchant with the acquiring bank, card network and issuing bank. The MDR paid by the merchant helps support this payment chain.

 

For debit cards, RBI has historically set caps on MDR. Its framework has also differentiated charges based on merchant category and whether the payment is made through physical or digital acceptance infrastructure.

 

A credit card works differently because the card issuer extends a line of credit to the customer. A typical credit-card transaction involves the cardholder, issuing bank, merchant, acquiring bank and card network. RBI defines the interest-free credit period as the time between the transaction and the payment due date, provided the customer clears the outstanding amount in full.

 

Credit-card MDR is not subject to the same RBI cap framework as debit cards. Finance Minister Sitharaman recently said merchants routinely pay around 1.5-2 per cent or more on credit-card transactions and up to 0.90 per cent on debit cards.

 

Credit cards also have additional economics associated with extending and managing credit. Issuers can earn interest and cardholder fees, while interchange and other payment-related income form part of the wider card ecosystem. Rewards, cashback and interest-free credit are therefore part of the broader credit-card business model rather than a standalone explanation for MDR.

 

So if both debit cards and ordinary UPI generally draw money from a bank account, why are they priced differently? 

 

Why is UPI free for merchants today?

 

The answer to the question above is policy rather than technology. The government introduced zero MDR on UPI from January 2020 to encourage digital payments and reduce the use of cash. Before that, UPI merchant transactions could attract MDR of up to 0.30 per cent.

 

This means merchants currently do not pay MDR on ordinary bank-account-funded UPI transactions even though the ecosystem continues to incur technology, processing, security and infrastructure costs.

 

Who pays for UPI when merchants do not?

 

The absence of MDR, however, does not mean a UPI transaction has no cost. Banks, payment service providers and other participants still incur technology, processing, security and infrastructure costs.

 

The difference is who bears those costs. The government has supported the ecosystem through incentives, while the payment industry has argued that a revenue mechanism is needed as transaction volumes continue to grow.

 

The Parliamentary Standing Committee on Finance recently noted that the government had allocated ₹2,000 crore to incentivise UPI transactions and offset zero-MDR losses, while the industry’s estimated operational cost was ₹20,700 crore. The Finance Ministry is now considering either restoring MDR for certain high-value transactions or introducing a tiered incentive structure to gradually reduce government support. 

Could MDR return for UPI payments?

 

Parliament has cleared a legal framework that allows the government to permit MDR on notified digital payment modes, including UPI. However, no UPI MDR rate or final framework has been announced yet.

 

According to Finance Minister Nirmala Sitharaman, any future charge would be limited to certain merchant transactions above a prescribed high threshold. Small merchants such as tea vendors, vegetable sellers, street vendors, auto drivers and kirana stores would not be covered.

 

The government has also said that consumers will continue to make UPI payments without a transaction charge, while any future merchant MDR would be nominal and lower than card MDR. The UPI and Services Steering Committee, headed by the National Payments Corporation of India (NPCI), is expected to work out the structure and threshold if such a system is introduced.