Time to say goodbye to subsidy for UPI? A case for tiered MDR regime

A time-bound, tiered MDR on large commercial UPI merchants, with small merchants and individuals permanently exempted, is in order, and so is revenue allocated to strengthen infra & rural expansion

India’s Unified Payments Interface (UPI) processed 22.6 billion transactions worth over ₹29.5 trillion in March 2026. In FY26, there were 241.617 billion transactions worth ₹314.23 trillion.

 

The National Payments Corp of India (NPCI) developed UPI as a secure, instant, and interoperable real-time payment system, and then Reserve Bank of India (RBI) governor, Raghuram Rajan, launched it on April 11, 2016 as a pilot with 21 member banks. The banks started making UPI-enabled apps available on the Google Play Store from August 25, 2016. That month, there were 93,000 transactions valued around ₹3 crore.

 

The same year, on December 30, Prime Minister Narendra Modi launched the UPI-based BHIM, or Bharat Interface for Money, app.

 

A recent study by an independent third-party research agency, conducted in consultation with NPCI, found that between 2021 and 2025, digital transactions in India rose nearly 11 times, with UPI’s share at 80 per cent. The number of banks operational on the UPI platform rose from 216 to 661 during this period. About 65 per cent of UPI users report multiple digital transactions per day. Preference for UPI is particularly pronounced in the 18-25 age group.

 

Among merchants, digital acceptance has reached near universality, with 94 per cent of small merchants having adopted UPI. About 72 per cent expressed satisfaction with digital payments, citing faster transactions, improved record-keeping, and operational convenience, while 57 per cent reported an increase in sales. 

 

No other retail payment system in the world can match UPI when it comes to scale, speed and interoperability. The icing on the cake: Zero cost for the users. This is a unique financial architecture. 

 

However, both the finance ministry’s Department of Financial Services and the RBI have deemed the free-to-use model unsustainable in the long run.

 

The Parliamentary Standing Committee on Finance, chaired by Bhartruhari Mahtab, recently voiced what the payments industry has been discussing in private: The current zero merchant discount rate (MDR) policy is not a permanent solution. The committee has proposed that while street vendors and small businesses may continue receiving free services, large commercial UPI merchants could be charged.

 

The DFS has confirmed the numbers behind that logic to the Parliamentary committee.

 

The government currently compensates banks, payment system operators, and app providers through an incentive scheme for processing zero-MDR transactions. The DFS told the committee that this incentive scheme covers only 11 per cent of actual industry costs. It also represents just 14 per cent of the MDR revenue the industry forgoes under the current policy.

 

Allocations under the incentive scheme over the years confirm the structural gap: ₹1,500 crore in FY22, ₹2,600 crore in FY23, ₹3,500 crore in FY24, which fell steeply to ₹1,500 crore in FY25. In the same financial year, the incentive for RuPay Debit cards was significantly reduced.

 

A system where the government uses public money to subsidise one-seventh of market-rate costs is not an ideal pricing strategy. It is a contingent liability, growing with every transaction processed.

 

Let’s look at how the payment networks operate in India. They connect consumers and merchants, and both parties see value in it. Research about such platforms establishes a clear pricing principle: Charging one side, while subsidising the other can expand total participation, increasing the system’s value for everyone. 

 

Price structure is not incidental to the success of the platform. It determines how costs and incentives are distributed across participants.

 

For instance, pioneering research by Jean-Charles Rochet and Jean Tirole on multi-sided platforms and two-sided markets explains how businesses such as Google, Visa, and Amazon operate by charging different prices from different customer groups to encourage participation from both, solving the “chicken-and-egg problem”.

 

UPI’s early pricing model subsidised both sides simultaneously. That was fine at the adoption phase. No-cost transactions played a key role in onboarding at least 500 million users and millions of small merchants within a few years. Indeed, the zero-MDR regime was the suitable policy at that time.

 

However, the problem confronting policymakers today is different. Infrastructure economics are not equal to adoption economics. A system that processes tens of billions of transactions every month requires sustained investment in reliability, fraud detection, dispute resolution, capacity planning, and security upgrades.

 

Those costs don’t diminish with scale. When infrastructure operates without a cost-recovery mechanism, there is no incentive for investments, and over time, it starts drying, quietly and unevenly, until the gap between required and actual investments becomes visible in the system’s performance.

 

The committee’s proposal addresses the distributional objections that have stalled the MDR debate for years. Small merchants and individual users remain on zero charges. The fee applies only to large commercial entities and high-volume institutional users. When it comes to organised retail, e-commerce platforms, and large-format service providers, UPI offers a competitive advantage. Their transaction economics can comfortably absorb the small cost component.

 

Mature, two-sided platforms price differentially across user segments as a matter of standard design. Card networks, logistics platforms, and marketplace infrastructure, all operate on cross-subsidy logic – large commercial users fund the infrastructure that smaller users access at lower or no cost. The committee has proposed extending the same logic to UPI, calibrated to India’s distributional priorities.

 

The objection that MDR will reverse small merchant adoption doesn’t hold against the proposal’s design. If small merchants are explicitly exempted, their adoption trajectory is unaffected. The question is whether large commercial users will reduce UPI acceptance if charged a modest fee. Given UPI’s consumer penetration and the absence of a credible alternative, that is highly unlikely.

 

The DFS has also flagged to the committee a problem beyond the MDR debate: The adoption of digital payments remains concentrated in urban areas. Rural and underserved geographies lag on merchant acceptance infrastructure, connectivity, and onboarding support. The government has added a cashback component to the incentive scheme to address this.

 

Sustained rural expansion requires hardware deployment, last-mile merchant onboarding, investment in connectivity and dispute resolution in a low-literacy ecosystem. A tiered MDR, structured with a ring-fenced allocation, converts what is now a pure fiscal outlay into a partially self-funding model. That’s not a compromise on UPI's public good character.

 

The zero-MDR policy was introduced in January 2020 as a temporary measure to accelerate adoption. Six years later, while UPI adoption achieved an unprecedented scale, the temporary measure continues.

 

A time-bound, tiered MDR on large commercial UPI merchants, with small merchants and individuals permanently exempted, is in order, and so is revenue allocated for strengthening infrastructure and rural expansion.

 

The Parliamentary committee has provided the long-needed political space for a course correction on costing logic. The government’s response will determine whether UPI’s next decade will match its first.

 

In a recent survey of at least 39,000 users across 376 districts, only 25 per cent said they would be willing to pay a transaction fee. The remaining 75 per cent indicated they would stop using UPI if charges were imposed. The users covered in the survey don’t need to bother since only large merchants may have to pay the fees.

 

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The writer is an author and senior advisor to Jana Small Finance Bank Ltd. His latest book: Roller Coaster: An Affair with Banking. To read his previous columns, log on to www.bankerstrust.in. X: @TamalBandyo