UPI and the Merchant Discount Rate (MDR): Who Pays for India’s Digital Payments Revolution?

The front page of The Hindu of 28 September 2026 carried a full-page advertisement by twelve public sector banks, including SBI, Bank of Baroda, Canara Bank, Punjab National Bank and Union Bank of India, under the headline “UPI: Same ease for you, getting stronger for tomorrow”. The message was carefully calibrated: all person-to-person (P2P) transactions remain free, 96 per cent of person-to-merchant (P2M) transactions remain free, and only the small share of larger merchant payments would attract a Merchant Discount Rate (MDR). An advertisement of this scale, from the country’s largest banks, signals that a significant change in the economics of the Unified Payments Interface (UPI) is under way.

To understand why this matters, one must recall that UPI, developed by the National Payments Corporation of India (NPCI), is now the backbone of India’s retail payments, processing well over twenty billion transactions a month by 2025. It has been free for merchants and consumers since January 2020, when the government mandated zero MDR on UPI and RuPay debit cards. The zero-MDR regime built a network, but it left banks, payment service providers and the NPCI with the cost of running the infrastructure, which the government has partly met through incentive schemes. The pressure to find a sustainable model has therefore been building for years.

For UPSC aspirants the topic sits at the intersection of financial inclusion, fiscal policy, regulation and consumer protection. It is relevant to GS-III (Indian economy, inclusive growth, banking and technology) and to the Essay paper, and it teaches a key lesson in public policy: free public digital infrastructure needs a credible funding model.

Background and Context

MDR is the fee a merchant pays its bank for accepting digital payments, typically shared among the acquiring bank, the issuing bank and the network. Under the Payment and Settlement Systems Act, 2007, as amended in 2019 through Section 10A, charges on electronic modes prescribed under Section 269SU of the Income-tax Act were barred from 1 January 2020. The advertisement of 28 September 2026 states the new contours as a set of public assurances; the operational details will depend on official notifications by the Reserve Bank of India (RBI) and the NPCI.

Five Important Key Points

• According to the bank advertisement, all person-to-person UPI transactions will remain free of charge.
• The advertisement states that 96 per cent of person-to-merchant transactions are free, and only 4 per cent exceed ₹2,000.
• Essential and government services are free up to ₹2,000, while transactions above ₹2,000 attract a flat ₹5 MDR.
• MDR is charged per transaction and not on the total UPI receipts of a merchant in a day, so multiple transactions of up to ₹2,000 each remain free.
• Small merchants receiving up to ₹1 lakh a month through QR codes are eligible for zero MDR, and the Maximum Retail Price (MRP) of a product remains the same whether paid by card, cash or UPI.

The Economics of a Zero-MDR System

Zero MDR is not zero cost. Payment infrastructure requires banking servers, fraud management, dispute resolution and customer support, and these costs are borne by someone. Since 2020 the Union government has offered incentives to banks for promoting UPI and RuPay debit transactions, running into several thousand crore rupees over successive years, and the size of these budgetary allocations has declined in recent years. Banks have argued that they are absorbing losses on high-volume, low-value transactions. A tiered structure, with a small fee above a threshold, is a classical response: it protects the mass of small users while allowing cost recovery from larger transactions, where the fee is negligible as a proportion of the value.

Legal and Regulatory Framework

The regulator of payment systems is the RBI under the Payment and Settlement Systems Act, 2007, while the NPCI operates as a not-for-profit umbrella organisation for retail payments. Any MDR on UPI must be consistent with Section 10A, which the government may amend or notify around. The Income-tax Act’s Section 269SU obliges certain businesses to offer prescribed electronic modes. Consumer protection concerns arise under the Consumer Protection Act, 2019, since surcharging a customer for using a particular payment mode can be an unfair trade practice. This is why the advertisement’s assurance that the MRP will remain “the same for any mode” is important: it signals that merchants are not expected to pass on the MDR to customers.

Small Merchants and Financial Inclusion

The advertisement’s promise of zero MDR for small merchants with up to ₹1 lakh a month of QR receipts is the most consequential inclusion feature. India has millions of street vendors, kirana stores, dairy sellers and micro-enterprises for whom even a one per cent fee would eat a substantial fraction of their thin margin. Programmes such as the PM SVANidhi for street vendors encourage digital transactions, and the payment history builds a credit footprint that can help unlock formal credit. Retaining zero MDR for this segment protects the inclusion gains that made UPI a global example, while the tiered structure keeps larger merchants within a cost-sharing framework.

Market Structure and Competition

UPI’s third-party app market is highly concentrated, with two apps handling the bulk of volumes, which has led the NPCI to propose a market-share cap, repeatedly deferred. Any MDR regime will influence the incentives of these apps, which currently earn little from UPI payments and monetise through ancillary services such as loans and insurance. A revenue stream from MDR could change that behaviour, and could also encourage the entry of smaller players. Competition policy and prudential regulation must therefore be considered together with pricing.

Global Comparisons and Governance Concerns

Brazil’s Pix, the closest comparator, is similarly free for individuals and charges merchants low fees, while Europe’s SEPA instant payments and the United States’ FedNow both operate with low interchange to keep payments cheap. Governance concerns in the Indian case include transparency of the fee tier, the risk of retrospective changes, the burden on merchants who exceed the threshold, and grievance redressal in case of failed or disputed transactions. The advertisement itself, by promising a single clear rule, is an attempt to pre-empt the confusion that arose earlier when interchange charges on prepaid payment instruments were introduced.

Bihar Connection

Bihar is one of the States where digital payments have penetrated deeply into small-town and rural commerce, from tea stalls and vegetable vendors to weekly haats. The State’s economy is dominated by micro and small enterprises, and its households depend heavily on remittances from migrant workers, who send funds through UPI to family accounts; these are P2P transfers and stay free. Direct Benefit Transfers to women beneficiaries under State schemes also flow into bank accounts that are then spent at small merchants. The zero-MDR ceiling for small merchants is thus directly relevant to Bihar’s informal economy, while the flat ₹5 charge on larger essential-service payments raises questions for cash-strapped local bodies and utilities.

Way Forward

Regulators should notify the tier structure formally, with a clear definition of the ₹2,000 and ₹1 lakh thresholds, to prevent ambiguity. The sharing of MDR between acquirers, issuers and the NPCI should be transparent and periodically reviewed. Merchants should be barred from surcharging customers, and the RBI’s ombudsman mechanism should be strengthened for failed transactions. The government should retain a targeted subsidy for the smallest merchants rather than reverse the zero-MDR policy altogether. Finally, enforcement of the market-share cap should be revisited to reduce systemic concentration risk.

Relevance for UPSC and SSC Examinations

For UPSC, the topic is relevant to GS-III (banking, financial inclusion, payments infrastructure, role of technology in the economy, inclusive growth) and to the Essay paper on digital public infrastructure. For SSC, it covers banking awareness, RBI functions, NPCI, UPI and digital payments. Key terms to remember: UPI, NPCI, MDR, P2P, P2M, Payment and Settlement Systems Act 2007, Section 10A, Section 269SU, RuPay, Pix, interchange fee, market-share cap, PM SVANidhi.