Is it always cheaper the better - RBI's approach to MDR

When RBI announced its proposal to change the MDR from percentage based to merchant category based, many newspapers wrote that the regulator’s move would boost digital transactions. In this article, I would like to show why it would not be a good move to artificially cap MDR and suggest few alternative policy regulations to improve the digital transactions.

RBI should de-regulate MDR by leaving it to the market forces to achieve efficiency. First, let us understand what MDR is and its importance to entire payment ecosystem. MDR charge is to Payment system what ticket income is to a movie theater. Just as the theater owner distributes the money earned through ticket fare among various parties involved, movie producer (issuing Bank), distributor (card networks), MDR is distributed among Card Network and issuing bank. Let us assume a situation where movie regulator (not sure if there is one), suddenly reduces the prices and also caps the cut to be given to the movie producer and distributor. Initially, not only the customer feels happy as prices dropped, but also the theatre owner will be ecstatic as he has better margins, just for a while. In the long run, the quality of the movie eventually drops from “Bahubali” to “Flying Jatt” as there is no incentive for producers to produce great movies. I hypothesize that similar situation would arise when MDR gets regulated and artificially kept low. Issuing banks and Card network companies will not have incentive to innovate. To avoid this situation, its recommended to leave MDR to market forces, except for government transactions, so that issuer and acquirer negotiates a sweet spot for the services they provide to the merchants.

While deregulation of MDR looks quite contradictory to achieve the desired outcome of increasing digital transactions, it helps to avoid worsening the root cause for low digital transactions. The root cause for low digitisation of payments is poor acceptance infrastructure such as POS, ATM. By reducing the MDR charges, RBI exacerbates takes away the margins in payments business from bank, worsening the problem of low infrastructure further. Similar deregulation approach adopted by RBI in savings interest rate deregulation , suggesting only ceiling rates of NEFT, RTGS charges worked quite well to improve customer experience. RBI can mitigate the risk of overcharging the customers by prescribing maximum MDR charges, let us say 2.5%, and leave the rest to the market.

Another alternative approach RBI can adopt to increase the digital transactions by improving the acceptance infrastructure is to give equal or better share of MDR to acquiring bank. The following table explains that MDR is skewed in favour of issuing Bank. To keep it simple, acquirer gets 20% of the MDR while issuer walks away with 80% of the prize money, which is why there are only, as of Jan 2017, 2.5 million POS machines and 2 lakh ATMs there are 712Mn debit and 26Mn credit cards. I am sure customer or merchant will not able to make a digital payment without a digital channel available.

Source: Payment Council of India

Quick math indicates that payments business line of Banking industry is likely to become 50% less profitable when MDR gets reduced from current levels to 0.95%/0.45% based on the merchant category. Lower margins to Bankers mean less number of ATMs/PoS, which means merchants don’t have ability to make payments even when it is less costly to accept a digital payment

Source: RBI

MDR at current rates  :   651 cr   Average MDR X (Value of DC trx +Val of CC Trx)

MDR at proposed rates:  186Cr -393Cr

In summary, RBI should focus on making the structural changes to address the root causes rather than trying to manipulating front end charges to improve digitisation. Policy changes such as Deregulation of MDR, even distribution of MDR between issuer and acquirer will help to get there faster.

PS:

• Calculations for MDR are approximated based on the distribution considering DC, CC
• View expressed above are purely personal