What is MDR and Why is it Debated?
MDR, or Merchant Discount Rate, is a fee that merchants pay to banks and payment service providers for processing digital transactions. For years, UPI transactions in India have operated under a 'zero-MDR' regime, a policy that was crucial for its widespread
adoption. This meant that neither the customer nor the merchant paid a fee, which made it a popular alternative to cash. The debate around introducing MDR for UPI stems from the high costs associated with maintaining the payment infrastructure, including servers, cybersecurity, and fraud prevention. Payment companies and banks have argued that a sustainable revenue model is necessary for long-term investment and innovation. RBI Governor Sanjay Malhotra had previously noted that while the decision rests with the government, “someone has to pay the cost” of running the massive infrastructure.
The New UPI Framework: What Changes?
Effective October 15, 2026, the National Payments Corporation of India (NPCI) will introduce a 0.4% MDR on person-to-merchant (P2M) UPI transactions above ₹2,000. This charge is capped at ₹300 for any transaction of ₹75,000 or more. It's crucial to understand that this is not a fee for customers; the government has prohibited merchants from passing this cost on to consumers. Person-to-person (P2P) transfers remain completely free, regardless of the amount. The government and NPCI have stressed that this structured MDR is designed to help fund the ecosystem's operational costs, with the revenue being distributed among the participating banks and payment providers.
A Shield for Small Businesses
The centerpiece of the new rules is the continued protection for small merchants. Businesses operating under the Person-to-Person-Merchant (P2PM) framework will continue to enjoy zero MDR. This protection applies to any small vendor, including neighbourhood shops and street vendors, who receives up to ₹1 lakh per month through UPI QR code payments. These merchants will not be charged MDR even for individual transactions that exceed the ₹2,000 threshold. A merchant will only be moved to the standard P2M category, where MDR applies, after their monthly UPI collections exceed ₹1 lakh for three consecutive months. This policy ensures that the vast majority of India's small and micro-enterprises are not burdened with new costs, preserving the financial inclusion gains driven by UPI.
Who Are the Winners and Losers?
The clear winners are small merchants and consumers. Small businesses can continue to accept digital payments without worrying about their margins being eroded by transaction fees. Consumers also win, as the everyday UPI experience remains free for both P2P transfers and most retail purchases. According to government data, transactions up to ₹2,000 constitute more than 95% of the total volume of UPI merchant payments, meaning the vast majority of daily commerce is unaffected. On the other hand, larger businesses that process high-value UPI transactions will now face a new operational cost. Payment service providers and banks, who have long advocated for a revenue stream from UPI, finally have a framework that allows them to earn from higher-value transactions, which they see as critical for the system's sustainability.
The Road Ahead for Digital Payments
This new, tiered approach marks a significant maturation of India's digital payments policy. It attempts to strike a balance between two competing goals: encouraging widespread digital adoption through zero-fee transactions for the masses and creating a financially sustainable model for the ecosystem's long-term health. While larger merchants might explore encouraging cash or bank transfers for high-value sales to avoid MDR, the convenience of UPI is a powerful incentive for customers to stick with it. The government has also proposed a dedicated fund, supported by 5% of MDR collections, to further promote UPI adoption among small merchants in underserved markets. This hybrid model—free for the majority, chargeable for a minority—aims to ensure that UPI remains a public good while also being a commercially viable platform for the companies that power it.
