Merchant discount rate

Also called: MDR · Topic: Payment Systems and Digital Finance · NCERT: Beyond NCERT

Meaning

Merchant discount rate (MDR) is the fee a merchant (shopkeeper or seller) pays to banks and payment firms for accepting card or digital payments. It is usually a percentage of the transaction value.

• Formula:
• MDR amount = Transaction value × MDR rate
• Amount the merchant receives = Transaction value − MDR amount

MDR matters because it decides who pays for digital payments. A high MDR makes merchants avoid digital payments. A zero MDR spreads digital payments fast, but banks and apps then earn nothing for running the system.

Explanation

How MDR works

• Every digital payment has a cost: servers, networks, fraud checks and customer support.
• In the cheque era, banks recovered this cost through cheque-book and clearing charges.
• In the card era, the merchant paid a fee on each card sale. This fee is the MDR.
• In the UPI era, the government made most merchant payments free. So "who pays?" became a policy question.
• The merchant pays, not the customer. The fee is cut from the money the merchant receives.

Who shares the MDR

The MDR is split among three players:

• Acquiring bank (the merchant's bank). It gives the merchant the card machine or QR code and puts the money into the merchant's account.
• Issuing bank (the customer's bank, which issued the card). Its share is called the interchange fee.
• Network, such as RuPay/NPCI, Visa or Mastercard. It carries the payment message between the two banks.

MDR is not a tax. The Government and NPCI do not collect it. It is shared among the firms that run the payment system (banks and payment apps), to pay for its operation and growth [4].

Worked examples

1. Card payment with MDR (illustrative numbers only)

• A customer pays ₹1,000 by card. The MDR is 2%.
• MDR = ₹1,000 × 2% = ₹20.
• The merchant receives ₹1,000 − ₹20 = ₹980.
• The ₹20 is shared among the acquiring bank, the issuing bank and the network.

2. UPI payment under zero MDR

• A customer pays a small tea-stall owner ₹1,000 by UPI.
• The merchant pays ₹0 MDR.
• Instead, the government pays the banks an incentive of ₹1,000 × 0.15% = ₹1.50 (FY 2024-25 scheme) [2].

What makes MDR rise or fall

• Law and regulation: the government can fix it at zero for chosen payment modes. India did this for RuPay debit cards and BHIM-UPI.
• Size of the merchant: a policy can keep small merchants free and charge only large ones.
• Value of the transaction: in India, MDR on UPI applies only to specified merchant payments above ₹2,000 [4].
• Type of instrument: the fee can differ for a card, a UPI payment from a bank account, and a wallet payment.
• Cost of running the system: more spending on servers and fraud control needs more revenue. That revenue comes from MDR or from a government subsidy.

In India

• Zero MDR from 1 January 2020: merchants pay no MDR on payments made through RuPay debit cards and BHIM-UPI.
• Legal basis: Finance (No. 2) Act 2019. It made two changes:
• It added s.10A to the Payment and Settlement Systems Act, 2007 (PSS Act). No bank or system provider may charge MDR on the prescribed digital modes.

• It added s.269SU to the Income-tax Act, 1961. Large businesses must offer these prescribed digital modes to their customers.

• Current position (2026):

• Person-to-person (P2P) UPI payments are free, whatever the amount [4].
• About 96% of merchant UPI transactions carry no charge. They are either below ₹2,000 or covered by the zero-MDR rule for small merchants [4].
• MDR applies only to specified merchant transactions above ₹2,000 [4].

• Customers are never charged.

• Government incentive scheme (to fill the zero-MDR gap):

• The problem: under zero MDR, banks earn nothing on these payments, but they still bear the cost of running them.
• The fix: the Centre pays banks a small incentive instead.

Year	Coverage	Outlay
FY 2022-23	RuPay debit and low-value BHIM-UPI (P2M)	₹2,600 crore [1]
FY 2024-25	Low-value BHIM-UPI (P2M) only	₹1,500 crore (estimated) [2]

• In FY 2024-25, the scheme covered only UPI P2M (person-to-merchant) payments up to ₹2,000 made to small merchants, at 0.15% of the transaction value [2].

• In 2026, the Department of Financial Services (Ministry of Finance) released a report on the scheme's socio-economic impact [3].

• Wallet (PPI) interchange (2023):

• A PPI (prepaid payment instrument) is a wallet or prepaid card. You load money into it first and spend it later.

• An interchange fee of up to 1.1% applies to merchant UPI payments above ₹2,000 made from wallets. Large merchants pay it. Customers do not.

• Scale of what zero MDR supports:

• Total digital payment transactions rose from 8,839 crore (FY 2021-22) to 18,737 crore (FY 2023-24) [5].

• Over this period, UPI grew at a CAGR (compound annual growth rate, the average yearly growth over a period) of 69% [5].

• Policy review: the RBI's Discussion Paper on Charges in Payment Systems (2022) set out the trade-offs in charging for UPI, cards, wallets, IMPS, NEFT and RTGS, and asked the public for views.

Don't confuse with

• Interchange fee: this is only one part of the MDR, the share that goes to the issuing bank (the customer's bank). MDR is the full fee the merchant pays.
• Tax / government levy: MDR is not a tax. It goes to banks, payment apps and networks, not to the Government or NPCI [4].
• Government incentive scheme: here the government pays the banks (0.15% in FY 2024-25) [2]. Under MDR, the merchant pays. The incentive replaces the MDR that zero-MDR payments no longer earn.
• PPI (wallet) interchange (2023): this fee of up to 1.1% applies only to wallet-based merchant UPI payments above ₹2,000. It is not the general MDR on bank-account UPI payments.

Prelims Hooks

• MDR is paid by the merchant, not the customer. It is shared among the acquiring bank, issuing bank and network. It is not a tax and is not collected by the Government or NPCI [4].
• Zero MDR on RuPay debit cards and BHIM-UPI has applied from 1 January 2020, under the Finance (No. 2) Act 2019.
• Trap: s.10A is in the PSS Act, 2007 (no MDR on prescribed modes). s.269SU is in the Income-tax Act, 1961 (large businesses must offer prescribed digital modes).
• P2P UPI is free whatever the amount. About 96% of merchant UPI transactions are free. MDR applies only to specified merchant payments above ₹2,000 [4].
• FY 2024-25 UPI incentive: ₹1,500 crore outlay, 0.15% on P2M payments up to ₹2,000 to small merchants [2]. FY 2022-23 outlay: ₹2,600 crore [1].
• Wallet (PPI) interchange (2023): up to 1.1% on merchant UPI payments above ₹2,000, paid by the merchant.

Mains Points

• Can a free public good last?
• Zero MDR drove UPI's growth: digital transactions rose from 8,839 crore in FY 2021-22 to 18,737 crore in FY 2023-24 [5].
• But the budget subsidy that replaces MDR has shrunk, from ₹2,600 crore to ₹1,500 crore [1][2].

• Way forward: a tiered MDR. Keep P2P and small merchants free, and charge a small fee to large merchants on high-value payments. This is already partly done above ₹2,000 [4].

• Inclusion vs investment (GS-III):

• For zero MDR: small merchants such as vegetable sellers adopt UPI quickly. Less cash means more formal records, which helps them get credit and helps tax collection.
• Against zero MDR: if banks and apps earn nothing, they invest less.
  • Less spending on server capacity → more outages.
  • Less spending on fraud controls → more risk for customers.
  • Apps look for money elsewhere (loans, ads, data) → consumer-protection concerns.

• The RBI's 2022 Discussion Paper set out this trade-off openly.

• Zero MDR and market concentration (GS-III, economy and security):

• When payments earn nothing, only firms with deep pockets can survive the losses.
• Smaller and bank-owned apps struggle, so a few big-tech and foreign-owned apps take most of the UPI volume.
• This raises concentration risk (the danger that one app failing stops a large share of national payments), along with data-control risk. A sensible MDR design is part of the answer, together with NPCI's 30% volume cap on third-party apps and support for bank-owned and public apps such as BHIM.

Related concepts

• Payment aggregator

Read more

• Who pays for payments: MDR, aggregators and market structure