India ends free ride for larger transactions on its ubiquitous digital payments network

India has discontinued the practice of providing free processing for large transactions on its widely used digital payments network, marking a significant change in its financial structure. The Unified Payments Interface (UPI) will now charge merchants a 0.4% fee on transactions exceeding ₹2,000 (approximately $21) starting October 15, according to the National Payments Corporation of India (NPCI), the entity overseeing the network.

Consumers will continue to utilize the service at no cost. Credit card and debit card fees typically hover between 1.5% to 2.5% and 0.9% per transaction, respectively, as per NPCI's frequently asked questions (FAQ) document.

The fee is capped at ₹300 (around $3) for transactions of ₹75,000 (about $783) and above, while payments under ₹2,000 will remain free for merchants. Small merchants receiving up to ₹100,000 (approximately $1,041) per month via UPI will also be exempt from the charges. This adjustment represents a notable pivot for a payments system that had been fee-free for merchants since 2020, a policy that had been widely anticipated by the payments industry, which argued that the zero-fee model hindered the ability to cover the escalating costs of maintaining the network.

In August, the Indian government had authorized UPI merchant fees, following amendments to India's payments law. A notification issued on Monday clarified that banks cannot charge fees on UPI transactions of up to ₹2,000, paving the way for fees on larger transactions. UPI has become the backbone of India's digital payments ecosystem, handling 24.51 billion transactions worth ₹29.9 trillion ($312 billion) in August, as reported by NPCI. Its widespread adoption has made scanning a QR code a common method of payment in India.

India had initially eliminated merchant fees on UPI transactions in January 2020 to spur adoption. However, authorities have expressed concerns about the sustainability of the current model given the network's extensive operations. Industry estimates, as per NPCI, suggest the annual cost of running UPI, including server capacity, fraud prevention, and technical support, reaches around ₹200 billion ($2.1 billion).

The newly introduced merchant fees are intended to be shared among UPI participants and allocated to enhance infrastructure, cybersecurity, fraud prevention, and customer service. NPCI has not disclosed the methodology used to calculate the ₹200 billion annual cost estimate, the anticipated revenue from the new fees, or how the funds will be allocated across the UPI ecosystem.

The implementation of merchant fees has sparked debates on whether they may diminish UPI's most significant advantage: its costlessness for consumers. While consumers are not directly charged, merchants accepting larger payments will now bear a fee that did not exist previously. Krishnamurthy Subramanian, a former chief economic adviser to the Indian government, questioned the trade-off between charging UPI transactions and the social benefits of the platform, such as reducing cash reliance, encouraging formal economy participation, and improving digital payment accessibility.

Subramanian emphasized the need to consider the opportunity cost of charging UPI transactions and the associated social benefits.

To mitigate this risk, NPCI has ensured that smaller transactions remain fee-free. UPI transactions of up to ₹2,000 account for over 95% of merchant transactions by volume, NPCI stated. The payments operator plans to utilize some of the fees to establish a fund aimed at expanding digital-payment infrastructure and merchant adoption in smaller cities and rural areas, with the fund's specifics set to be finalized with India's central bank over the next three months.

The new fee could also generate revenue for payment companies that have invested significantly in building the infrastructure to process UPI transactions. Fintech firms such as Paytm, Pine Labs, PhonePe, and Razorpay, among others, could benefit from the fee distribution across the payments ecosystem. Nonetheless, the effectiveness of the move will be determined by how merchants absorb the added cost or encourage customers to use alternative payment methods, particularly for larger purchases and in businesses with slim profit margins.

Merchants are barred from passing the fee onto customers, NPCI affirmed, asserting that the 0.4% charge is sufficiently low for businesses to accommodate. Consumers will continue to pay the advertised price irrespective of the payment method used.