How merchant discount rate can drive credit card acceptance in a big way

Credit card numbers in India continue to hit new highs; in April, the issued base was 86.5 million, with total spending at Rs 1.32 trillion. Yet for such an in-your-face business, the country has one of the lowest “credit-card activation rates” in the world. Over half the plastic is not activated by customers within the first three months after it reaches their wallets. And of the 86.5 million base, those who hold a single card account for nearly 50 million.

Mint Road’s move to pair RuPay credit cards with the Unified Payments Interface (UPI) in June last year was spoken of as being a game-changer that would trigger wider acceptance beyond the roughly 8 million point-of-sale (PoS) machines to nearly 50 million outlets which have embraced UPI. But there is nothing from the field yet to suggest that this is how it may play out. The signals are mixed.

According to a report released in May by NeoGrowth Credit (Decoding Digital Payments: A Retailer Perspective), a non-banking financial company that focuses on lending to micro, small and medium enterprises, 70 per cent of the outlets believe that more than half of their sales will be via UPI. This was based on the digital lenders’ customer data of 3,000 retailers along with a survey of 1,000 retailers, across 25-odd cities and 70-plus retail segments.

The period covered was October-December of 2019, 2021 and 2022 – the peak festive seasons on either side of the pandemic. Card usage (credit and debit) was declining, the report said, in areas such as fashion and lifestyle, and in the metros.

According to Arun Nayyar, managing director (MD) and chief executive officer (CEO) of NeoGrowth Credit, “over 50 per cent of retailers reported an increase in sales after adopting digital payment modes. They feel that accepting digital payments has enhanced the overall customer buying experience.” But is that all there is to it?

It’s the MDR again

“The absence of the merchant discount rate (MDR) has played a significant role in driving UPI’s widespread adoption among merchants, distinguishing it from traditional card-based payments,” says Ketan Patel, CEO of MSwipe Technologies, a leading deployer of PoS units.

The MDR kicks in every time you transact on ticket sizes above Rs 2,000 on RuPay-UPI credit cards; it is shared by participants in the loop — issuers, acquirers, the network (RuPay) and non-bank deployers. (Outside of this arrangement, even Visa and MasterCard come into the picture.)

Patel seems to suggest that the MDR is a friction point. In fact, among the reasons why there are only 8 million PoS units in the country are the Rs 10,000-plus hardware, and monthly charges of about Rs 300 to onboard merchants, apart from the MDR. It took a few months for the National Payments Corporation of India and banks to hammer out the pricing on RuPay-UPI credit cards at two per cent. Of this, 1.5 per cent goes to the issuing bank, with the rest (50 basis points) being shared by RuPay and the acquiring entity (either a bank, or the likes of Mswipe or Paytm).

On the subject of resistance to the MDR at smaller outlets, Shyam Srinivasan, MD and CEO of Federal Bank, reckons that “any new arrangement takes time to settle down. Give it six months more and then we will talk.” Federal Bank is now piloting its RuPay-UPI credit card foray.

A compelling reason why smaller merchants may, over time, drop their reluctance to embrace RuPay-UPI-linked credit cards, say bankers, is that customers tend to use credit cards for higher-value transactions, so as to benefit from the interest-free credit window period, which enables them to earn reward points and cashbacks. “It will be challenging for a substantial portion of the merchant base to avoid credit-card payments for an extended period”, adds Patel.

New acts

Is it time to rethink the MDR on credit cards in general, to boost their usage?

Mint Road’s discussion paper, Charges in Payment Systems, released in August 2022, sought feedback on a couple of critical aspects.

One was a move to split the game into two — the cost of enabling a digital payment at an outlet, and the cost of interest foregone (including the credit risk) by the issuer. The merchant can be charged only for the cost of enabling payment, which is similar to a debit card; the other element of cost (the cost of providing interest-free credit) is anyway recovered by the issuer from the cardholder separately.

The other was to make the MDR on such transactions equal to that on debit cards plus the average rate charged by a few large banks for 30 days’ credit, considering that customers get, on average, a 30-day interest-free period on credit card bills. This MDR may be reset for the entire industry, once a year at the beginning of the financial year, based on the average lending rates of a few large banks during the previous financial year.

Are we missing the big picture in all of this?

“Over time, we may have pricing on UPI through a variable MDR”, says Raman Khanduja, co-founder of Mintoak Innovations, a digital payments platform. “It’s a first in the world — the use of a real-time account for credit-card transactions providing instant settlements into the merchants’ bank account. This significantly alters the role of the acquiring banks”, says Uttam Nayak, former senior vice-president at Visa.

It’s an indirect way of saying that the four-party model in credit cards — customers, issuing banks, acquiring banks, and merchants — is ripe enough to be re-imagined. The roll-out this month of FedNow, the United States Federal Reserve’s instant payment service, may be a pivotal moment for US-based card networks. “This is a Tesla moment and will challenge the traditional business models linked to card payments for decades,” adds Nayak.

What is left unsaid is that the local credit cards business will take its cues from this development.