Price regulation of UPI: Policymakers must be careful

Source– The post is based on the article “Price regulation of UPI: Policymakers must be careful” published in The Indian Express on 7th November 2022.

Syllabus: GS2- Indian economy

News- The article explains the issue of price regulation of UPI payment.

Why might a regulator want to intervene in the price setting of the payments market?

Goals of financial inclusion or viewing digital payments as a public good.

Addressing market failures such as the presence of dominant firms or externalities.

What are the challenges associated with intervention in the price setting of the payment market?

In the case of UPI, the government subsidises the operational costs of facilitating UPI transactions, which is reportedly inadequate. In January 2022, the Payments Council of India reported that the industry expected a loss of Rs 5,500 crore. This to be the best allocation of limited government resources.

Merchant discount rate on UPI payment is 0.25%. It is not reasonable. MDR cap is set at 0.9 percent for debit cards and an MDR of 2 per cent being proposed for RuPay credit cards on UPI.

There are behavioural challenges in moving from zero MDR to a positive MDR. Anchored at a zero MDR since January 2020, merchants  with thin margins may hesitate to accept an increase in MDR.

What can be the further course of action?

Consumers benefit more if the size of the merchant network accepting a payment instrument is larger. Merchants benefit more if many consumers use debit cards.

UPI involves payment service providers of payers and payees, the remitter and beneficiary banks as well as NPCI. The market for merchant acquisition is usually more competitive and can be left unregulated. If necessary the interchange fee between the two payment service providers can be regulated. If both markets are sufficiently competitive, regulation should focus upon establishing a floor charge.

A related example is available in the telecom industry. Facilities provision is regulated through the interconnection. Retail prices for the telecom services segment are left to the market.

The next step is to determine the price level. The optimal level would depend on whether the regulator cares only about total welfare of all stakeholders  and whether the issuing and acquiring banks make positive margins on each transaction.

In general, benefits of regulatory intervention outweigh the costs of intervening. The costs of intervening not only include the administrative costs, but also potential costs arising from setting the wrong interchange fee or cap.

Policymakers must collect more data on costs of transfer, user preferences, both merchants and consumers. They should undertake a thorough analysis of substitutability and competition in the digital payments sector.