Monday, Nov 28, 2022

Conditions for a less-cash India

Financial institutions should incentivise digital transactions, not charge them

 demonetisation, digital economy, digital financial transactions, digital payments, PoS device, demonetisation effects, online bank transactions, India news, Indian Express Illustration by C R Sasikumar

There has been a huge acceleration in digital financial transactions in recent months. Stakeholders are working overtime to increase these, both in terms of numbers and volume. In my view, there are three factors essential for ensuring the scalability and sustainability of digital payments. These are: cost, convenience and confidence.

India is a very cost-sensitive market. If I can save a rupee by using cash as compared to digital, I would opt for cash. Hence, the cost of digital transactions should be almost zero, if not negative, compared to cash. Additionally, if there is an incentive compared to cash transactions, so much the better. However, currently, there are various charges on digital transactions. Irrespective of who (purchaser or seller) pays, it will have an impact on the cost of goods/services. of us would have experienced a situation where we are asked to pay 2 per cent extra for using card.

This charge, known as merchant discount rate (MDR), came about with credit cards. In that situation, the institution issuing credit cards (the issuer), the sponsoring bank of the point-of-service (PoS) device with the merchant (the acquirer) and the settlement provider (typically VISA, Mastercard or more recently, RuPay) all charge for a transaction. The MDR, charged from the merchant, is divided among these three parties. Somehow, this method has also continued for debit cards where there is no credit default risk and payment from the account is instantaneous.

With cards, the PoS device is supplied by the acquirer and hence there can be some justification for the charge, though this charge should be minimal. Unfortunately, the same concept is continuing for mobile transactions as well, though there are no cards or PoS devices. While there were proposals for rationalising this system, not much has happened thus far in a sustainable manner. Temporary hold or payment of charges by some other entity are not sustainable solutions. Often the argument given for keeping these charges market-driven, with no regulatory intervention, is to ensure that concerned stakeholders, especially the acquirers, have enough incentives to set up acquisition infrastructure. This has resulted in continuation of the status quo. While the argument of incentives to stakeholders is sound, one should consider the reasonableness of the charges for various systems.

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In my view, there is no justification for MDR charges on mobile payment applications. In the mobile app world, PoS machines are the users’ smartphones. When they make any financial transaction, they are using their own bandwidth. The question is: What should be a fair charge which the payee or the seller should pay to the three entities which are participating at the back-end — the bank of the purchaser, the bank of the seller/merchant and the settlement body (NPCI).

In the telecom world, the “work done” principle is used to determine such charges. Take the inter-connect user charges (IUC). If a customer of operator A makes a call to a customer of operator B, then while operator A charges his customer for the call, operator B is paid by A in lieu of handling that call to its customer. The rate per-minute is computed based on work done by B’s network and are decided by the regulator.

This same principle can be applied for online transactions. Suppose A transfers money to B (who can be anybody including a merchant) using BHIM. The transaction information travels to the bank of A. It checks A’s balance (and other authentication factors like PIN etc.) and if ok, it goes to NPCI, the interbank switch. NPCI sends the message to B’s bank and B’s bank credits the money to B’s account.


In this example the work done by these entities is as follows: A’s bank has added a debit entry into A’s account, NPCI has created a settlement entry and B’s bank creates a credit entry in B’s account. All these three entries are completely digital and if one computes the work done, it is almost zero. Interestingly it is A and B who are paying the data charges for this transaction. Hence there is no network charge payable by any back-end entity. There is no movement of cash.

Thus, in a mobile payment system, the users should not be categorised as merchants or non-merchants. These should all be treated as peer-to-peer transactions with no charges. It is bank’s duty to enable the customer conduct basic banking operations. After all, the banks do not levy any charge when the person approaches their counter with a cheque or withdrawal slip, where more work is done by the teller. Mobile transactions are making the lives of banks much easier (even easier than ATMs as there is no cash handling, security, etc.)

Hence, while there may be some rationale for charging MDR (though at much lower rates) for cards because of the PoS machines and card issuance and maintenance, there is absolutely no justification for any MDR charge for mobile banking. Even the authentication of identity is done through Aadhaar, by UIDAI, free of charge.


The other issue of cost which needs to be dealt with is the “convenience charges” being levied by various entities, both private and public, for online transactions. For instance, if you book a movie ticket, a flight ticket, pay an electricity bill or school fee online, a convenience fee is levied. IRCTC — till it was scrapped in the current budget — used to levy a convenience charge of Rs 20 per ticket. For most websites, the convenience fee is one of their revenue streams.

The justification of levying a convenience fee is to charge for the “privilege” you get of using alternative payment options. It is also to cover the payment processing charges and what gateways must pay banks for online transactions. The fee is usually non-refundable. A question can be asked: Whose convenience is it? Buying a cinema or airline ticket online means that the customer is paying the data charges to make the transactions and printing her own ticket. On the other hand, if she purchased the ticket from the counter, it would mean the time of the counter-clerk, printing cost of ticket et al. A digital transaction reduces the cost of service providers and they should provide a discount on online transactions.

The other essentials for ensuring sustainable transactions are the convenience and confidence of ordinary people. This would require user-friendly (and idiot-proof) applications which are safe and secure from cyber attacks. This would require security and interface certification of such applications and the sooner we put in place such mechanism, the better. Any major incidence of fraud will create a setback for digital transactions.

Digital financial transactions and a less-cash India is critical to the growth of the country. It will mean more liquidity, better tax-compliance and GDP growth. More importantly, it will create a virtuous cycle of creating credit histories, availability of credit to poor at reasonable interest rates and digital credit dispensation. This will lead to a truer and deeper financial inclusion. Even credit offerings online will become available. Financial institutions, in my view, should not look at MDRs as an income source but look at larger gains like more liquidity/float and less cash handling costs (on ATMs and counters).

First published on: 04-03-2017 at 12:02:54 am
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