UPI'S CHALLENGE: FINANCIAL SUSTAINABILITY AFTER A DECADE OF RAPID GROWTH

Why In News?

Parliament passes the Taxation and Other Laws (Amendment) Bill, 2026, removing the legal bar on levying Merchant Discount Rate (MDR) on UPI.

What is UPI?

Unified Payments Interface (UPI) is a real-time payment system that allows instant transfer of money between bank accounts using a mobile device.

UPI is built, owned, and operated by the National Payments Corporation of India (NPCI), an RBI-promoted umbrella entity for retail payments.

• NPCI is an Indian government sector company that operates retail payments and settlement systems in India.

Key Features

• Real-Time Transfers: Send and receive money instantly at any hour, including weekends and holidays.

• No Bank Details Needed: Transact safely using a Virtual Payment Address (VPA) or by scanning a QR code without sharing sensitive account numbers.

• Two-Factor Authentication: Authorize payments securely using your linked mobile number and a private UPI PIN.

• Multiple Apps: Access services through popular applications like Google Pay, PhonePe, Paytm, or the official BHIM app.

UPI Latest Data 

• UPI processes about 24,162 crore transactions worth ₹314 lakh crore in FY 2025-26.  

• This marks roughly 30% year-on-year growth in volume and 21% growth in value over the previous year.

• 703 banks are live on the UPI platform, reflecting near-universal banking system integration.

• UPI accounts for roughly 85% share of India's digital payments by volume.

• UPI represents about 49% of global real-time payment volume, making India the single largest contributor to real-time digital payments worldwide.

• Only 4% of person-to-merchant (P2M) UPI transactions are above ₹2,000 in value, yet this small slice accounts for around two-thirds of UPI payments by value — a critical data point for any tiered-MDR design .

Significance of UPI 

• Financial inclusion: UPI extends formal digital payment access to citizens without needing debit/credit cards, aiding Jan Dhan-Aadhaar-Mobile (JAM)-linked inclusion goals.

• Digital economy: UPI underpins e-commerce, gig-economy payments, and app-based service transactions across urban and rural India.

• Formalisation of transactions: Digital payment trails reduce cash-based informal transactions, aiding tax compliance and credit assessment.

• Small merchant payments: UPI's zero-MDR policy since January 2020 has allowed even street vendors and small kirana stores to accept digital payments at no cost.

• Faster payments: Settlement is instant and available 24x7x365, unlike traditional banking hours-bound transfers.

• Digital Public Infrastructure (DPI): UPI functions as a foundational layer of India's Digital Public Infrastructure (DPI) stack, alongside Aadhaar and the India Stack, enabling innovation by third-party developers.

What is the Merchant Discount Rate (MDR)?

MDR is the fee a merchant pays to their bank/payment provider for accepting digital payments from a customer, usually expressed as a percentage of transaction value.

Fee paid by merchant: Traditionally, MDR is deducted by the merchant's bank on card/digital payments — merchants earlier paid around 1% MDR on card payments before the government waived it for UPI/RuPay in 2020.

Role of banks: Banks handling merchant accounts (acquiring banks) typically capture a larger share of any potential MDR fee.

Role of Payment Service Providers (PSPs): PSPs facilitating the transaction infrastructure also draw a share of the fee where applicable.

Role of payment apps: Third-party UPI apps (PhonePe, Google Pay, Paytm, etc.) that route transactions have a direct financial stake in whether MDR returns, since it forms a potential revenue stream currently absent.

Comparative rates: Credit card MDR ranges 1–3% of transaction value, while debit card MDR is capped at up to 0.9% — both far higher than any UPI MDR under discussion.

Why is UPI Facing a Sustainability Problem?

High transaction costs: Running a real-time payments network at UPI's scale — 24,162 crore transactions a year — requires continuous, heavy infrastructure spending.

Zero or low merchant charges: The Zero MDR policy, in effect since January 2020, means banks, NPCI, and fintech companies earn nothing directly from UPI P2M transactions.

Rising infrastructure costs: Handling daily transaction volumes reportedly touching 30 crore transactions a day strains servers, bandwidth, and processing capacity.

Cybersecurity costs: Fraud losses linked to UPI run to over ₹1,000 crore annually and are rising as AI-enabled scams grow more sophisticated.

Dependence on government support: The Centre's UPI incentive payout from 2021-22 to 2024-25 totals only ₹8,730 crore, covering just 11% of total payment-industry cost, according to the Standing Committee on Finance — showing subsidies fall far short of covering real costs.

Declining incentive budget: The government's UPI incentive allocation was ₹1,500 crore in FY25 and has been on a declining trend, intensifying the funding gap.

System stress signals: UPI witnessed six major system outages in the past year, including one lasting five hours, pointing to real capacity constraints under a subsidy-dependent model.

What are the Major Challenges?

Rising operating costs: Infrastructure, cybersecurity, and compliance costs continue climbing as transaction volumes scale further.

Concentration of transactions: PhonePe and Google Pay together handle almost 80% of UPI transactions, with the top three apps (including Paytm) commanding 83.23% volume share and 86.29% value share — a market concentration that raises systemic-risk concerns.

Cybersecurity risks: Rising, increasingly AI-assisted fraud (over ₹1,000 crore annually) demands continuous security investment.

Systemic dependence on UPI: With 85% of India's digital payments routed through UPI, any prolonged outage carries economy-wide disruption risk.

Maintaining universal access: Balancing revenue generation with the constitutional/policy commitment to financial inclusion for small merchants and low-income users.

Balancing innovation and affordability: Ensuring MDR revenue supports competition among third-party UPI apps rather than entrenching the dominance of the top three players.

Way Forward

Introduce a tiered revenue model: Apply MDR selectively rather than uniformly, protecting the bulk of small transactions.

Keep small-value payments free: Preserve zero-cost access for transactions below a defined threshold to protect ordinary users and small merchants.

Charge selected high-value transactions: Focus any MDR on the small share (around 4%) of large-value merchant transactions that account for the bulk of transaction value.

Protect small merchants: Ensure clear, low turnover thresholds so genuinely small businesses remain fully exempt.

Strengthen cybersecurity: Reinvest a portion of any new revenue into fraud prevention and system resilience to curb rising losses.

Ensure competition among payment providers: Enforce genuine competition safeguards (including the pending 30% market-share cap) so that MDR revenue doesn't simply entrench the PhonePe-Google Pay-Paytm dominance.

Reinvest revenue in digital infrastructure: Use MDR proceeds to expand server capacity, reduce outages, and extend UPI's reach to the "next 30 crore" unbanked or underbanked Indians.

Conclusion

UPI's first decade proved scale is possible at zero cost, but its next decade will test whether India can fund that scale sustainably without compromising the inclusion it was built to deliver.

Source: INDIANEXPRESS