Sanitising Distortions in Digital Payments

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The latest measure by the Government of India to withdraw the legal tender character of high denomination currency will ship the country several notches ahead towards a more digital economy, in spite of the transitory pain in implementation. To ease the current currency crunch in the country, several temporary and quick-fix measures to encourage acceptance and usage of digital payments are being introduced which includes waiver of merchant fees for Debit cards by banks and increase of limits for select Prepaid Payment Instrument among others.

Notably, more than 728 million debit cards outstanding as of September 2016. The financial inclusion programme of the Government and the Reserve Bank of India (RBI) has already given primary digital access to almost every adult Indian along with a bank account. Since the need and convenience to go digital is now being felt by most of the consumers and businesses across different verticals and sizes, it is imperative to think of some long-term solutions. This paper could not have come at better time than now as it suggests ironing out some of the frictions in the electronic payment space to give long run impetus to the current wave of digitalisation.

The costing of digital payments should be transparent and free from any additional non-payment related extra cost burden that obstructs its adoption by consumers and retailers. In this connection, we compare the extant costing structure of credit-based and credit-less digital payments. The cost burden of the perceived ‘free’ credit embedded in the payment system is not really ‘free’. Hence, to find out solutions in order to transit to a fair and non-discriminatory pricing is the need of the hour.

As a way forward for encouraging cost-effective, credit-less digital payments, India needs to devise innovative ways to have an efficient and effervescent ecosystem for digital payments. This will enable consumers and retailers to enjoy full benefits of brick and mortar and online markets in line with the country’s digital India initiatives.

Bring Parity in Digital Payments

  • Credit cost pertaining to the credit card product should be made explicit rather than mixing/ camouflaging it with the payment feature of the product. This will ensure that credit cards are used by only those consumers who consciously desire to avail credit and not by those who are availing credit because it is perceived to be ‘free’.

  • Merchant Discount Rate (MDR)[1] for credit cards should be brought down at par with debit cards so as to unbundle the ‘credit’ and ‘payment’ features of credit cards, making the reduced MDR independent to the electronic payment choice made by customers. Issuing banks should be given freedom to impose a credit fee, in lieu of the revenue loss for decreased interchange. The credit fee may be charged in the çredit card’s monthly statement by the card issuing bank for use of credit facility (and not for using a digital payment facility).

  • MDR for credit card and debit payments may be kept high and same so that MDR includes the credit cost. The issuing bank here should give cash-back, to the extent of credit cost, to users of debit payments. The cash-back feature for debit payments will attract consumers to move away from cash to digital payments and promote digital payments through incentives.

  • In case any incentive structure exits in the digital payment space, that should be there to steer the system towards cheaper alternative rather than expensive methods that are lucrative to a few. The alternate pricing strategies for digital payments can be as under:

I. For transactions of less than or equal to ₹1000 – Interchange of 0.2 per cent with MDR cap of 0.5 per cent for both credit/debit based transactions. Credit cost of nearly 1.0 per cent to be imposed in monthly credit statement;

II. Alternatives for transactions exceeding ₹1000 can be as under:

  • Interchange of 0.2 per cent with MDR cap of 0.5 per cent for both credit/ debit based transactions. Credit cost of nearly 1.0 per cent to be imposed in monthly credit statement; or

  • Interchange of 0.7 per cent with MDR cap of 1.0 per cent for both credit/ debit based transactions. Issuing bank gives 0.5 per cent cash-back to its customer on retail debit transaction. Credit cost of nearly 0.5 per cent to be imposed in monthly credit statement; or

  • Interchange of 1.2 per cent with MDR cap of 1.5 per cent for both credit/debit based transactions. Issuing bank gives 1.0 per cent cash back to its customer on retail Debit transaction.

I. The fee for the digital payment network including insurance against cyber security breach has to be derived out of the revenue earned by the issuer and the acquirer, or be a minor part of the MDR.

II. Explicitly charging credit card users for the credit cost, which might amount to giving teaser loans at about 10.5 per cent per annum till the payment is due and about 40 per cent per annum thereafter, for the whole period of credit (including the grace period).

  • Higher cap for acquirer fee is to hasten banks for merchant acquisition: Here, the debit (debit card, mobile-based, online, or other credit-less digital payment modes) interchange routed through a payment network is proposed to be capped at 0.2 per cent and acquirer fee at 0.3 per cent of transaction amount. This is expected to invigorate penetration of acceptance network in the country, which presently is limited and for which there is a cost bank incurs especially in case of acquisition of small merchants, mom-and-pop stores, and merchants in villages and small towns. Banks may be persuaded to offer innovative solutions including m-POS, Unified Payment Interface (UPI), , bringing access of cheaper and seamless modes of digital payments particularly to the small merchants.

  • Pricing for mobile-based retail transactions: With new technologies expected to migrate consumers to mobile-based payment transactions and other cheaper means of digital payments, additional set of rules are recommended as under to adapt the pricing strategies to mobile platforms:

a) there should be no additional fee outside MDR for UPI or other similar payment form-factors for merchant transactions; and

b) monthly rental/maintenance for POS or other similar expensive devices (provided by banks) that enables digital payments should be outside MDR and be separately charged depending on its usage and cost.

  • Acceptance of foreign cards: Foreign cards have higher MDR than domestic cards. In order to safeguard the interests of domestic retail market, it is recommended that the choice between accepting card payments in foreign card holder’s home currency or in local currency (the choice influences merchants’ cost) should lie with the merchant. This way, the merchants would be able to steer foreign card payments in home currency making it cheaper for them.

Other Measures to promote Digital Payments

  • Limiting ‘free’ cash to disincentivise cash: Given the availability of digital payments, the government and regulators should disincentivise excessive cash in form of imposing fee on monthly cash deposits/withdrawal (from bank counters and ATMs) in excess of a certain minimum amount. This disincentive would bring parity between digital payments (where payments are charged on cost basis) and cash (where costs are not made apparent), and thus stimulate digital payments.

  • Merchants should not be allowed to surcharge: Allowing merchants to surcharge credit cards (for the credit cost component in MDR) is one way to handle the cost differential vis-à-vis debit cards. However, if the customers are gullible, this freedom may get misused – merchants may overcharge; surcharge a debit card in the process; discriminate between customers that will be difficult to monitor; and may bring in a feeling of distrust among consumers and dispirit digital payment usage. Thus, for credit card based transactions, merchants should not be given the freedom to surcharge.

  • Incentivise digital payments: With a 0.5 per cent to 1 per cent cash back on credit-less digital payments as proposed above, merchants who do not favour digital payments would embrace them to remain in business and the consumers would drive this in view of the above cash back scheme. Gradually, more and more merchants would become tax compliant thereby adding to the exchequer’s kitty.

  • Financial education to further digitalisation of Indian payments: Consumer awareness and education towards digital retail payments is of prime importance. Central banks and the governments of developing countries need to aggressively drive financial education on digital payments. The combination of reasonable transaction fees, technology based innovative payment modes, together with consumer awareness for digital payment would facilitate digital India mission and make us a less-cash society.

  • Bank statements can make a lot of difference: Credit card users have the privilege and comfort of receiving a consolidated monthly statement showing all retail transactions done during the billing cycle. This adds value to the product and brings convenience to credit card users. Monthly statements of savings account lack such details. Such simple innovations to improve presentation of retail transactions in monthly statements of savings account remains in the hands of the banks and competition should guide them to make such simple yet important value-additions.

While migration to GST along with the drive to withdraw specified bank notes will give digital payments a strong fillip; to make it a habit amongst consumers and merchants before unaccounted cash again catches up, the distortions in the digital payment space (credit-based vis-à-vis credit-less alternatives) need to be urgently addressed for which the paper provides directions.

Based on a Paper presentation by Dr. Ashish Das, Professor of Statistics with the Indian Institute of Technology Bombay and Dr. Praggya Das, Director with the Reserve Bank of India. 

[1]  In India the Merchant Discount Rate (MDR) charged to merchants for accepting Credit cards usually ranges from 1.2 per cent to 2.5 per cent. A major share of this MDR goes to the issuer bank in form interchange. Based on the prevailing 1-month lending rate for unsecured credit, a conservative estimate of the cost of „free‟ loan for Credit cards is estimated to exceed ₹50 billion in 2016-17. This credit cost, imposed indirectly on the merchants is, in turn, passed on to all her customers through increased selling price of goods and services. Thus, credit-less digital payments cross-subsidise the hidden cost of credit embedded in the payment system.