How To Keep Card Interchange Charges In Check

In a recent editorial titled “How To Reduce Card Interchange Charges”, Economic Times advocates a combination of subsidy and competition to reduce merchant fees for accepting card payments.

In case you missed it, the government of India has been aggressively pushing cashless payments recently after it demonetized the INR 500 and 1000 notes (and announced plans to introduce new design notes in INR 500, 1000 and 2000 denominations). Since payment card is the most widespread mode of cashless retail payments in India, there’s a renewed focus on stimulating the use of debit and credit cards and, not surprisingly, Merchant Discount Rate has quickly entered the policymaker’s crosshairs.

At the outset, Economic Times’ suggestion of subsidy is novel. It also sounds fair – after all, if banks and government benefit from the move to a cashless regime, they should be willing to pass on some or all of their gains to merchants and card networks.

However, given that banks and government have their own deficits to plug, what’s the guarantee that they won’t appropriate the gains from going cashless for themselves? Besides, ET bases its advice on an assumption of 2% MDR, which is only applicable for credit cards. Given that India’s central bank cum banking regulator Reserve Bank of India has set debit MDR at 0.75-1% (Source: RBI) and the fact that debit cards outnumber credit cards by 30:1 in India, it’s quite possible that the blended rate arrived at by using ET’s formula could actually exceed the statutory debit MDR.

So the subsidy option may be out.

Let’s see if we can replace it with something else.

Looks like we can. Think enforcement.

RuPay charges a fixed debit interchange of 60 paise to Issuer Bank and 30 paise to Acquirer Bank in India. Which is quite low. For the uninitiated, RuPay is a (relatively) new card network launched by National Payments Corporation of India, a wholly-owned retail payments subsidiary of RBI, which in turn is wholly-owned by the government of India. As of now, RuPay offers only a debit card that works only within India.

As against the fixed fee levied by RuPay, Indian banks – including public sector behemoths like State Bank of India – seem to be getting away by charging an ad valorem rate of as high as 2.95% for RuPay transactions.

As noted earlier, RBI has set the MDR for (non RuPay) debit transactions at 0.75-1%. However, in actual practice, the rates charged seem to be much higher.

I stumbled upon this fact when talking to a few co-workers recently about fuel surcharge on digital payments.

I’ve been using credit card for tanking up my car for ages. I’ve always noticed that my credit card statement displays a higher amount than what I pay at the pump. To take an example, I recently filled up fuel worth INR 1600. This was the figure mentioned on the chargeslip I received from the gas station and in the realtime SMS alert I got from my card issuing bank. However, when the credit card statement came a month later, I noticed that it showed a higher value of INR 1646.00 for this transaction. That means the bank has slapped an additional charge of INR 46, which works out to 2.875% on the base figure of INR 1600. The very next line was PETRO SURCHARGE WAIVER for INR 40.16. In effect, the bank – not the gas station – billed 2.875% more and refunded almost all of it back in the form of the waiver. I effectively overpaid INR 5.84 (being INR 46 – INR 40.16) for choosing a cashless mode of payment. I think it’s due to non-recoverable government taxes on the surcharge. Since the amount was small, I’ve never bothered to investigate it. (Considering that 90% of cardholders apparently never read their statements, I seem to already be investigating them a lot!)

card-interchange-lower-fi

My co-workers told me that they’re slapped a similar surcharge even when they pay for fuel by debit card. In other words, banks charge nearly 3% extra when RBI has mandated a maximum MDR of 1% for debit card.

So there’s clearly an opportunity to enforce existing MDR rates to bring down the charges.

Let me move on to working out a “fair” MDR rate.

ET recommends using the public sector card network RuPay’s calculations of cost of processing a card transaction as the baseline in arriving at a fair MDR rate.

Going by experience, forget international companies like Visa / MasterCard, it’s questionable if the legions of card issuing and card acquiring banks – even public sector banks – will accept RuPay’s version of the cost. They have different software, infrastructure and uptimes, not to mention bonuses for their honchos!

In fact, it’s questionable whether these corporations will even agree to the cost-plus method of pricing their services implied by ET.

Now, let’s assume government doesn’t bother with all the niceties and just issues a diktat to slash interchange rates. Before someone points out that governmental interventions don’t have a place in a free market like India, let me highlight two examples wherein governments of free market pantheons have mandated card interchange rates (although they did so after lengthy public consultations in those countries, but that’s a story for another day).

  1. EU fixed credit interchange at 0.3% (Source: Adyen)
  2. The Durbin Amendment capped US debit interchange fees at 24 cents per transaction (Source: Bloomberg).

With the basic right of the government to intervene in this matter established, let’s see how another related mandate has been working in actual practice.

Over six months before the recent remonetization move, the Indian government had issued a diktat to its public sector undertakings to stop levying fees for accepting payments via debit card / credit card / bank transfers. However, I know at least two PSUs that continue to levy their previous fees for digital payments.

So, once again, better enforcement of existing rules will help bring MDR under control.

Finally, let me turn to driving competition via RuPay, another approach advocated by ET.

For the uninitiated, payment card is a multisided business that endows incumbents with a huge “network effect” benefit.

card-scheme-4-side

It’s very difficult to unseat the incumbents in this business. Local card networks like Discover, JCB and MBNA have failed to make a dent on Visa and MasterCard despite trying for decades with equally compelling offerings and multicountry presence.

There’s only one notable exception to this. I’ll come to it in a bit.

Visa and MasterCard are the incumbents in the card network business virtually everywhere in the world including India. RuPay is the new kid on the block. A merely lower MDR rate won’t help RuPay fight Visa and MasterCard.

What will?

China UnionPay can offer a few lessons on that subject. It’s the only local card network to make a dent on Visa / MasterCard. It offers both debit and credit cards. While it started locally, it quickly took the battle to Visa / MasterCard’s backyard by aggressively expanding overseas.

For RuPay to make a difference, it needs to offer both debit and credit cards and operate internationally. In other words, the Indian government needs to empower NPCI to become a full-service card network with global footprint. Only then will it be able to use RuPay to keep Visa / MasterCard’s MDR in check (though not necessarily low).

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India already has in place the policy framework and the building blocks of competition required to drive low merchant discount rates (or at least keep them in check). What it needs now is tighter enforcement of its policies and greater empowerment of NPCI to “go ye forth and conquer” the card business globally!

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