Impact of Proposed UPI Transaction Fees on Digital Payment Adoption and Market Dynamics in India: An Empirical Study
This empirical study analyzes the 2020–2026 impact of introducing a 0.40% Merchant Discount Rate on large UPI transactions in India, finding that while the fee alleviates infrastructure funding gaps, it creates inelastic demand among micro-merchants, drives mid-tier merchants toward cash or ticket-splitting, and consolidates market power among dominant payment providers, thereby necessitating calibrated regulatory interventions.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
For over a decade, India has witnessed a quiet revolution in how people pay for goods. Instead of exchanging physical currency, millions now tap their phones to send money instantly through a system called the Unified Payments Interface, or UPI. This digital network, built by the country's central bank and a national payments corporation, connects hundreds of banks and allows anyone to transfer funds to another person or a shop with a simple scan of a code. For years, this system operated on a principle that seemed almost too good to be true: it was free. The government and banking regulators mandated that no fees be charged to the people buying things or the small shopkeepers selling them. This rule, known as a zero-fee mandate, removed all financial barriers to entry, encouraging even the smallest street vendors to adopt digital payments and helping millions of unbanked citizens join the formal economy. However, running a massive digital network costs money. The banks and technology companies that process these billions of transactions must pay for powerful computers, secure servers, and teams of experts to prevent fraud. For years, these costs were covered by the government through tax-funded subsidies, but as the volume of transactions exploded, the financial strain on the system became unsustainable.
A new study by Alvin Jose, a researcher at the Institute of Cost and Management Accounts of India, examines what happens when this free model shifts toward a paid one. The research focuses on a recent regulatory change where a small fee, known as a Merchant Discount Rate, was introduced for specific types of transactions. Under the new rules, effective in late 2026, a fee of 0.40 percent is applied only to business-to-consumer payments that exceed ₹2,000. Crucially, the system remains completely free for transfers between individuals, for small shopkeepers with low monthly sales, and for any transaction below the ₹2,000 threshold. The study analyzes data from 2020 through 2026 to understand how this change affects the behavior of merchants and the overall health of the digital payment ecosystem. The goal was to see if charging a fee would cause people to stop using the system, or if the network could adapt without losing the financial inclusion it achieved.
The researchers gathered a vast amount of information, including transaction records from the national payments corporation, financial reports from banks, and a detailed monthly survey of 1,200 shops across different types of cities. They looked closely at how merchants reacted to the new fee structure, comparing the behavior of tiny vendors, medium-sized retailers, and large corporate stores. The findings reveal a clear divide in how different businesses respond. For the smallest merchants, who typically sell items for less than ₹2,000 and operate on very thin margins, the new fee has almost no effect. Because their daily sales fall below the threshold where the charge applies, they continue to use the digital system just as before. For these small vendors, the benefits of not having to carry cash or count change far outweigh the distant possibility of ever paying a fee.
The situation changes noticeably for medium-sized retailers, such as independent clothing stores or electronics shops. These businesses often sell items that cost between ₹2,000 and ₹10,000, placing them right in the zone where the fee kicks in. The study found that these merchants are highly sensitive to the cost. When faced with the new charge, many of them began to change their behavior to avoid paying it. Some started asking customers to split a single large purchase into two smaller transactions, each under the ₹2,000 limit, so that neither would incur the fee. Others began encouraging customers to pay with cash for larger amounts or displayed personal QR codes instead of official business ones to bypass the commercial fee. This suggests that while the fee is small in percentage terms, it is significant enough to alter the daily operations of businesses that operate on tight margins.
In contrast, large commercial enterprises and big department stores showed very little reaction to the fee. For these massive retailers, accepting digital payments is essential for keeping lines moving and preventing customers from leaving their carts. Furthermore, the fee they pay is still much lower than the cost of accepting credit cards, which can charge merchants between 1.50 percent and 2.50 percent. Because the new UPI fee is so much cheaper than their existing options, these large companies simply absorb the cost as a normal part of doing business. The study indicates that for them, the fee does not change their behavior at all; they continue to accept digital payments seamlessly.
Beyond the behavior of individual shops, the research also looked at the broader structure of the market, specifically who controls the apps people use to make payments. Currently, a few large companies dominate the landscape, with two apps handling more than 80 percent of all transactions. The study suggests that the new fee structure might actually make this dominance stronger. The fee is shared among the banks and the app providers, but the amount each party receives is very small. To make a real profit from such a tiny fee, a company needs to process a massive volume of transactions. The big, established apps already have this volume, allowing them to generate significant revenue from the small fees. Smaller competitors or new apps, which do not yet have millions of users, would struggle to cover their costs with these tiny margins. Consequently, the new system could make it even harder for new players to enter the market, cementing the power of the current giants.
The study concludes that the shift to a fee-based model is a necessary step to ensure the long-term survival of the digital payment network. By charging fees on high-value commercial transactions, the system can finally pay for the expensive technology and security it needs to function without relying on government subsidies. This change protects the vast majority of daily transactions, which remain free, while ensuring that the infrastructure is funded by those who benefit most from high-value commerce. However, the research warns that regulators must remain vigilant. They need to watch for merchants who try to bypass the rules by splitting transactions or charging hidden fees to customers. Additionally, they must ensure that the new revenue is used to improve the system's speed and security, and that the market does not become so concentrated that it stifles innovation. The transition represents a move from a government-subsidized experiment to a sustainable, self-funding public utility, balancing the need for financial inclusion with the economic reality of running a global-scale digital network.
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