Subsidy on Small-value UPI Payments Cut: Banks Look for Ways to Offset Cost

India’s Unified Payments Interface (UPI) has transformed everyday payments for millions. By enabling fast, zero-fee digital transactions, even for small amounts, UPI made paying at tea stalls and large stores equally hassle-free. But recent government policy changes could alter the future of cheap or free digital payments, particularly for small merchants and the banks serving them.

Recent Changes: What Has Happened?

For the fiscal year 2024-25, the incentive paid to banks for processing small-value UPI payments at small merchant outlets was slashed from 0.25% to 0.15% per transaction by the Finance Ministry. A total outlay of ₹1,500 crore, down by more than half from the previous year, is allocated to support low-value UPI (P2M, i.e., Person-to-Merchant) transactions.

All low-value UPI transactions (under ₹2,000) at small merchants will receive a 0.15% incentive to the acquiring bank. Large merchants and higher-value transactions receive no such incentive.

Why This Matters

The zero-fee model for UPI was sustained by hefty government subsidies, absorbing infrastructure and operational costs for banks and payment processors. These measures were pivotal in catapulting UPI into the world’s largest real-time payments platform, with monthly volumes surpassing 18 billion transactions by early 2025. However, as UPI’s popularity soared, so did its cost.

With the subsidy reduced and limited to small merchants, banks and fintech companies face a gap between operational costs and government support. 

• UPI subsidy cut

For example, the digital payments industry could face losses of ₹500-600 crore as a result of the withdrawal and reduction of incentives for both UPI and RuPay debit cards.

How Banks Are Responding

To bridge this growing shortfall, banks are actively considering—and in some cases, implementing—ways to offset these costs:

• Charging Payment Aggregators: Leading banks such as ICICI, Yes Bank, and Axis Bank have begun charging “transaction handling fees” (about 2-4 basis points per transaction, capped at ₹6-10) to payment aggregators who use their UPI infrastructure. Payment aggregators may absorb or eventually pass on these costs to merchants (and, indirectly, consumers).

• Seeking MDR Revival: The Payments Council of India, supported by several fintechs and industry bodies, has formally requested the government to reintroduce Merchant Discount Rate (MDR) fees on UPI and Rupay transactions—particularly for large merchants or high-value transactions. MDR is a small percentage fee on each transaction previously paid by merchants, helping banks sustain digital infrastructure.

• Selective Fee Implementation: While regulations currently prohibit fees directly on small UPI transactions, some banks now “monetize” larger merchant relationships or offer tiered fee structures based on volume, escrow account status, or service features.

• Focusing on Large Merchants: Reduced subsidies only support small merchants. For large retailers with high transaction values, some banks are likely to advocate for MDR or equivalent charges to cover costs going forward.

What Does This Mean for Merchants and Consumers?

• Small Merchants: For now, most will continue enjoying zero-MDR for UPI payments up to ₹2,000, thanks to ongoing government incentives. However, future cuts or limits could impact this benefit.

• Large Merchants: They may soon have to pay MDR or equivalent fees, as banks seek to balance costs.

• Consumers: Small transaction users remain unaffected in the short term, but if MDR returns—especially for high-value purchases or at major chains—some costs could trickle down to end-users via added charges.

Risks and Opportunities

Risks:

• Without adequate subsidies or the ability to charge MDR, banks face mounting operational losses, which may affect service quality or even discourage digital payments at the smallest levels.

• Uncertainty about the policy may discourage small vendors from accepting UPI, pushing them back towards cash transactions—jeopardizing the cashless mission.

Opportunities:

• The evolving fee structure could drive innovation in digital payments, with banks competing on service, speed, and value-added features to justify potential costs.

• Improved system uptime and transaction success rates, as part of performance-linked incentive disbursals, will enhance user experience across India’s digital economy.

The Bottom Line

India’s world-leading UPI system is at a crossroads. The cutback in government subsidies for small-value payments has already prompted some banks to start charging intermediaries or lobbying for MDR, especially for large merchants. While small businesses and everyday users are protected, for now, the digital payment landscape may shift in the coming years as stakeholders seek a sustainable model that balances access, affordability, and profitability.