To put it plainly, MDR or Merchant Discount Rate is the rate charged by a bank to the merchant for providing debit or credit card services.
You must have observed the name of a bank on the POS machine (card swiping machines) of retailers. This machine is a service provided by that bank to the merchant wherein the amount paid by the customer gets accumulated in the current account of the retailer. The retailer is charged by the bank for this service in two ways. Firstly, the retailer needs to pay a decided rent on the POS machine (as the bank usually owns the machine). Secondly, there MDR is charged on each transaction.
When you purchase a commodity from a store, a small percentage goes to the bank whose card you are using, another percentage goes to the retailer's bank (with the current account and POS machine) and a tiny portion goes to payment card company (Mastercard/Visa). The percentage that goes to the retailer's bank is the MDR.
Further understanding of card payments
On purchase, the merchant accepts your card physically (by swiping it on the POS machine) or online (online payments by entering account details). Through the electronic system, information about the transaction is sent to the card holder's (i.e., your) bank. The bank then checks if you have enough balance for payment and that your card is not invalid or expired. The transaction is then approved or denied.
At the end of the day, (close of business) the merchant sends the transactions electronically to its bank (merchant bank) where it holds the current account. The merchant bank then sends the details to the settlement bank. The settlement bank acts like the 'clearing house' for payment. It is usually a payments technology company like Visa or Mastercard. On receipt of the details of the transaction, the settlement bank verifies the transaction between the merchant bank and the cardholder's bank. This process is known as the 'interbank clearing and settlement,' after which the money moves to the merchant account. It is electronically done and only takes a few seconds.
The interbank clearing is done to facilitate the involvement of more than two banks for settlement. During this process, the merchant bank also receives its MDR fees.
MDR in India
The percentage charged on every transaction varies from the amount of transaction to the type of business of the merchants. Online merchants are also charged MDR but at a different rate. Usually higher.
As per the new reforms made by RBI in the second week of December, small merchants with turnover up to 20 lakhs for the past year will be charged 0.40% MDR starting from January 2018. In the same way, other merchants will be charged at the rate of 0.90%, with a limit of Rs. 1000 per transaction. Also, as a move to promote mobile payments, the MDR is set at a lower rate of 0.80% for QR code payments.
Initiatives taken by the Indian government
After protests that the newly hiked MDR would discourage digital payments rather than encourage them, the government of India has now incentivized MDR for two years. From the 1st of January 2018, merchants will not have to bear the burden of MDR for transactions up to Rs. 2000.
In the past year, we have seen an increase in the use of digital payment modes by consumers. Although many merchants were forced to install POS machines due to reduced supply in cash, some retailers put this burden on the consumer with claims that it would otherwise reduce their earnings margin. Incentivising MDR will especially encourage retailers to accept digital modes of payments.