The Crux behind the “Convenience” of Credit Cards!

“Hey man, the benefits in HDFC Regalia cards are superb."

“Nah, they are better with Diners Club.”

Most of us have had such conversation with our friends and family members on whose credit card offers better services. Rewards, Privileges, convenience, social status, everything has got associated today with credit cards. However, what still remains a mystery for many of us is how do these credit cards earn money for their issuers?

So, putting out a 10 second elevator pitch before we go on to demystify the credit card workings:

“Credit Cards Industry is highly profitable for the banks!”

Now let us peel each of the layers of this industry.

Going by the current numbers, there are approximately 60 MM credit cards issued in the Indian financial system by the banks. Out of this ~60% are active credit cards. What’s an active credit card? It’s simply any card through which a transaction has been done in last 30 days. So, there are many folks in the system who have just got their cards issued or maybe banks forced them to take one but haven’t done a transaction recently. Also, on the other end there are people who have got more than 1 credit card issued, because there are only ~25 - 30 MM unique credit card users. That’s only just 2% of the Indians and this validates the point why credit cards are still seen as a product for the aristocrat strata. However, that’s not really true because as per latest Edelweiss report, the number of credit cards is expected to grow to 83.5 MM cards by 2025. That’s roughly 27% CAGR (Compound Annual Growth Rate). And banks are equally joyous with the increase in circulation of this beautiful product which is sold in the name of attractive rewards but ends up generating enough interest and fee income for them.

Credit Card industry classifies their customers into three categories: Revolvers, Transactors and Defaulters. Revolvers are those who don’t pay their credit card bill in full and go for minimum payments to rollover the balance amount. They unfortunately end up paying interests to the tune of 3.5% per month on the carry forward amount. This interest is the major source of earnings through credit cards for the banks, because at 42% (3.5% x 12) per annum, that’s super high compared to any form of loans available in the market. These revolvers are simple middle-class people earning 25-30K per month and have who paid some wedding expense or medical bill through their credit cards getting caught in the spiral debt trap. And at the expense of these revolvers, people like us who are just the Transactors “GAIN”. We enjoy the reward points, those extra discounts on favorite restaurants, extra 45 days of credit on our bills, but just are a little cautious to pay our outstanding before the due date. Generally, for 100 credit cards issued by a bank, 25 are with Revolvers, 70 are with Transactors and approximately 5 with Defaulters (who don’t pay any bills for a particular month).

Another major earning for the credit card issuer is the Merchant Discount Rate(MDR) or the processing fee. This is the charge which any merchant, like your supermarket, e-commerce player, BookMyShow etc., accepting payment through a credit card has to pay to the bank. This fee normally ranges between 1.5-2.5% of the transaction value. But this fee is more like a cover up for the direct operational cost which the bank has to bear, like the network fees (~0.5%) to Visa and Master, reward points(~0.7%) which people like you and me enjoy for spends using credit cards and the credit cost(~0.9%) for the additional 45-60 days of interest free period. There are other fees also included for usage of credit cards like joining fee, annual fee, late payment fee, currency exchange transaction fee etc., but most of these are passed on as additional rewards only to the customer and end up giving just 0.7% per month extra on the annual spends.

Image Source: Freepik

Today, credit card book in India in totality stands at INR ~1,250 Bn. Out of this, ~35% is interest free, ~40% is revolving which gives 42% interest per annum and rest ~25% book is of people who have taken an EMI or Personal Loan on the allocated credit card limit which earns bank 18% per annum interest. Hence, this overall blended book gives a bank an average of ~22% interest per annum. Even if we include all the marketing, operational, credit and taxation costs associated with selling of credit cards by the banks, a healthy 2% per annum returns on an average on spend of each credit card can be gained. That’s roughly around 4000 INR per card and multiplying it with 36 MM active cards, it translates into ~144B INR profit after tax per annum. THESE ARE MIND BLOWING RETURNS!!! And with total credit card in circulation doubling every 5 years these returns are bound to increase for the banks.

So next time you be take out your credit card to make a payment on BigBasket or encashing your reward points to book a flight, remind yourself on who in turn is paying for these privileges on your behalf. And if you also felt privileged (just like our friend Taslish Chaddha) to know the intricacies involved in the credit card business, then don’t forget to subscribe and spread this article.

Happy weekend from Finns&Marks!

By: Anmol Gupta | Isha Garg