Recently one of the new age private banks forays into the credit card business. One of my clients asked me why we have so many credit card companies. The reason being, it becomes more difficult to select the right credit card. In India, only banks can offer a credit card. Here by credit card companies i mean banks including their partners, marketing agencies, sales agents etc. From bird’s eye view, it is a charitable business. A bank issues a credit card to the customer. Customer use the card and bank provide temporary credit. Customer pays the bill and that’s it. Prima facie the only source of income for banks is interest income in case of delay in payment of credit card bill. Unfortunately, It is not true.
In my previous post, 7 tricks how banks make you spend more on credit cards i shared that customers who pay bills on time are bad for credit card business :). Therefore, interest income from delayed payments is only one of the ways to make money or earn a profit. There are many other ways for a bank to make money or earn profit thus credit card companies put a lot of efforts in credit card business. Let’s check out
How Credit Card Companies Make Money or Earn Profit
1. Marketing Tie-ups:
You know who is making money these days? Anyone who helps brand/companies extend their reach. With each passing day, it is difficult to generate business. You may check the financial results of the company. For example, brands are spending more on digital marketing because of its reach. The credit card companies have direct access to their customer base and can influence their spending. Therefore, credit card companies can help in both i.e brand promotion and to generate sales. It is very effective and potent tool to reach new customers. In other words, the objective is to increase sale. These tie-ups are in the form of freebies, cashback offers, EMI offers etc. Knowingly or unknowingly customer end up spending more on the credit cards.
As per RBI data, HDFC Bank has issued 62.8L credit cards followed by ICICI Bank at 35L credit cards. SBI, Citibank, and Axis Bank are at no 3, 4 and 5 respectively. Assuming i tie up with HDFC bank and ICICI Bank then i will get a direct access to approx 1 Cr Credit Card customers. Hypothetically, if i am willing to pay Rs 10 i.e. industry average to reach a customer then it means a profit of Rs 10 Cr for top 2 banks. This is just a fees/commission to reach.
I as a brand may be willing to pay Rs 300 per sale conversion. For example, LG has tied up with HDFC Bank to offer interest-free EMI to the customers of HDFC Bank. LG executive told me that there is a processing fee of Rs 300 to avail this offer. This is charged by HDFC Bank. My guesstimate is that this is definitely a conversion fee. The interest cost is borne by the LG. The offer is irresistible for a customer. Therefore, assuming a conservative conversion rate of just 1% i.e. 62,800 customers availed this offer. It means HDFC Bank earned Rs 1.88 Cr as a profit or income from the single promotion. Moreover, the credit card was swiped on HDFC bank POS thus savings on interbank charges. Assuming 10 such promotions are live every month then it means the business of 18.8 Cr per month. I have considered very conservative figs.
My general observation is that brands enter into low-value tie-ups with small credit card companies like max Rs 50 cash back or a free movie ticket. On the other hand, high-value tie-ups are with big boys like cashback of Rs 500 or interest-free EMI.
2. Interest on Balance Outstanding:
It’s a universal fact that interest rate on a credit card is highest among all forms of credit facilities even higher than private lending. It can be as high as 42% (annually) or 3.5% (monthly). According to industry estimates, more than 50% of the credit card balance outstanding is not paid on time. These customers are GOD for credit card companies. Let me clarify that it is not necessary that 50% credit card balance outstanding means 50% customers are defaulting/delaying the payment. The amount should be considered in absolute terms only.
I don’t want to make this post data heavy. Assuming everything remains equal. In this case, credit card companies are receiving half the payment (absolute) on time and there is a delay in balance half payment. Therefore for delayed payment credit card companies are charging 42% interest rate. To simplify, we can safely assume that credit card companies are earning interest of 21% of the total outstanding balance. In other words, the amount spent on a credit card by the customers is fetching an interest of 21% to banks. From which line of credit, the bank can generate interest income of 21%. Even if you adjust settlements and written off amount, my guess is that net interest income should be 18% or more.
This explains why one of the leading new age private banks launched credit cards :)
3. Cash Advance Charges:
The credit card users are aware that they can withdraw cash against credit card limit. Normally cash limit is 40% of credit limit. This cash limit can come handy in case of any emergency cash requirement as a short term loan. For example, if my credit limit is Rs 5L then i can withdraw a cash of Rs 2L from my credit card account. I have to bear transaction fees of 2.5% (Min Rs 300). Therefore, if i withdraw 2L then i will be charged transaction fees of Rs 5,000.
Besides transaction charges, the bank also charges an interest rate of up to 42% (annually) i.e. 3.5% p.m. from the date of withdrawal until the date of full payment.
This is one of the costliest loan option and a most profitable option for the bank to lend during an emergency to the customer.
4. Annual and Renewal Fees:
This is normally paid by the customers whose credit card spend is low. In other words, credit card companies charge annual/renewal fees in case customer is using credit card below the threshold limit set by the bank. It helps to recover the cost of providing the service to low usage customers.
5. Miscellaneous Charges:
Besides this, credit card companies also charge some miscellaneous charges like
(a) Late Payment Charges
(b) Charges on over limit. Normally 2.5%.
(c) Payment return charges
(d) Reward redemption fee
(e) Cash processing fee
(f) Reissue of card
Words of Wisdom:
I hope by now you agree with me that “Credit Card is Good if you make the payment on or before Payment Due Date“. If there is a delay the credit card is a worst financial instrument to avail credit facility and may land you in a debt trap. Interest-free credit period of up to 50 days is the only best part of the credit card. How you can utilize this period to your advantage, i explained it in my post, How to use credit cards smartly?
Though the objective of this post is to highlight how credit card companies make money or earn profit but always remember that life is zero sum game. The gain of credit card companies is the loss for a credit card user. Therefore, it is important that you should not contribute to the profit/gain/income of credit card companies :).
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