Credit Cards are very popular these days and it is widely used in all kind of shopping in the era of the cashless transaction. All banks are chasing you every day to give you credit cards with a lot of offers.
Have you ever wonder, when you receive calls from the bank telling you that, you are one of the lucky customers for which they are giving you a best MasterCard or VISA credit card with a lot of offers and lifetime free of charge.
Why these bank companies are dying to give you a credit card? You are only paying what you spent – then how these banks are making money? What is MasterCard, VISA or American Express printed on your card and what’s their role? You might be having so many questions like this, therefore, I thought to write a detailed report on its business model.
You might not be known, but there is a lot of background process happens when you swipe your credit card at the shopping center. When you use a credit card, money moves electronically through many hands, from the issuer, through the network, to the merchant’s bank.
The network also makes sure that the transaction is attributed to the proper cardholder you so that your issuer can bill you. Let’s understand all the parties involved in processing your credit card payment at any merchant’s outlet.
Parties are involved in processing Credit Card payment
Card Holder and Merchant:
The person who owns the credit card is the Card Holders and A merchant is a person who trades in commodities produced by other people. Historically, a merchant is anyone who is involved in business or trade. They both are the source of revenue in the entire payment process.
The entity which issues the Credit Card to Customer like HSBC, Citibank, etc. These banks are responsible to generate a monthly statement, collecting the monthly bill, putting late payment fine and helping you in all credit card related issues. It extends a line of credit to the consumer. Liability for non-payment is then shared by the issuing bank and the acquiring bank, according to rules established by the card association brand.
Acquiring Bank is responsible for making payments to the merchant when you use their payment terminal. They deal with merchants once the purchase made using a credit card. Merchant gets the money once the Acquiring Bank confirms the transaction irrespective of Credit Card bank – no matter whether it is domestic or international Credit Card.
Payment Networks are the companies printed on your credit card (typically branded with a MasterCard, VISA or American Express, etc. logo). And serve as the link between acquiring banks and issuing banks. Issuing and Acquiring bank are not communicating directly, instead, these banks have relationships with a network, rather than with each other, for payment verification or fulfilling card purchases.
These payment networks have their own network and agreement with banks which differentiate them from each other. This allows a card issued by Domestic Bank in India to be used at a shop in Japan, for instance, without requiring the banks to have a direct relationship with each other.
American Express is acquirer, issuer as well as has its own network. Banks can use each other’s network if an agreement is reached.
Following diagram will help you to understand the overall Card payment process:
Let’s try to understand this transaction with a series of events behind the successful transaction:
- Mr. Bean (Card Holder) purchases a Mobile phone of $100 and swipes his card at payment terminal for the payment.
- The Acquirer Bank pays the Merchant $97.50 after deducting Merchant Discount Fees, as per the MDR (generally varies between 0.9% to 3.5%, based on various criteria). (MDR is a fee charged from a merchant by a bank for accepting payments from customers through credit and debit cards in their establishments.)
- The Issuer Bank pays the Acquirer Bank $98.00 after deducting the Interchange Fees (Interchange fees are determined by a large number of complex variables. In simple terms, it is a flat rate plus a percentage of the total sales value).
- The Issuer Bank collects the full transaction amount $100 from the Cardholder, Mr. Bean.
- Both the Acquirer Bank and the Issuing Bank pays Payment Network (MasterCard/VISA) an agreed fee.
In Short, merchant bears the overall loss and his discount is distributed between Acquiring Bank (Acquirer fees), Issuing Bank (Interchange Fees) and Payment Network (Network Fee). No doubt these Card companies are investing too much in promoting their card and encouraging people for cashless transaction.
Revenue Sources for a Card Issuer (Issuing Bank):
- Interchange Fees: Every time you use a credit card, the merchant pays a processing fee equal to a percentage of the transaction (MDR). The portion of that fee sent to the issuer via the payment network is called “interchange,” and is usually about 1% to 3% of the transaction. These fees are set by payment networks and vary based on the volume and value of transactions.
- Late Payment Fees and Revolving Interest Charges: A significant amount of card users do not pay their bills in full each month. The customer’s unpaid credit card balance starts to incur interest at rates varying roughly from 1.75% to 4% per month (APR varies between 16% to 48%). Among a card company’s customer base, the majority would be “revolvers” (people who keep paying less than full amount every month), and these guys are most profitable for the bank.
- Annual / Renewal Charges: Some Specific Cards have signed up fees and annual renewal fees as they provide more benefits are partner outlets, hotels, etc.
- Foreign Transaction Charges: When you purchase something outside of your home country in that country’s currency, your credit card is charged the transaction rate at a certain conversion rate of the currency, and a foreign currency conversion charge is levied to your account.
- Cash Advance Fees: Issuers charge these fees when customers use their credit card to get cash at an ATM. The fees generally range from 2% to 3% of the amount of cash taken out.
- Balance Transfer Fees: When you transfer debt from one credit card to another to get a lower interest rate, you’ll usually be charged a fee of 3% to 5% of the amount transferred. Some cards don’t charge these fees or waive them for a certain period of time.
- Conversion of Outstanding to easy EMI: Most banks offer customers a choice to convert outstanding amount payable to easy EMI at a specified interest rate.
- Reward Points Redemption Revenue: Banks charge a small fee if you pay for any product or service with your reward points. In many cases, retailers have tie-ups with banks whereby you as a Cardholder earn bonus points by spending at these retailers. Such retailers/partners can have a monetary relationship with the Issuer whereby they pick up the rupee value of the bonus reward points.
- 3rd Party Product Sale Commission: The sales agent who’s trying to sell you the credit card, is probably cross-selling other products too, like deposits or mutual funds. For any such investment or liability product, the credit card line of business takes a commission.
- Co-Brand and Other Marketing Revenues: In some cases, card statements can become advertising destinations by merchants through either merchant-funded offers or plain advertisements. In India, this is still nascent, but there can be costs associated with such activities.
- Other sources of revenue are:
- Card Replacement Fees
- Supplementary Card Issuance Fees
- Charges towards Inward Integration of Payment Gateways
Revenue Sources for an Acquiring Bank:
- Acquirer Fees: We have mentioned earlier that acquirer takes a small commission out of the MDR for its role in the payment settlement process.
- PoS Terminals: Banks sell these PoS (Point of Sale) terminals to merchants at a cost. In India, this cost varies between Rs.8,000 to Rs.12,000 per terminal — one-time fee. Post that, the merchant is charged per transaction (which obviously is shared between the Acquirer, Issuer, and Network).
- Merchant Settlement Cycle Interest: All transactions at the merchant’s PoS are settled by the Acquirer at regular intervals. The time for which the money resides with the Acquiring Bank is actually invested in short term investment funds or bonds to earn interest out of it.
Needless to say, in many cases for a particular transaction, the Issuer and Acquirer can be the same Bank.
Revenue Sources for a Payment Network:
- Service Revenues: These are earned for providing financial institution clients with the support services for the delivery of Visa-branded payment products and solutions. These are generated from the payments volume on Visa-branded cards and payment products for purchased goods and services.
- Data processing revenues: These consist of revenues earned for authorization, clearing, settlement, network access, and other maintenance and support services that facilitate transaction and information processing. These are generated from the number of transactions processed.
- International transaction revenues: These consist of revenues earned for cross-border transaction processing and currency conversion activities. These are primarily generated from cross-border payments and cash volume.
- Client incentives: These consist of long-term contracts with financial institution clients for various programs designed to build payments volume, increase Visa-branded card acceptance, and win merchant routing transactions. These incentives are accounted for as reductions to operating revenues.
Payment Networks like Visa and MasterCard takes very less percentage of the total transaction but they process unimaginably number of transactions resulting them huge revenue and profit. As of 2018, MasterCard ranked 236th and VISA ranked 161st on the Fortune 500 list of the largest United States corporations by revenue. Below numbers might give you a heart attack.
MasterCard, VISA revenue trend
Remember, MasterCard or VISA doesn’t provide any finance to the customer neither they print the credit card for the customers. It’s the bank issuing bank which does all the process and manages giving credit and receiving back from the customers. They are not responsible for customers default or any financial losses. Their growth has been tremendous and impressive since it’s establishment.
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