Explained: How banks earn from credit cards?

Credit cards have become one of the most favoured modes of payment among customers these days, particularly the younger lot as it provides convenience, enhanced security and on top of it, rewards in various forms.

For banks, they benefit by earning a percentage from annual fees collected from cardholders.

A part of the issuers’ revenue stream comes from their share of the merchant fees that are charged each time the card is swiped, said Adhil Shetty, CEO at Bankbazaar.com. He added, however, the biggest revenue for the issuer comes from the finance charges, which include interest and penalties on late payments.

“Considering credit cards charge as much as 2-4 percent per month on the unpaid amount in addition to penalties, this comes to a hefty amount. Even if users convert their outstanding to an EMI, the interest rate is usually higher than the personal loan rate. Plus, the issuer can charge a processing fee for the conversion,” Shetty explained.

In India, on average, Shetty tells that 28-30 percent of customers revolve their outstanding balance and the banks charge higher rates to cover risks.

However, the typical delinquency rate is around 2 percent.

“This makes credit cards a viable model for issuers,” Shetty stresses.

Globally, as of now, the bigger players in the credit card market include Amex, Bank of America, Chase, Citi, Barclays, etc. While in India, HDFC bank is the largest credit card issuer with close to 15 million cards.

Last year, the Reserve Bank of India (RBI) had put an embargo on HDFC Bank's credit card issuance due to a series of technical glitches in its software. This temporary halt on sourcing of cards had to some extent, impacted the bank’s business and also enabled competitors to gain.

However, the restrictions have been relaxed by the central bank recently and the bank is now aiming to roll out strategies to “come back with a bang” in the credit card industry.

It's important to note here that despite this profitable model of credit cards, there are banks that are still not very aggressive in expanding their credit card business.

On this, Shetty tells that this may be because of the bank’s business model and priorities. Different banks may have different strengths that they want to build on.