Credit card issuers (banks) have several types of costs:
[edit] Interest expenses
Banks generally borrow the money they then lend to their customers.
As they receive very low-interest loans from other firms, they may
borrow as much as their customers require, while lending their capital
to other borrowers at higher rates. If the card issuer charges 15% on
money lent to users, and it costs 5% to borrow the money to lend, and
the balance sits with the cardholder for a year, the issuer earns 10% on
the loan. This 10% difference is the "net interest spread" and the 5%
is the "interest expense".
[edit] Operating costs
This is the
cost of running
the credit card portfolio, including everything from paying the
executives who run the company to printing the plastics, to mailing the
statements, to running the computers that keep track of every
cardholder's balance, to taking the many phone calls which cardholders
place to their issuer, to protecting the customers from fraud rings.
Depending on the issuer, marketing programs are also a significant
portion of expenses.
[edit] Charge offs
When a consumer becomes severely delinquent on a debt (often at the
point of six months without payment), the creditor may declare the debt
to be a
charge-off. It will then be listed as such on the debtor's credit bureau reports (
Equifax, for instance, lists "R9" in the "status" column to denote a charge-off.)
A charge-off is considered to be "written off as uncollectable." To
banks, bad debts and even fraud are simply part of the cost of doing
business.
However, the debt is still legally valid, and the creditor can
attempt to collect the full amount for the time periods permitted under
state law, which is usually 3 to 7 years. This includes contacts from
internal collections staff, or more likely, an outside
collection agency. If the amount is large (generally over $1500–$2000), there is the possibility of a lawsuit or
arbitration.
[edit] Rewards
Many credit card customers receive rewards, such as
frequent flyer points, gift certificates, or
cash back
as an incentive to use the card. Rewards are generally tied to
purchasing an item or service on the card, which may or may not include
balance transfers,
cash advances,
or other special uses. Depending on the type of card, rewards will
generally cost the issuer between 0.25% and 2.0% of the spread. Networks
such as Visa or MasterCard have increased their fees to allow issuers
to fund their rewards system. Some issuers discourage redemption by
forcing the cardholder to call customer service for rewards. On their
servicing website, redeeming awards is usually a feature that is very
well hidden by the issuers. With a fractured and competitive
environment, rewards points cut dramatically into an issuer's bottom
line, and rewards points and related incentives must be carefully
managed to ensure a profitable
portfolio. Unlike unused gift cards, in whose case the
breakage in certain US states goes to the state's treasury, unredeemed credit card points are retained by the issuer.
In relative numbers the values lost in bank card fraud are minor,
calculated in 2006 at 7 cents per 100 dollars worth of transactions (7
basis points).
[18] In 2004, in the UK, the cost of fraud was over £500 million.
[19]
When a card is stolen, or an unauthorized duplicate made, most card
issuers will refund some or all of the charges that the customer has
received for things they did not buy. These refunds will, in some cases,
be at the expense of the merchant, especially in mail order cases where
the merchant cannot claim sight of the card. In several countries,
merchants will lose the money if no ID card was asked for, therefore
merchants usually require ID card in these countries. Credit card
companies generally guarantee the merchant will be paid on legitimate
transactions regardless of whether the consumer pays their credit card
bill. Most banking services have their own credit card services that
handle fraud cases and monitor for any possible attempt at fraud.
Employees that are specialized in doing fraud monitoring and
investigation are often placed in Risk Management, Fraud and
Authorization, or
Cards and Unsecured Business.
Fraud monitoring emphasizes minimizing fraud losses while making an
attempt to track down those responsible and contain the situation.
Credit card fraud
is a major white collar crime that has been around for many decades,
even with the advent of the chip based card (EMV) that was put into
practice in some countries to prevent cases such as these. Even with the
implementation of such measures,
credit card fraud continues to be a problem.
[edit] Promotion
Promotional purchase is any purchase on which separate terms and
conditions are set on each individual transaction unlike a standard
purchase where the terms are set on the cardholder’s account record and
their pricing strategy. All promotional purchases that post to a
particular account will be carrying its own balance called as
Promotional Balance.
[edit] Revenues
Offsetting costs are the following revenues:
[edit] Interchange fee
In addition to fees paid by the card holder, merchants must also pay
interchange fees to the card-issuing bank and the card association.
[20][21] For a typical credit card issuer, interchange fee revenues may represent about a quarter of total revenues.
[22]
These fees are typically from 1 to 6 percent of each sale, but will
vary not only from merchant to merchant (large merchants can negotiate
lower rates
[22]),
but also from card to card, with business cards and rewards cards
generally costing the merchants more to process. The interchange fee
that applies to a particular transaction is also affected by many other
variables including: the type of merchant, the merchant's total card
sales volume, the merchant's average transaction amount, whether the
cards were physically present, how the information required for the
transaction was received, the specific type of card, when the
transaction was settled, and the authorized and settled transaction
amounts. In some cases, merchants add a surcharge to the credit cards to
cover the interchange fee, encouraging their customers to instead use
cash,
debit cards, or even
cheques.
[edit] Interest on outstanding balances
Interest
charges vary widely from card issuer to card issuer. Often, there are
"teaser" rates in effect for initial periods of time (as low as zero
percent for, say, six months), whereas regular rates can be as high as
40 percent. In the U.S. there is no federal limit on the interest or
late fees credit card issuers can charge; the interest rates are set by
the states, with some states such as South Dakota, having no ceiling on
interest rates and fees, inviting some banks to establish their credit
card operations there. Other states, for example Delaware, have very
weak
usury laws. The
teaser rate
no longer applies if the customer doesn't pay their bills on time, and
is replaced by a penalty interest rate (for example, 23.99%) that
applies retroactively.
[edit] Fees charged to customers
The major fees are for:
- Late payments or overdue payments
- Charges that result in exceeding the credit limit on the card (whether done deliberately or by mistake), called overlimit fees
- Returned cheque fees or payment processing fees (e.g. phone payment fee)
- Cash advances and convenience cheques (often 3% of the amount)
- Transactions in a foreign currency (as much as 3% of the amount). A few financial institutions do not charge a fee for this.
- Membership fees (annual or monthly), sometimes a percentage of the credit limit.
- Exchange rate loading fees (sometimes these might not be reported on the customer's statement, even when applied).[23] The variation of exchange rates applied by different credit cards can be very substantial, as much as 10% according to a Lonely Planet report in 2009.[24]
