Beyond the Benefits: The Economics of Credit Cards

The credit card offers interest-free loans for 45 days. However, what further entices the audience are the complimentary services it provides, such as reward points, cashback, and enticing lifestyle benefits like access to airport lounges and free rounds of golf.

But how do companies manage to offer these perks? Before delving into that, let’s first explore how they generate revenue in the first place.

Credit Card revenue breakdown

1. Interest Fees:

   The credit lines offered by these cards typically come with an interest-free period of 30–60 days, depending on the company. However, what happens after this period? Unfortunately, the answer is hefty interest charges. If you choose to pay through Equated Monthly Installments (EMIs), the interest rate can exceed 10%. Alternatively, if you fail to select any payment option within the allotted time, the interest rate can soar to over 30%. This source of income constitutes up to 50% of the revenue for credit card companies.

2. Interchange fees:

   When you make a payment using a credit card, a small fee is charged to the merchant you’re paying. This fee is known as the Merchant Discount Rate (MDR), and approximately 20% of it is retained by credit card companies to facilitate the transaction. This portion, referred to as the interchange fee, contributes up to 30% of the revenue for credit card companies.

3. Membership fees:

   Most credit card companies typically impose a one-time joining fee along with an annual maintenance fee for the credit card, constituting approximately 10% of their revenue.

4. Other Incomes:

   In addition to interest income, interchange income, and membership fees, credit card companies generate revenue through various other fees. These fees may encompass balance transfer fees, late payment fees, cash advance fees, foreign transaction fees, and other charges linked to specific services or transactions. Recoveries from loans previously written off also fall into this category.

Credit cards expenditure

1. Interest Loans:

   Credit card companies cover the costs of various rewards offered, such as cashback, reward points, and air miles.

2. Bad Debts:

   In some cases, the credit line provided by the company might need to be written off as a bad loan if the individual is unable to repay it. Since credit cards lack collateral, there is no means of recovering the funds except by pursuing the debtor.

3. IT and promotional expenses:

   This constitutes a significant expense for credit card companies. Acquiring new customers and encouraging ongoing credit card usage necessitates substantial expenditures on marketing and promotions.

Credit card companies continuously encourage people to spend more for a simple reason: the more you spend using their cards, the more they earn through the Merchant Discount Rate (MDR) discussed earlier. Additionally, if you make purchases beyond your budget and struggle to repay them on time, they profit further by imposing high-interest rates.

A credit card can be a beneficial tool if you manage your finances effectively. This is because individuals who delay payments, carry balances on their credit cards each month, or make purchases through EMIs effectively subsidize the credit card rewards and perks enjoyed by other customers.

What would occur if everyone consistently paid their credit card dues on time?

If everyone were to begin paying their credit card dues promptly and without resorting to EMIs before the due date, credit card companies would face the possibility of closure or be compelled to pivot their revenue models by implementing interest charges on credit or exploring innovative alternatives. In either scenario, the companies’ profit margins would diminish, rendering the business model less viable.