What Is A Credit Card
A credit card is a thin rectangular piece of plastic or metal issued by financial institutions, which allows you to spend money from a pre-approved limit to pay for your transactions at both online and offline merchants. The card issuing institution determines the limit, based on your profile, income and credit history.
Eureka Moment: In 1949, businessman Frank McNamara was dining with his clients at a New York restaurant when he realized that he had forgotten his wallet. Frank and his associates discussed the idea of a multipurpose charge card as a way to avoid similar embarrassments, which led to the formation of ‘Diners Club’.
The rest, like they say, is history: birth of a fiercely competitive & ever-evolving industry with a ubiquitous worldwide presence, at a grassroots level. The credit card galaxy transmogrifier at regular intervals and whole new constellations of credit cards continuously comes to the fore and acquires luminescence.
How Does A Credit Card Work?
In the credit cards chain, the most important link is the consumer i.e. you. Accordingly, it is so essential to be fully informed about all facets surrounding card selection & usage, and we will subsequently touch on these aspects. It is, however, equally important to be somewhat familiar with ‘what lies beneath’.
Apart from the card holder, there are four principal actors in the value chain.
1. Issuing Banks: Almost all banks (and recently, a few neobanks) issue credit cards. From a banking perspective, this is the start of the customer life-cycle.
2. Payment Processing Networks: Connect the banks/merchants/customers and enable a seamless settlement of transactions, examples include Visa, Mastercard, Diners, RuPay. Their core competence lies in efficiently maintaining & operating an enabling technical capability on a 24×7 basis, at a global scale.
3. Merchants: Hotels, airlines, malls, online purchase, fuel pumps, and all such points where you would use the card. The acquiring bank installs an Electronic Data Capture (EDC) machine at these outlets. When you make a purchase, the merchant swipes your plastic and receives real-time authorization to complete the transaction.
4. Acquiring Banks: Place their EDC machines at points of sale i.e. with merchants. It is possible that you would use a HDFC card (issuer) at an outlet which has an Axis Bank (acquirer) EDC machine. The switching is facilitated by a network, say Visa. This holds true for domestic or international transactions. The acquiring bank is the entity which ensures the merchant receives his dues in accordance with a pre-set timetable.
Elaborating via a purely hypothetical example: you purchase a book at Shoppers Stop for INR 100 through a YES Bank card (Visa), where Shoppers was using an Axis Bank EDC machine. YES Bank will debit you INR 100 and remit INR 98.50 (less interchange) to Axis; and Axis will pay Shoppers INR 98 (value of transaction less merchant discount rate – MDR); in addition, the switching network (Visa) will earn commission 25 paisa from YES Bank.
Illustrative Table
The above is only a base level intersection map. In actual fact, multifarious customised models (details remain highly confidential) are continuously in operation. For instance, it is entirely possible for Visa to recover switching fees from both YES Bank and Axis Bank.
Innovations by Neobanks
Over the past seven decades, operating models and value chains have undergone continuous & fundamental changes. In recent times, Neobanks have added a whole new dimension to the financial services landscape and have created alternate paths for customer service. At a global level, these tech-enabled banks are offering a wide range of avant-garde products and services. India is also witness to the advent of neobanks, who have now begun providing credit cards and digital lending via BNPL (Buy Now Pay Later). These fintech start-ups are frequently partnering with traditional banks to issue credit cards, and variations thereof.
Some banks are aggressively exploring partnerships with fintech players to acquire a newer set of customers for their platforms. Banks provide open application programming interfaces (APIs) to fintechs, and leverage their ecosystem to on-board credit card customers. Apart from traditional credit rating procedures, card issuers are exploring alternate credit risk models, thus enabling issuance of credit cards to customers without an existing credit score. Consequently, there has been an uptick in new credit card customers. However, it is early days and the jury is still out regarding the success of the new initiatives.
As Frank McNamara would have triumphantly opined, a credit card is the proverbial “win-win” for all the constituents: banks, networks, merchants, consumers.
Banks earn from credit card spends and also from cross-selling loans & other services to an ever increasing base of credit card holders. The networks earn a fee for enabling an efficient multi-constituent settlement process. The merchants, both physical and online, are beneficiaries of a much higher level of sales. However, it is society as a whole, along with millions of consumers who have witnessed recurring & persistent large scale benefits.
Societal benefits
Traditionally India has had a conservative mind-set towards borrowing, and a large section of the population would view ‘spending before earning’ with a degree of unease. Over a period of time, credit cards have gradually fostered a dramatic change in consumer behaviour whereby plastic is now viewed as a friend, not a foe.
In 1980, the Central bank launched the first credit card in India. In 2013, there were 18.7 million cards in force (CIF), and currently that figure stands at 66 million. Given India’s demographic dividend, the comparative figure for 2025 is expected to cross 150 million.
Widespread credit cards issuance and usage is evidence of the extent to which cards have become an integral part of our lives and an essential item in individual wallets. Furthermore, the credit card ecosystem is a veritable mainstay in the successful digitization of the economy and is an effective tool for mainstreaming consumer spending and all the related positive fallouts i.e. transactions are on record, thus enabling robust tax collections.
Additionally, humongous credit card spends (crossed 1 lakh crores in October 2021) have delivered the much needed positivity on demand stimulus, especially for a Covid-afflicted economy.
Access to organised financial services is a noteworthy step towards overall “financial inclusion”. A credit card is an entry level product and spreads awareness about other credit facilities, for example, home loans, personal loans.
Additionally, most cards come with an in-built insurance feature and as such, readymade protection is on the table for the consumer. The availability of formal credit is even more widely appreciated in semi-urban and rural India. Farmers take the facility of Kisan credit cards for managing their finances.
Benefits of a Credit Card
A credit card provides a card holder up to 50 days of interest free credit, if the entire balance is paid before the due date. The primary difference between a credit card and a debit card is that the former is a Buy Now Pay Later (BNPL) instrument; whereas in a debit card the money is deducted immediately from the customer’s bank account.
Banks also accept a minimum amount due i.e. 5%-7% of the bill, and roll over the balance to the next month. However, this accommodation comes at a prohibitive interest rate of 1.5%-4.0 % per month. It is therefore always advisable to pay credit card bills on time and maintain a good credit history.
During emergencies, you can use the card to withdraw cash from ATMs, at a stipulated fee.
Frequently, parents leverage low limit credit cards as an education tool, to familiarise their wards with plastic usage and to instill a sense of responsibility.
Features of a Credit Card
- Credit limit: The credit limit on your card is the upper limit for transactions. Card holders with a good repayment history are awarded an enhanced credit limit by the bank.
- Annual and Joining Fees: While there are a few no joining fee Credit Cards in the market, most Credit Cards have a joining fee and an annual fee. The fee can range from Rs 500 per month for a basic card, to tens of thousands for premium offerings. In some cases, there is a fee waiver, subject to a predefined minimum spend.
- Card’s billing cycle: On a predetermined date, each month your credit card statement is generated. The last date for bill payment is 15-20 days after the billing date. Thus, you get a window of up to 50 days for paying your credit card bills.
- Interest rate: Every time you delay your credit card payment beyond the free credit period, a stipulated interest cost is levied. The interest is charged on a monthly basis and ‘interest on interest’ accrues till the outstanding balance is cleared. Always repay your Credit Card bills in time. Disciplined financial behaviour is an excellent tool to build your credit score.
- Minimum payment due: You can delay your credit card payments by paying the minimum due. The balance amount is rolled over at an exorbitant rate of interest.
- Foreign mark-up: Overseas travellers should verify the foreign currency mark-up fee, it may range from 2% to 4%.
- Rewards and Benefits: Each card comes packed with certain types of benefits, catering to a distinctive category of users. To maximise benefits, select a card which best aligns to your spend pattern.
- Multiple cards: To fully capitalize on benefits, select two to three diverse categories of cards e.g. travel, fuel, lifestyle, online shopping. In addition, ensure that the cards do not have the same settlement date i.e. 15th or 30th of the month. Thus enabling longer periods of free credit.
- Card security: While your credit card is loaded with a CVV and a chip/magnetic strip, it is still advisable to monitor security hygiene. Always transact at reliable stores & websites. While transacting on a POS, do check the details before feeding the pin. Never share card PIN & CVV with anyone. Simple hack like saving the card issuer’s hotline number in the mobile can enable swift action.
Bottom Line
The credit card industry offers employment to millions, lifts consumer demand, accelerates digitization, acts as an innovation catalyst, empowers financial inclusion and will always remain relevant to our lives – in one form or another.
