How do Credit Card companies make money — The Business Model (2024)

Credit card companies make the bulk of their money from three things: interest, annual fees charged to cardholders and transaction fees paid by merchant businesses that accept credit cards. But despite the mushrooming of fintech startups and mobile wallets, many people still wonder — do card companies make money if I pay in full? Why do some credit cards have an annual fee and some are free?

Here, we take a deep dive to understand the business model around credit cards.

1. Card Holder and Merchant (they both are sources of revenue)
2. Issuing Bank: The entity which issues the Credit Card to Customer, like HDFC Bank, YES Bank, Citibank, etc. 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.
3. Acquiring Bank: It is responsible for making payments to the merchant. They deal with merchants — requests them to accept their card.
4. Payment Network: Networks like Visa, MasterCard, American Express serve as the link between acquiring banks and issuing banks. These banks have relationships with a network, rather than with each other, for fulfilling card purchases. This allows a card issued by say ICICI 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 others network if an agreement is reached.

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.

Mr.Kohli, on 2nd May, went to buy a Sony Bravia Smart TV, from Croma with his HDFC Bank Regalia Credit Card (which is on the MasterCard network). The guys at Croma Showroom swipes the HDFC Bank Regalia Credit Card on an EDC machine (Electronic Data Capture machine) provided by ICICI Bank. Immediately upon swiping, Mr. Kohli is asked to enter his Card PIN, and then on successful authorisation, he gets a confirmation SMS on his phone that Rs.59,990 has been charged to his HDFC Bank Regalia Credit Card.

In the above example, Mr. Kohli is the card holder, Croma is the merchant, HDFC Bank is the Card Issuer, ICICI Bank is the Acquirer and MasterCard is the Payment Network.

The Acquirer Bank (ICICI Bank in this example) pays the Merchant (Croma) the full transaction amount of Rs.59,990 after deducting Merchant Discount Fees, as per the MDR (generally varies between 0.9% to 3.5%, based on various criteria). The Issuer Bank (HDFC Bank) pays the Acquirer Bank (ICICI Bank) 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 (HDFC Bank) collects the full transaction amount from the Cardholder (Mr. Kohli). Both the Acquirer and the Issuing Bank pays Payment Network (MasterCard) a fee.

In Short, merchant discount is distributed between Acquiring Bank (Acquirer fees), Issuing Bank (Interchange Fees) and Payment Network (Network Fee).

This Mr. Kohli, again on 5th May, orders a Bang & Olufsen Beosound 35 Home Multiroom Wireless Music System Speaker from Amazon.com (the US site), as he couldn’t find this particular model in India, and pays $2,495 online with the same HDFC Bank Regalia Credit Card.

Now following are the facts around Mr. Kohli’s HDFC Bank Regalia Credit Card (note: numbers are for illustration only, may not be actuals pertaining to this Credit Card):

• Bill Cycle: 1st of the month to 31st of the month
• Bill Generation Date: 1st of every subsequent month
• Bill Payment Due Date: 16th of every month
• Late Payment Interest Charge: 3% per month (36% APR)
• Annual Fees on the Credit Card: Rs.3,000
• Minimum Amount Due: 20% of Bill generated on 1st of the month

Now, assuming he has no outstanding payment till 1st May, and no other fees left to be paid, and no other transaction was made on the Card in May, Mr. Kohli gets the following bill, on 1st June:

• Croma Payment — Rs.59,990
• Amazon.com Payment (@Rs.67 per USD) — Rs.1,67,165
• Foreign Currency Conversion Charges (@3.5%) — Rs.5,850
• Service tax on Conversion Charges (15% on Rs.5,850) — Rs.877.50
• Annual Card Fees — Rs.3,000
• Service tax on Annual Card Fees — Rs.450
• Total Bill — Rs.2,37,332.50 (payable by 16th Jun)
• Minimum Amount Due — Rs.47,466.50

Now, there are 4 scenarios:

1. Mr. Kohli pays full amount of Rs.2,37,332.50 by 16th Jun. Zero interest charges are accrued in next bill.
2. Mr. Kohli pays a partial amount but more than the minimum amount due. Say he pays Rs.1,00,000. Interest charges of 3% per month will be levied on the outstanding payment of Rs.1,37,332.50 in every bill, till full or part payment happens.
3. Mr. Kohli pays less amount than the minimum amount due, say he pays Rs.25,000. In the next bill, interest of 3% per month on the entire bill amount of Rs.2,37,332.50 will be included.
4. Mr. Kohli does not pay in June at all. In this case, interest charges @ 3% per month on complete bill amount of Rs.2,37,332.50 will keep getting added in bill, till full or part payment. And, Mr. Kohli’s credit score will get reduced.

Understanding how Credit Cards make money is now much easier with this background.

1. Interchange Fees:

As explained above, 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.

2. 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, majority would be “revolvers” (people who keep paying less than full amount every month), and these guys are most profitable for the bank.

3. Annual / Renewal Charges:

Specific Cards have sign up fees and annual renewal fees. For example, the American Express Platinum Travel Credit Card has joining fees of Rs.3,500, and Rs.5,000 is the annual fees from the subsequent year onwards.

4. 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 currency, and a foreign currency conversion charge is levied to your account.

5. 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.

6. 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.

7. Conversion of Outstanding to easy EMIs

Most banks offer customers a choice to convert outstanding amount payable to easy EMIs at a specified interest rate.

8. 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.

9. 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.

10. Co-Brand and Other Marketing Revenues

• In some cases, card statements can become advertising destinations by merchants through either merchant-funded offers or plain advertisem*nts. In India, this is still nascent, but there can be costs associated to such activities.
• For Co-brand credit cards, like Jet Airways American Express Platinum Credit Card, there is a strong fiduciary relationship between the 2 partners — both in terms of transaction and reward points / miles related revenues.

11. Others

Some other sources of revenue are:

• Card Replacement Fees
• Supplementary Card Issuance Fees
• Charges towards Inward Integration of Payment Gateways

1. Acquirer Fees

We have mentioned earlier that acquirer takes a small commission out of the MDR for its role in the payment settlement process.

2. 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).

3. 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.

1. 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.

2. 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.

3. 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.

4. 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.

In Summary, for every transaction, all the 3 parties (Issuer, Acquirer, Network) makes money. In some cases, Issuer and Acquirer are the same. And in the case of American Express, all the 3 are the same.