MyCardBlog

We are expecting more returns by swiping Credit Cards. Although I believe credit card issuers gain a lot of profits from their card holders, we should also consider the costs of credit card issuers. The high returns come with high risks. Let’s see the costs of the credit card issuers. (in part adapted from Wiki)
Credit card issuers (banks) have several types of costs:
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.

Interest expenses
Banks generally borrow the money they then lend to their customers. When we use our credit cards, we borrow the money from card issuers for about 1 month. However, credit card companies have to put the money in the merchants’ accounts in their banks. (A huge cost!) 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 5% difference is the “interest expense” and the 10% is the “net interest margin”. This is especially true for American Express. Don’t like Chase and Citi, they don’t have a chance to get money out of their own bank.

Rewards
Many credit card customers receive rewards, such as frequent flier 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 spend. Networks like Visa or MasterCard have increased their fees to allow issuers to fund their rewards system. However, most rewards points are accrued as a liability on a company’s balance sheet and expensed at the time of reward redemption. As a result, 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. Others encourage redemption for lower cost merchandise; instead of an airline ticket, which is very expensive to an issuer, the cardholder may be encouraged to redeem for a gift certificate instead. 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. There is a case to be made that rewards not redeemed should follow the same path as gift cards that are not used: in certain states the gift card breakage goes to the state’s treasury. The same could happen to the value of points or cash not redeemed. Also don’t forget the sign-up bonus from credit card companies. Usually we can get $50 to $250 cash or gift certificate as a bonus for being a new card holder.

Fraud
Where 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.
The cost of fraud is high; in the UK in 2004 it was over £500 million. Credit card companies generally guarantee the merchant will be paid on legitimate transactions regardless of whether the consumer pays their credit card bill. “Soft fraud” is fraud committed by the customer himself: getting a card and using it with no intention ever to repay the balance. Such customers are called “diabolicals” by the credit card companies, which try to avoid them at all cost.

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.) It is one of the worst possible items to have on your file. The item will include relevant dates, and the amount of the bad debt. A charge-off is considered to be “written off as uncollectible.” 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. 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. In the US, as the charge off number climbs or becomes erratic, officials from the Federal Reserve take a close look at the finances of the bank and may impose various operating strictures on the bank, and in the most extreme cases, may close the bank entirely. (Several days ago, I heard that somebody transferred $30,000 from Citi and then went back to China. Citi won’t go to China and sue him. This is a reason why some credit card issuers state that you must be a US Citizen.)