Credit Cards
Credit cards are a type of payment card that allows the cardholder to borrow funds from a bank or financial institution in order to make purchases. When a credit card is used to make a purchase, the cardholder is essentially borrowing money from the issuer of the card, with the promise to pay it back at a later date.
Credit cards typically have a credit limit, which is the maximum amount of money that the cardholder is allowed to borrow. The credit limit is determined by the card issuer based on the cardholder’s creditworthiness and financial history.
Credit cards can be used to make purchases in person, online, or over the phone. They are often accepted at a wide range of merchants, including retailers, restaurants, and service providers.
Credit cards usually come with an interest rate, which is the cost of borrowing the money. If the cardholder does not pay the balance in full each month, they will be charged interest on the outstanding balance. Credit cards may also come with other fees, such as annual fees, late payment fees, and balance transfer fees.
Benefits of Using Credit Card
- Buy Now, Pay Later — Credit cards allow you to buy what you need today, while paying for it at a later date. Every credit card comes with a set credit limit that’s applicable on such purchases. There is an interest-free grace period in which there aren’t any additional expenses on the purchase.
- Easy EMI payments — Management of immediate financial expenses has become easier by the ability to convert the purchase value into manageable monthly EMIs using a credit card. Therefore, when you purchase a new TV or mobile, you can choose not to pay the amount in a lump sum but over a flexible repayment tenor.
- Redeemable Rewards — Reward points earned with every purchase you made can be redeemed for travel, purchasing lifestyle items, to cover fuel expenses, etc.
- Discounts and Cashback Benefits — Credit cards offer discounts and cashback offers on dining, lifestyle, travel and entertainment spends at select partner stores, applicable to both online and offline purchases.
- Interest-Free Cash Withdrawals — Many credit cards in India allow the cardholder to withdraw cash during emergencies without any interest penalties.
- Insurance Coverage — Some premium credit cards also offer comprehensive insurance covers like air accident, personal accident and accidental death covers.
- Universal Acceptance — Most Indian credit cards can be used internationally, allowing you to travel without worrying about carrying a significant amount of cash.
- Easy Auto-payments — The auto-payment facility enables on time payment of recurring bills and relieves us of the hassle of missing a deadline. Additionally, you can also link your credit card to your mobile wallet and online payment platforms to enjoy scan and pay benefits.
- Improved Credit Score — CIBIL is one of the credit rating agencies that evaluates your credit score based on your debt repayment history. Paying the monthly credit card bills on time improves your credit score, making you a reliable borrower. This helps you build a strong credit history and avail of loans in the future at a lower interest rate.
Types of Credit Cards
There are numerous types of credit cards that are available for use. However, we will stick to the five most commonly used types.
- Regular credit cards - Regular credit cards are the simplest type of credit card. They don’t offer perks and rewards. They are ideal for parents who want to provide their children with the convenience of using a credit card. One benefit of regular credit cards is that they have a predetermined credit limit, which allows the user to control their use of the card. Once the purchases have reached the limit, no further purchases can be made, and they will need to make payments first in order to open up the card again.
- Balance transfer credit cards - This type of card is an option offered to those who have a balance on existing cards. The debt is paid off with the new card and the owner pays the debt to the new card at ideally lower interest rates.
- Student credit cards - A student credit card is specifically designed for individuals who need a credit card but do not have a credit history yet. It requires a higher approval rating compared to standard or regular cards.
- Charge cards - Charge cards are beneficial in the sense that they do not charge interest or fees simply because the balance needs to be paid in full at the end of every month. However, in the event of a failed payment, charges are made, or the card may be revoked, depending on the terms and conditions set by the financial company.
- Subprime credit cards - This type of card is considered to be among the worst and most scheming type of cards, as it targets individuals with a bad credit history. Its fees are exorbitant, but people still use them because of the lack of choices and opportunities to open a credit line elsewhere. Even if there are already federal laws regulating the fees subprime credit cards can charge, they seem to find ways and loopholes that let them continue their scheme.
*Note that some types of credit cards are not available in India.
How do Credit Cards Work?
Whether it be online or in the store, credit cards can be used to make quick and easy payments. For each transaction, the card details are sent to the merchant’s bank. The bank then receives the authorisation from the credit card network to process the transaction. The card issuer now has to verify the information of the card bearer and approve the transaction.
As discussed above, a credit card has a set limit of available credit. On approval of the transaction, payment is made to the merchant and your card’s available credit is reduced by the transaction amount. At the end of your billing cycle, your card issuer will send you a statement showing all the transactions for that month, your previous balance and new balance, your minimum payment due, and your due date.
All Parties in a Transaction:
- Issuing Banks: Credit cards are issued by almost all banks (and recently, a few neobanks). From a banking perspective, this is the start of the customer life-cycle.
- Payment Processing Networks: These networks connect the banks/merchants/customers and enable a seamless settlement of transactions. For egs: Visa, Mastercard, Diners, RuPay. Their core competence lies in efficiently maintaining and operating an enabling technical capability on a 24×7 basis, at a global scale.
- Merchants: A credit card can be used at a multitude of places including hotels, malls, restaurants, petrol pumps, etc. The acquiring bank instals an Electronic Data Capture (EDC) machine at these outlets. To make a purchase, the merchant will swipe your plastic. This will in turn require real-time authorization to complete the transaction.
- Acquiring Banks: These financial institutions place their EDC machines at points of sale (with merchants). It is possible to use a card issued by a bank at an outlet of a different bank. For egs: a customer may 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 is possible for domestic or international transactions as well. The acquiring bank is the entity which ensures the merchant receives his dues in accordance with a pre-set timetable.
Factors for Issuing Credit Cards:
- Credit score: Credit scores are considered while approving credit card applications. As credit bureaus calculate credit score on the basis of your past repayment behaviour, card issuers use your credit score to judge your creditworthiness. Usually, those with credit scores of 750 and above have higher chances of credit card approval. Many credit card issuers avoid issuing credit cards to those without credit history.
- Income: If you fail to meet the monthly income criterion, your credit card application will be rejected outright even if you successfully meet other eligibility conditions. However, this criterion would vary within the same card issuer depending on the card type. Cards with higher benefits have higher monthly income requirements.
- Occupation: Occupation plays a major role in the approval of your credit card application. Usually, salaried people have higher chances of credit card approval than self-employed people as the former has comparatively steady cash inflow than the latter. Employees of less-known companies and financially-distressed companies are not preferred as the financial failure of such companies may adversely impact the repayment capacity of their employees.
- Location: The location of the applicant also impacts the approval of his card application. Banks list certain areas within their service areas as ‘negative areas’ or ‘black-listed areas’. Credit card applications received from such negative or black-listed areas may get rejected even if the applicants score well on other parameters.
How do Credit Card Companies earn money?
- Transaction fees charged to the merchant every time you use your credit card. These are levied on the merchant and thus, the ordinary customer does not need to worry about these fees.
- Interest payments when you don’t pay off your debt in full.
- Fees, like late payment or annual fees.
Credit cards charge a number of fees, ranging from annual fee to cash advance fees to late payment fees. Most cards won’t have an annual fee unless they offer big rewards or are designed for people with low credit scores. In this case, the minimum monthly payment should be made on time, or there may be a penalty with a late fee and higher interest rate, harming your credit score.
Owners of rewards credit cards must remember that if you carry a balance, the interest on that balance will eat up any rewards you earn. If there is a chance you will not be able to pay off your balance every month, steer clear of rewards cards.
Growth of Credit Cards in India:
Old and traditional India had a conservative approach towards borrowing. Most people viewed ‘spending before earning’ with a degree of unease. Gradually, credit cards have brought about a dramatic change in consumer behaviour whereby plastic is now viewed as a friend, not a foe.
The Central Bank of India launched the first credit card in India in 1980. Today, that number has increased to 66 million. Keeping in mind India’s demographic distribution, that figure is projected to cross 150 million by 2025.
Credit cards have become an integral part of our lives and an essential item in individual wallets as evident by their widespread issuance and usage. 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. One such benefit is that transactions are on record, enabling robust tax collections. Immense credit card spending (crossing 1 lakh crores in October 2021) have delivered the much needed positivity on demand stimulus, especially for a Covid-afflicted economy.
It must be noted that the aim of overall “financial inclusion” is also being fulfilled by access to organised financial services in all areas. A credit card is an entry level product and spreads awareness about other credit facilities, for egs: home loans, personal loans, etc. where they may not be very popular.
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