Why do we use Debit Cards when Credit Cards make more sense

Today, most urban Indians carry plastic in their wallets, especially after the Government’s push to increase cashless transactions. Many of them carry both credit and debit cards, but still prefer to pay by debit cards, especially for smaller transaction sizes. Therein lies a paradox. Given the various rewards associated with most credit cards, and *free* use of funds for 2–4 weeks, its safe to assume that consumers are almost always better off paying with a credit card than with a debit card.

Numbers though, tell a different story. India has roughly about 70 crores of debit cards and less than 3 crores of credit cards in circulation, as per the October 2016 RBI Data Release. Average monthly spend per credit card is a little more than Rs.10,000, while average monthly spend per debit card is much lesser than Rs.500 (not including inactive cards). In countries with higher density of creditworthy population too, growth rates of debit card usage has been higher than that of credit card usage.

  1. Mental Accounting: People use different payment instruments for different spends of their spending budgets. Many people prefer to use debit cards for recurring payments, bill payments, small ticket size purchases and even weekly groceries, while they use their credit cards only for big ticket purchases like booking air tickets, buying white goods, etc. Nowadays, there’s increasing adoption of mobile wallets to make micro-payments for small services — cabs, bills, recharge, etc. which obviously have got a fillip due to the recent demonetisation and attractive cashback offers in your wallet. Debit cards provide the same accounting function as cash and checks but the convenience of cards. There’s also some mental pain associated with credit cards — accounting for future payments, accrued rewards and the fear of missing credit card payment cycles and incurring losses due to interest payment. In many cases, they prefer to pay before they are consuming things, because then, they can consume pain free (What’s with the need to punish ourselves?). Putting a payment on a credit card makes more sense from this perspective when the benefits are long-lived and off in the future.
  2. Liquidity Management: People receive payments in lumps — a monthly salary, an occasional bonus, for example. They also face blocks of obligations, such as emergencies, home improvements, buying consumer durables. Decision to finance purchases is part of household management, hence, careful usage of credit cards. Whereas for most other spend categories, debit card usage is perceived to be hassle-free, simpler and adheres to our mental accounting models.
  3. The behavioural economics of paying and borrowing: People have money in various FDs/RDs and savings accounts earning low interest while simultaneously carrying high-interest rate loans on their credit cards and other lines of credit. This is same as businesses that have cash on hand, but raise money from bonds and equity markets. The reason for it is that people value having enough liquidity to pay for lumpy expenditures and handle emergencies. A percentage of credit cardholders choose credit cards intelligently and use them responsively. They get better at making sound decisions over time. At the same time, other people tend to be short-sighted, impulsive and over-optimistic about whether they will repay and their willingness to repay.
  4. Propensity to spend more with Credit Cards: The literature is mixed on whether particular payments instruments lift retail sales. A number of studies have found that people spend more if they have a credit card. Many people believe they lack the financial discipline and with credit at their disposal, would fall prey to impulse purchase desires. A debit card keeps those emotions firmly in check.
  5. Lack of Awareness: Provided a consumer is financially well-disciplined, and scrupulous enough to minimize the cost of credit, usage of credit cards over a long period of time are more beneficial than debit cards. There is definitely a lack of awareness of benefits and most efforts by Card Issuers fall short in being bring the value of credit card usage upfront compared to other payment mechanisms.
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