You spend and your bank earns - Credit cards

I use 4 credit cards - all of them are lifetime free cards. And I always pay my money on time. Yet, the banks mint money from me.

Yes, even when I don’t pay any late fee or interest charges, I’m a great source of revenue for my bank.

But how do they do it? And why is the credit card game so beneficial for banks?

Let’s dissect it.

Imagine you’re at Socials with friends on a Friday evening. Just got done with dinner, and probably happy-high with the drinks 😉

The waiter brings your bill, and you remove your card to pay.

Now, the waiter brings a card machine to you for swiping the card.

In case you’ve ever noticed, this machine will have a bank’s name written on it

(If you haven’t noticed it, do it the next time you go. But not with 3 LIIITs inside your system please).

The machine will have the logo of either a bank, or a company like Pine Labs, Mswipe, PayU or the likes.

For simplicity, let’s take the case where it’s a bank.

Now, this bank, that has given the machine to the restaurant is called the Acquiring bank. Let’s say this is SBI.

You pay with your HDFC Bank credit card. HDFC is called the Issuing Bank.

And this is where the money-making business starts.

The acquiring bank (SBI) processes the transaction. Now there are various other parties involved, but let’s not complicate it.

Socials is the “merchant” whom you will pay. Assuming the bill is Rs. 5,000 (and assuming you’re going light on those drinks), when you swipe your card, Socials won’t get the entire Rs. 5,000.

It will pay a fee, known as a “Merchant Discount Rate” or MDR. This fee is typically in the range of 1-4% of the amount that has been swiped.

The merchant pays this fee because he is getting the facility to accept card payments from customers.

Now, this MDR is the money that gets distributed among various parties:

- The Issuing bank (HDFC)
- The Acquiring bank (SBI)
- The network which has issued the card (Visa, Mastercard, Rupay etc)
- Other entities such as Mswipe, if they’re involved

(I won’t get into the details of when other entities get involved, but the point is, your credit card issuing bank earns money from the merchant for every single transaction)

For example, if I spend Rs. 20,000 with my credit card every month, assuming my issuing bank gets 0.5%, it’s making Rs. 100 from my spends, every month.

That’s 1,200 a year, from each customer.

So the next time you pay using your lifetime free credit card and wonder how the bank is earning by giving you credit, this is what it’s doing.

That’s all for today! If you liked this post, why don’t you share it with a friend so that they also know how this stuff works?

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I’m on leave tomorrow, but I wish you good luck for the Monday Blues 😉