Banks And Credit Cards – How They Make Money
They are all over the place like vultures waiting to scavenge. They attempt to block your path while you make you way out of the train station, attempt to show you a fake friendly face as if they have known you for decades, and you never hear from them ever again after this 1 interaction.
No I’m not talking about your next door neighbors. I’m talking about those kids canvassing for credit card sign ups in public places.
They wake up early to prepare their material for the day. They set up shop at one of those busy places with heavy human traffic. Then they catch you while you are on your way home. This is the best time as you are more relaxed than if you are on your way your work. And you are less likely to be in a rush unless Desperate Housewives is showing in 15 minutes.
Yes these people call themselves bankers.
Something must have changed in the banking world. Because I’ve always associated the word “banker” with people in power suits frowning on every detail a customer provides so that he can decline a loan.
Now bankers are kids right out of college who are ever so eager to give out loans and credit with anything that is eligible for one.
If you are wondering how can it be worthwhile for “bankers” to sweat it out during the day getting unsuspecting passer-bys to sign up for free credit cards, I assure you that they could very well be making more money than you were when you first joined the workforce.
If not, no youngster in this new pampered world will slug it out in the streets. Literally.
And you must be out of your mind if you entertain the thought, even for a second, that banks would continue running a loss making operation. Banks are definitely banking it. Pun intended.
You must wonder how card issuers and banks make money when you get the cards for free and don’t even allow a single cent to run overdue. They have to pay salaries for staff, rentals for their mobile kiosks, and even the glossy marketing collateral. So where is the money being made?
To answer that question, we have to first answer the question of: What basically is a credit card?
At it’s most fundamental form, a credit card allows card owners to spend money they do not have. No. To be more specific, it allows card owners to spend the money they don’t have now, but will have in future.
It’s not my intention to go all philosophical here. But that is exactly what it is.
The amount you can spend upfront, the credit limit, is determined by the financial standing of the individual. The credit history of the person will also play a role in determining whether a card application gets approved and how much credit to grant.
This credit facility, which is the credit card, allows users to conveniently lavish themselves with designer handbags, expensive dinners, and the occasional grocery trip.
At the end of the billing month, you will receive a statement showing what you spent and the amount due. You will then have a choice of either paying off the whole sum or pay a minimum sum. Everyone would probably be familiar with how to make the most of them.
The bank would prefer that you don’t pay it all so that they can charge you a generous interest rate of usually over 20%. It’s a paradox why they want people not to pay, yet penalize them for overdues by reporting adverse accounts to the credit bureau. Resulting in the card owner’s credit score taking the beating.
But nevertheless, with these things in mind, consumers still swipe their credit cards like there’s no tomorrow.
The use of the credit cards is actually where the money is made.
Retailers, both online and offline, have transaction and processing fees to contend with every time they accept a payment by credit card. This means that $20 steak dinner you just had was not totally paid to the restaurant. The bank get a cut, and the card issuer gets a cut too. Furthermore, retailers have to pay a recurring subscription fee for the use of the machines that make these encrypted electronic transactions possible.
This is why sometimes, you find that retailers are willing to give you a discount if you pay by cash. Because they don’t have to pay these pesky third parties.
If that’s the case, what’s the difference between credit card companies and banks?
You won’t be shamed to think that they are the same. Because you actually know the difference between them. It’s just that they come together all the time that we often forget that the organizations sucking us dry are actually 2 separate entities.
Consumer banks are those like Bank of America, JP Morgan Chase, Wells Fargo, etc. And on the side of the credit card companies, we have those like MasterCard, VISA, American Express, etc.
At some point in history, some wise corporate people decided that it would be a breakthrough strategy to combine the core competence of credit card companies and banks. Banks get to loan out more money at spectacular interest rates, and credit card companies get to repeat the word “Kaching!” the world of digital transactions.
It’s a match made in heaven. And they are now almost inseparable.
Different revenue models
If you still don’t have a clear picture of where the money is made. Let’s list them down.
Banks make money from:
- transaction fees
- annual fees
- late payment fees
- administrative fees
- internet banking
- interest on outstanding balances
- up-sell and cross-sell of other products and services
Credit card companies generate revenue from:
- transaction fees
- machine set up fees
- rental of credit card terminals
There is no saying how both parties might split any of the revenues among themselves.
Are retailers screwed?
On the surface of these information, you might feel a little sympathy for retailers who are getting squeezed by these financial institutions.
Because they mark up their margins before setting their prices. How else do you think capitalism works?
If you have ever spent time working in the procurement, you would have seen with your own eyes how products move through the supply chain. Prices can be marked up 10 times, even a hundred times, from the moment when it was produced until it reaches the hands of an end-user.
This means that in the end, the consumers are still the ones who are paying the banks and card issuers.
Now that we have gone full circle, you can see that you and I are the ones paying for everything. So next time, you are thinking about signing up for a free credit card, please know that it’s not actually free.
With all these said, it is easy to point the finger at the CEOs and the greed of Wall Street.
But really, it’s all an ecosystem that keeps the economy going.
But more importantly, how credit cards have made you consumption of products and services so convenient.
Because if you face the honest truth. Can you imagine a world without credit cards?