1.5.1. Costs

 
Credit card issuers (banks) have several types of costs:

1.5.1.1. Interest expenses

Banks generally borrow the money they then lend to their customers. 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 spread".

1.5.1.2. 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.

1.5.1.3. 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.) The item will include relevant dates, and the amount of the bad debt.

A charge-off is considered to be "written off as uncollectable." 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 for the time periods permitted under state law, which is usually 3 to 7 years. 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.

1.5.1.4. Rewards

Many credit card customers receive rewards, such as frequent flyer 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 spread. Networks such as Visa or MasterCard have increased their fees to allow issuers to fund their rewards system. 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. Unlike unused gift cards, in whose case the breakage in certain US states goes to the state's treasury, unredeemed credit card points are retained by the issuer.

1.5.1.5. Fraud

The cost of fraud is high; in the UK in 2004 it was over £500 million.[20] When 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. Credit card companies generally guarantee the merchant will be paid on legitimate transactions regardless of whether the consumer pays their credit card bill. Most banking services have their own credit card services that handle fraud cases and monitor for any possible attempt at fraud. Employees that are specialized in doing fraud monitoring and investigation are often placed in Risk Management, Fraud and Authorization, or Cards and Unsecured Business. Fraud monitoring emphasizes minimizing fraud losses while making an attempt to track down those responsible and contain the situation. Credit card fraud is a major white collar crime that has been around for many decades, even with the advent of the chip based card (EMV) that was put into practice in some countries to prevent cases such as these. Even with the implementation of such measures, credit card fraud continues to be a problem.

1.5.1. Costs

1.9. Controversy

 
Credit card debt has increased steadily. Since the late 1990s, lawmakers, consumer advocacy groups, college officials and other higher education affiliates have become increasingly concerned about the rising use of credit cards among college students. The major credit card companies have been accused of targeting a younger audience, in particular college students, many of whom are already in debt with college tuition fees and college loans and who typically are less experienced at managing their own finances.

A 2006 documentary film titled Maxed Out: Hard Times, Easy Credit and the Era of Predatory Lenders deals with this subject in detail. The nonprofit group Americans for Fairness in Lending works with Maxed Out to educate Americans about credit card abuse.

Another controversial area is the universal default feature of many North American credit card contracts. When a cardholder is late paying a particular credit card issuer, that card's interest rate can be raised, often considerably. With universal default, a customer's other credit cards, for which the customer may be current on payments, may also have their rates and/or credit limit changed. The universal default feature allows creditors to periodically check cardholders' credit portfolios to view trade, allowing these other institutions to decrease the credit limit and/or increase rates on cardholders who may be late with another credit card issuer. Being late on one credit card will potentially affect all the cardholder's credit cards. Citibank voluntarily stopped this practice in March 2007 and Chase stopped the practice in November 2007. The fact that credit card companies can change the interest rate on debts that were incurred when a different rate of interest was in place is similar to adjustable rate mortgages where interest rates on current debt may rise. However, in both cases this is agreed to in advance, and is a trade off that allows a lower initial rate as well as the possibility of an even lower rate (mortgages, if interest rates fall) or perpetually keeping a below-market rate (credit cards, if the user makes his debt payments on time). It should be noted that the Universal Default practice was actually encouraged by Federal Regulators, particularly those at the Office of the Comptroller of the Currency (OCC) as a means of managing the changing risk profiles of cardholders.

Another controversial area is the trailing interest issue. Trailing interest is the practice of charging interest on the entire bill no matter what percentage of it is paid. U.S Senator Carl Levin raised the issue at a U.S Senate Hearing of millions of Americans whom he said are slaves to hidden fees, compounding interest and cryptic terms. Their woes were heard in a Senate Permanent Subcommittee on Investigations hearing which was chaired by Senator Levin who said that he intends to keep the spotlight on credit card companies and that legislative action may be necessary to purge the industry.

In the United States, some have called for Congress to enact additional regulations on the industry; to expand the disclosure box clearly disclosing rate hikes, use plain language, incorporate balance payoff disclosures, and also to outlaw universal default. At a congress hearing around March 1, 2007, Citibank announced it would no longer practice this, effective immediately. Opponents of such regulation argue that customers must become more proactive and self-responsible in evaluating and negotiating terms with credit providers. Some of the nation's influential top credit card issuers, who are among the top fifty corporate contributors to political campaigns, successfully opposed it.

Hidden costs

In the United Kingdom, merchants won the right through The Credit Cards (Price Discrimination) Order 1990 to charge customers different prices according to the payment method. As of 2007, the United Kingdom was one of the world's most credit-card-intensive country, with 2.4 credit cards per consumer.

In the United States, until 1984 federal law prohibited surcharges on card transactions. Although the federal Truth in Lending Act provisions that prohibited surcharges expired that year, a number of states have since enacted laws that continue to outlaw the practice; California, Colorado, Connecticut, Florida, Kansas, Massachusetts, Maine, New York, Oklahoma, and Texas have laws against surcharges. As of 2006, the United States probably had one of the world's if not the top ratio of credit cards per capita, with 984 million bank-issued Visa and MasterCard credit card and debit card accounts alone[36] for an adult population of roughly 220 million people. The credit card per US capita ratio was nearly 4:1 (as of 2003) and as high as 5:1 (as of 2006).

Redlining

Credit Card redlining is a spatially discriminatory practice among credit card issuers of providing different amounts of credit to different areas, based on their ethnic-minority composition, rather than on economic criteria, such as the potential profitability of operating in those areas.

Source: wikipedia.org

1.9. Controversy

2.1. Credit Card Terms

 
Important terms of use generally must be disclosed in any credit card application and even in solicitations that don’t require an application. Here are the most important terms to understand — or ask about — when you are choosing among credit offers.

Fees. Many credit cards charge membership and/or participation fees. Issuers have a variety of names for these fees, including “annual,” “activation,” “acceptance,” “participation” and “monthly maintenance” fees. These fees may appear monthly, periodically, or as one-time charges, and can range from $6 to $150. What’s more, they can have an immediate effect on your available credit. For example, a card with a $250 credit limit and $150 in fees leaves you with $100 in available credit.

Transaction Fees and Other Charges. Some issuers charge a fee if you use the card to get a cash advance or make a late payment, or if you exceed your credit limit.

Annual Percentage Rate. The APR is a measure of the cost of credit, expressed as a yearly rate. It must be disclosed before your account can be activated, and it must appear on your account statements.

The card issuer also must disclose the “periodic rate.” That’s the rate the issuer applies to your outstanding balance to determine the finance charge for each billing period.

Some credit card plans let the issuer change the APR when interest rates or other economic indicators — called indexes — change. Because the rate change is linked to the index’s performance and varies, these plans are called “variable rate” programs. Rate changes also can raise or lower the finance charge on your account. If you’re considering a variable rate card, the issuer must tell you that the rate may change and how the rate is determined.

Before your account is activated, you also must be given information about any limits on how much your rate may change — and how often.

Grace Period. A grace period, also called a “free period,” lets you avoid finance charges if you pay your balance in full before the date it is due. Knowing whether a card gives you a grace period is important if you plan to pay your account in full each month. Without a grace period, the card issuer may impose a finance charge from the date you use your card or from the date each transaction is posted to your account.

Balance Computation Method for the Finance Charge. If you don’t have a grace period — or if you plan to pay for your purchases over time — it’s important to know how the issuer calculates your finance charge. Which balance computation method is used can make a big difference in how much of a finance charge you’ll pay — even if the APR and your buying patterns stay pretty much the same.

Balance Transfer Offers. Many credit card companies offer incentives for balance transfers — moving your debt from one credit card (Card Issuer A) to another (Card Issuer B). All offers are not the same, and their terms can be complicated.

For example, many credit card issuers offer transfers with low introductory rates. Some issuers also charge balance transfer fees. If Card Issuer B charges four percent to transfer $5,000 from Card Issuer A, your fee would be $200. In addition, if you pay late or fail to pay off your transferred balance before the introductory period ends, Card Issuer B may raise the introductory rate and/or charge you interest retroactively. And if you use your card from Card Issuer B to make new purchases, any payments you make will go toward your balance with the lowest interest rate — and finance charges at the higher interest rate will be assessed on the portion of your balance that came from new purchases.

2.1. Credit Card Terms

2.2. Balance Computation Methods

 
Average Daily Balance. This is the most common calculation method. It credits your account from the day the issuer receives your payment. To figure the balance due, the issuer totals the beginning balance for each day in the billing period and subtracts any credits made to your account that day. While new purchases may or may not be added to the balance, cash advances typically are included. The resulting daily balances are added for the billing cycle. Then, the total is divided by the number of days in the billing period to get the “average daily balance.”

Adjusted Balance. This usually is the most advantageous method for cardholders. The issuer determines your balance by subtracting payments or credits received during the current billing period from the balance at the end of the previous billing period. Purchases made during the billing period aren’t included.

This method gives you until the end of the billing period to pay a portion of your balance to avoid the interest charges on that amount. Some creditors exclude prior unpaid finance charges from the previous balance.

Previous Balance. This is the amount you owed at the end of the previous billing period. Payments, credits, and purchases made during the current billing period are not included. Some creditors exclude unpaid finance charges.

Two-cycle or Double-cycle Balances. Issuers sometimes calculate your balance using your last two month’s account activity. This approach eliminates the interest-free period if you go from paying your balance in full each month to paying only a portion each month of what you owe. For example, if you have no previous balance, but you fail to pay the entire balance of new purchases by the payment due date, the issuer will compute the interest on the original balance that previously had been subject to an interest-free period. Read your agreement to find out if your issuer uses this approach and, if so, what specific two-cycle method is used.
How do these methods of calculating finance charges affect the cost of credit? Suppose your monthly interest rate is 1.5 percent, your APR is 18 percent, and your previous balance is $400. On the 15th day of your billing cycle, the card issuer receives and posts your payment of $300. On the 18th day, you make a $50 purchase. Using the:

- Average Daily Balance method (including new purchases), your finance charge would be $4.05.
- Average Daily Balance method (excluding new purchases), your finance charge would be $3.75.
- Average Daily Balance Double Cycle method (including new purchase and the previous month’s balance), your finance charge would be $6.53.
- Adjusted Balance method, your finance charge would be $1.50.
If you don’t understand how your balance is calculated, ask your card issuer. An explanation also must appear on your billing statements.

2.2. Balance Computation Methods

2.3. Other Costs and Features

 
Credit terms vary among issuers. When considering a credit card, think about how you plan to use it: If you expect to pay your bills in full each month, the annual fee and other charges may be more important than the periodic rate and the APR, and whether there is a grace period for purchases. If you use the cash advance feature, many cards do not permit a grace period for the amounts due — even if they have a grace period for purchases. That makes considering the APR and balance computation method a good idea. But if you plan to pay for purchases over time, the APR and the balance computation method definitely are major considerations.

You’ll also want to consider if the credit limit is high enough, how widely the card is accepted, and the plan’s services and features. For example, you may be interested in “affinity cards” — all-purpose credit cards sponsored by professional organizations, alumni associations, and some members of the travel industry. An affinity card issuer often donates a portion of the annual fees or charges to the sponsoring organization, or qualifies you for free travel or other bonuses.

Default and Universal Default. Your credit card agreement explains what may happen if you “default” on your account. For example, if you are one day late with your payment, your issuer may be able to take certain actions, including raising the interest rate on your card. Some issuers’ agreements even state that if you are in default on any financial account — even one with another company — those issuers’ will consider you in default for them as well. This is known as “universal default.”

Special Delinquency Rates. Some cards with low rates for on-time payments apply a very high APR if you are late a certain number of times in any specified time period. This can exceed 20 percent. Information about delinquency rates should be disclosed in credit card applications and in solicitations that do not require an application.

2.3. Other Costs and Features

3.1.3. Credit Crisis

 
The credit crisis of 2007 and 2008 has strongly affected American Express' operations. Traditionally, banks lent their money on deposit to credit card holders for purchases. However, American Express (along with the largest credit card issuers such as Discover and Citigroup) does not have enough funds on deposit with its bank subsidiaries to fund all of its outstanding cards. Instead, it has long relied on selling its credit card loans as bonds in what is known as the asset backed securities market. As 2007 and 2008 progressed, investors were scared away from buying mortgage bonds, then business loan bonds, and finally most forms of credit card bonds. To prevent a major collapse of multiple large credit card lenders, the US government enacted a special program where the Federal reserve would purchase various bonds, including credit card, SBA loan, and other bonds, to ensure that the flow of credit would continue for the US economy. The federal reserve also allowed the company to convert into a bank holding company to take advantage of additional programs, such as a program which allows the company to borrow funds by selling bonds guaranteed by the government. These moves have been seen as essential for American Express to survive. One important reason for this is that credit card bonds aren't usually like mortgage bonds insofar as mortgage bonds are often sold with little or no recourse to the seller. Credit card bonds, however, can force American Express to inject cash into the bonds if the earnings within the bonds fall to a certain point, as credit card bonds were traditionally designed not with the purpose of protecting the seller from risks of non payment on the credit cards but rather providing the seller with the ability to lend more of the borrowed money than what would normally be allowed with bank deposits.

Source: wikipedia.org

3.1.3. Credit Crisis