1.5. Profits and losses

 
In recent times, credit card portfolios have been very profitable for banks, largely due to the booming economy of the late nineties. However, in the case of credit cards, such high returns go hand in hand with risk, since the business is essentially one of making unsecured (uncollateralized) loans, and thus dependent on borrowers not to default in large numbers.

1.5.1. Costs
1.5.1.1. Interest expenses
1.5.1.2. Operating costs
1.5.1.3. Charge offs
1.5.1.4. Rewards
1.5.1.5. Fraud

1.5.2. Revenues
1.5.2.1. Interchange fee
1.5.2.2. Interest on outstanding balances
1.5.2.3. Fees charged to customers

1.5. Profits and losses

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

1.5.2. Revenues

 
Offsetting costs are the following revenues:

1.5.2.1. Interchange fee

In addition to fees paid by the card holder, merchants must also pay interchange fees to the card-issuing bank and the card association. For a typical credit card issuer, interchange fee revenues may represent about a quarter of total revenues.

These fees are typically from 1 to 6 percent of each sale, but will vary not only from merchant to merchant (large merchants can negotiate lower rates), but also from card to card, with business cards and rewards cards generally costing the merchants more to process. The interchange fee that applies to a particular transaction is also affected by many other variables including: the type of merchant, the merchant's total card sales volume, the merchant's average transaction amount, whether the cards were physically present, how the information required for the transaction was received, the specific type of card, when the transaction was settled, and the authorized and settled transaction amounts. In some cases, merchants add a surcharge to the credit cards to cover the interchange fee, encouraging their customers to instead use cash, debit cards, or even cheques.

1.5.2.2. Interest on outstanding balances

Interest charges vary widely from card issuer to card issuer. Often, there are "teaser" rates in effect for initial periods of time (as low as zero percent for, say, six months), whereas regular rates can be as high as 40 percent. In the U.S. there is no federal limit on the interest or late fees credit card issuers can charge; the interest rates are set by the states, with some states such as South Dakota, having no ceiling on interest rates and fees, inviting some banks to establish their credit card operations there. Other states, for example Delaware, have very weak usury laws. The teaser rate no longer applies if the customer doesn't pay his bills on time, and is replaced by a penalty interest rate (for example, 24.99%) that applies retroactively.

1.5.2.2. Fees charged to customers

The major fees are for:

- Late payments or overdue payments
- Charges that result in exceeding the credit limit on the card (whether done deliberately or by mistake), called overlimit fees
- Returned cheque fees or payment processing fees (eg phone payment fee)
Cash advances and convenience cheques (often 3% of the amount). Transactions in a foreign currency (as much as 3% of the amount). A few financial institutions do not charge a fee for this.
- Membership fees (annual or monthly), sometimes a percentage of the credit limit.
- Exchange rate loading fees (these may sometimes not be reported on the customer's statement, even when they are applied).

1.5.2. Revenues

1.11. Credit cards in ATMs

 
Many credit cards can also be used in an ATM to withdraw money against the credit limit extended to the card, but many card issuers charge interest on cash advances before they do so on purchases. The interest on cash advances is commonly charged from the date the withdrawal is made, rather than the monthly billing date. Many card issuers levy a commission for cash withdrawals, even if the ATM belongs to the same bank as the card issuer. Merchants do not offer cashback on credit card transactions because they would pay a percentage commission of the additional cash amount to their bank or merchant services provider, thereby making it uneconomical.

Many credit card companies will also, when applying payments to a card, do so at the end of a billing cycle, and apply those payments to everything before cash advances. For this reason, many consumers have large cash balances, which have no grace period and incur interest at a rate that is (usually) higher than the purchase rate, and will carry those balance for years, even if they pay off their statement balance each month.

Source: wikipedia.org

1.11. Credit cards in ATMs

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