Credit Card

A credit card is part of a system of payments named after the small plastic card issued to users of the system. It is a card entitling its holder to buy goods and services based on the holders promise to pay for these goods and services.^[1] The issuer of the card grants a line of credit to the consumer (or the user) from which the user can borrow money for payment to a merchant or as a cash advance to the user. A credit card is different from a charge card, where a charge card requires the balance to be paid in full each month. In contrast, credit cards allow the consumers to 'revolve' their balance, at the cost of having interest charged. Most credit cards are issued by local banks or credit unions, and are the same shape and size as specified by the ISO 7810 standard.

How credit cards work???

Credit cards are issued after an account has been approved by the credit provider, after which cardholders can use it to make purchases at merchants accepting that card.

When a purchase is made, the credit card user agrees to pay the card issuer. The cardholder indicates his/her consent to pay, by signing a receipt with a record of the card details and indicating the amount to be paid or by entering a Personal identification number (PIN). Also, many merchants now accept verbal authorizations via telephone and electronic authorization using the Internet, known as a 'Card/Cardholder Not Present' (CNP) transaction.

Electronic verification systems allow merchants to verify that the card is valid and the credit card customer has sufficient credit to cover the purchase in a few seconds, allowing the verification to happen at time of purchase. The verification is performed using a credit card payment terminal or Point of Sale (POS) system with a communications link to the merchant's acquiring bank. Data from the card is obtained from a magnetic stripe or chip on the card; the latter system is in the United Kingdom and Ireland commonly known as Chip and PIN, but is more technically an EMV card.

Other variations of verification systems are used by eCommerce merchants to determine if the user's account is valid and able to accept the charge. These will typically involve the cardholder providing additional information, such as the security code printed on the back of the card, or the address of the cardholder.

Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, any outstanding fees, and the total amount owed. After receiving the statement, the cardholder may dispute any charges that he or she thinks are incorrect (see Fair Credit Billing Act for details of the US regulations). Otherwise, the cardholder must pay a defined minimum proportion of the bill by a due date, or may choose to pay a higher amount up to the entire amount owed. The credit provider charges interest on the amount owed if the balance is not paid in full (typically at a much higher rate than most other forms of debt). Some financial institutions can arrange for automatic payments to be deducted from the user's bank accounts, thus avoiding late payment altogether as long as the cardholder has sufficient funds.

Interest charges??

Credit card issuers usually waive interest charges if the balance is paid in full each month, but typically will charge full interest on the entire outstanding balance from the date of each purchase if the total balance is not paid.

For example, if a user had a $1,000 transaction and repaid it in full within this grace period, there would be no interest charged. If, however, even $1.00 of the total amount remained unpaid, interest would be charged on the $1,000 from the date of purchase until the payment is received. The precise manner in which interest is charged is usually detailed in a cardholder agreement which may be summarized on the back of the monthly statement. The general calculation formula most financial institutions use to determine the amount of interest to be charged is APR/100 x ADB/365 x number of days revolved. Take the Annual percentage rate (APR) and divide by 100 then multiply to the amount of the average daily balance (ADB) divided by 365 and then take this total and multiply by the total number of days the amount revolved before payment was made on the account. Financial institutions refer to interest charged back to the original time of the transaction and up to the time a payment was made, if not in full, as RRFC or residual retail finance charge. Thus after an amount has revolved and a payment has been made, the user of the card will still receive interest charges on their statement after paying the next statement in full (in fact the statement may only have a charge for interest that collected up until the date the full balance was paid...i.e. when the balance stopped revolving).^[2]

The credit card may simply serve as a form of revolving credit, or it may become a complicated financial instrument with multiple balance segments each at a different interest rate, possibly with a single umbrella credit limit, or with separate credit limits applicable to the various balance segments. Usually this compartmentalization is the result of special incentive offers from the issuing bank, to encourage balance transfers from cards of other issuers. In the event that several interest rates apply to various balance segments, payment allocation is generally at the discretion of the issuing bank, and payments will therefore usually be allocated towards the lowest rate balances until paid in full before any money is paid towards higher rate balances. Interest rates can vary considerably from card to card, and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card or any other credit instrument, or even if the issuing bank decides to raise its revenue.

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

Costs

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".

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.

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.^[18]

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.

Rewards

Many credit card customers receive rewards, such as frequent flier 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.

Fraud

The cost of fraud is high; in the UK in 2004 it was over £500 million.^[19] 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 of the banking services have their own credit card services that handles fraud cases and monitoring any possible attempt of fraud. Employees that is specialized in doing fraud monitoring and investigation are often placed in Risk Management or Fraud and Authorization or Cards and Unsecured Business. The fraud monitoring emphasize in minmizing fraud losses while doing their best to track down fraudster from getting as much illegal information and using the credit card as their can. The credit card fraud is one of the major problem within white collar crimes that has been around for many decades and even though the creation of chip based card (EMV) in some countries was in place to prevent these fraud case, there are still many cases reported and still around in these countries.