How Banks Make Money From Credit Cards?

How Banks Make Money with Credit Cards
How Banks Make Money with Credit Cards

A credit card is a cashless financial tool that is provided by banks and financial institutions allowing cardholders to borrow funds. The limit of funds is decided by financial institutions based on the cardholder’s history and credit scores. The higher the credit score, the bigger the limit cardholders get. When users swipe their credit card or use it online, the money gets deducted from the pre-approved limit. Users can pay back the money prior to billing, within the interest-free period, without paying any interest. 

Nowadays, credit cards are majorly used for online and offline shopping because of their rewarding nature as they provide cashback, loyalty points, lounge access, and other exclusive benefits.

But, have you ever thought about how financial institutions or banks make money with credit cards? How are they able to provide such rewarding and lucrative facilities? What is the business model behind credit cards? Here are the answers to your question that how banks and financial institutions make money through credit cards. Here you can also, Check credit card eligibility.

How do Credit Card Companies Make Money?

1. Interest Charges

Interest charges are a major revenue channel for banks and financial institutions. If a credit card holder doesn’t pay the credit card bill within the interest-free period, banks can charge a substantial interest rate ranging from 30-45% annually. Also, the interest rates are applied to the unpaid amount on a daily basis from day one once you fail to repay the entire amount within the grace period.

Tips to avoid Interest Charges

You can avoid interest charges by repaying the due amount in the interest-free period itself. There are several bank apps that let you schedule your repayment automatically; use these apps to pay your credit card bills on time and avoid interest charges. If you are not able to repay the whole amount in one go, pay as much as possible and convert the rest of the amount to a personal loan which carries much lower interest than what a credit card does.

2. Annual/ Renewal charges

An annual fee is charged by credit card issuing banks/financial institutions irrespective of usage, which can range from Rs 499 to Rs 2,500 on entry-level cards. It can even extend into lakhs of rupees depending on the type of card.

Annual Fee According to Card Types

Card Type Card Name Annual Charges*
Lifetime FreeAmazon Pay ICICI0
Entry LevelSBI SimplyCLICKRs. 499
PremiumAxis SELECTRs. 3,000
Ultra PremiumAmerican Express PlatinumRs. 60,000

Charges are subject to change*

Tips to avoid Annual Charges

You can use lifetime free credit cards to avoid the annual charges. You can also opt for the fee waiver that allows you to waive off annual charges by making a minimum spend in a year. For example; the HDFC Diners Black has a steep renewal fee of Rs 10,000, but can be waived off on spending more than Rs 5 lakhs in a year.

3. Cash withdrawal charges

Cash advance fee/ Withdrawal fee is a small percentage of the amount deducted during the withdrawal of cash via credit card. Cash advance cost is also higher as it has no interest-free period; the time cash gets withdrawn from an ATM, the interest rate applies on the whole amount from that very moment.

Tips to avoid Cash withdrawal charges

As cash withdrawal doesn’t provide any grace period. try to avoid this practice as much as possible. Instead use debit cards to withdraw from an ATM. Using a credit card to withdraw money is not a good idea as the cons far outweigh the benefits.

4. Miscellaneous charges

Banks make money with credit cards by charging various types of fees to cardholders. Other than annual fee, cash withdrawal fee, and interest charges, some other fees include international transaction fees, late payment fees, balance transfer fees, and more. These charges are respective of usage and are charged on transaction or situation basis.

5. Merchant Fee

Banks and Financial institutions make money every time you make a purchase. How? When a user swipes a credit card offline or uses it online, the retailer gets charged 1-3% as a merchant fee depending on the issuer or payment platform. When you pay the amount via a credit card, banks or financial institutions deduct a small percentage of the amount as an interchange fee.

6. Co-branding charges

Brands are trying various methods and experimenting with different techniques to grab attention, reach more customers, and increase sales. A co-branded credit card is one of the results of this practice. Brands are collaborating with credit card companies to launch their brand-specific credit card where they offer brand-specific discounts. Banks charge these brands for launching their co-branded cards as they push customers to make purchases from their brand by offering discounts and cashback offers.

7. Assessment Charges

Assessment charges, which are also referred to as ‘Swipe Fee’, is charged by credit card companies on the monthly sales of each credit card brand like MasterCard, Visa, Discover, and American Express, which process credit card transactions of the merchant. The credit card brand charges a smaller amount as an assessment fee on each transaction. These charges depend on associations.

Card Assessment Charges
Mastercard charges 0.095% assessment fee
Visa Card charges 0.11% assessment fee
Discover card charges 0.0925% assessment fee

Check the credit card processing statement for any updates. Credit card companies usually revise these charges annually.

FAQs

Why are Credit Cards profitable for banks?

Credit cards are profitable for banks because they have the highest interest rates among their lending products. Some credit cards charge up to 50% per annum in interest charges for late payments..

Where do banks make most of their money on credit cards?

Banks make money with credit cards through interest rates applied on the due amounts you are unable to pay in the interest-free period.

Do credit cards make money if you pay on time?

Yes, credit cards make money even if you pay on time because they charge 1-3% of transaction charges from retailers.

How do credit card companies make money if you pay in full?

There are various ways in which credit card companies make money if you pay in full. Some of the ways are annual charges, merchant fees, co-branding fees, and more.

Why do banks want us to use credit cards?

Banks want us to use credit cards because there is a chance of failure of bill repayment in time, which can result in high-interest charges.

How do banks make money by offering 0% APR credit cards?

Banks make money by offering 0% APR credit cards as they get a merchant fee from retailers on every transaction.

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