Credit Card Bubble: The Burgeoning Credit card debt

?1.4 Lakh Crore. That was credit card debt, or rather spends, in the month of May 2023. June saw 88.7 million cards in force. up from 87.4 million in May, showing a 30% growth year on year. All while Inflation rose to 4.8%. And reports per transunion suggest delinquency rate surged 66 basis points YoY, to reach 2.94 percent. Is this the bursting of the bubble, of the purported $1 trillion market, by 2023?

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"Credit Card Spends hit all time high in May, 2023"

"Credit cards in Circulation rise month on month to new highs in June, 2023"

These are probably some of the news headlines all of us have seen since the start of the financial year. We have seen a uptick in the financial savviness of us average Indians, thanks in part to the finfluencers. For a lot of them talk about the best credit cards to use, and earn rewards points on them, and save while spending. Who would have thought that possible, right?

However, what if, all we have seen is only the underbelly of the dragon, and we're oblivious to the scales and fire breath of the rest of the beast?

That is what the Fintech Chronicler intends to do with this edition of the newsletter. So if you are an avid credit card user, keep reading, because here are somethings you want to know the next time you pull out your card to swipe!

Understanding how credit cards work

Let's start with the basics of how a credit card purchase works. (I've tried to be concise but if you'd prefer a visual flowchart, please scroll below).

The customer simply shows their credit card to the cashier at checkout. The EMV chip on your card is read by the merchant's payment terminal. All the way from the acquiring bank to the payment network to the card issuer, a chain of authorisation requests is started by this action. The availability of credit is verified by the card issuer. The merchant will provide a receipt verifying payment to the cardholder after it receives the authorization message on its terminal.

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The settlement responsibility for the card issuer is determined by the payment network (more on costs below). The settlement bank for the card association receives payment from the card issuer. Once the card association deducts their fee, they forward the remaining balance to the acquirer. After deducting their fees, acquirers eventually transfer the remainder to the merchant.

Lets explain the different players in this transaction lifecycle.

Card Issuers

Issuing banks (sometimes called "Issuer") issue payment cards like Visa, Mastercard, American Express, etc. to consumers. It recrods in-store and online purchases. The issuing bank validates the transaction and sends funds to the acquiring bank when a store purchase is made.

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Merchant Banks

The financial institution that handles the merchant's money is known as the Acquiring Bank (sometimes known as the "acquirer" or "merchant's bank"). Merchants can accept credit and debit card payments, use payment gateways, and collect consumer funds with the assistance of their acquiring bank.

In a nutshell, acquirers take in money and issuers hand it out. In addition, Acquirers target corporations with their offerings, whereas Issuers go for consumers. Although there are some distinctions in the way they operate, acquirers and issuers are inextricably linked.

Card networks

The most well-known examples of card networks are Visa and MasterCard, followed by American Express and Discover. They act as a digital payment network that brokers conversations between merchants and the banks that issue their payments. In addition to these global leaders, we also have NPCI's (National Payment Corporation of India) Indian-born network, RuPay.

Point to note here is that, American Express, acts as both an issuer and the network.

How do Credits Cards Make Money : The business of Credit Cards

That was about the flow of money, but who takes what cut in this equation? What we are really asking is, how do the players in the credit card network make money?

There are broadly 4 cateogries I’d bucket the various credit card payments related fees.

MDR or Merchant Discount Rate

Payment processing companies charge merchants and other organisations a fee known as the merchant discount rate (MDR) for each debit and credit card transaction processed. This is typically 2-5% of the transaction amount. This gets split into the following.

Interchange Fees

This is the fees that are paid to the card-issuing bank, from the Merchant acquiring bank, in exchange for covering the costs of processing the payment,authentication and authorising the transaction, taking care of ?fraud and bad debt.

Network Switching fees

The switching costs are a commission charged by the card network provider to the merchant's bank for processing credit card transactions. Think of it as a fees levied for connecting the issuing bank with the merchant bank.

Payment Markup

Often times, the Payment gateway, the POS provider, the mercahnt bank also add a markup, as fees for facilitating the money hitting the merchants’ bank. Typically this is negotiable, depending on the sixe of the merchant and the exected monthly traffic they bring in.

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Now you get, that as the credit card usage increases, and defaults on credit card payments stay in check, all the players int eh system are incentivised. This brings us to the various offers these players have, in order to entice us towards their cards.

Why should you use Credit Cards?

I’ll admit it, I have often found myself getting on a new card, just because the sign up bonus was dope. So don’t really think I qualify for giving advice on practicing restraint to improve your credit score. But here is?framework I built to figure out what I would want to get a credit card.

Credit card Rewards: Who funds it ?

Since we are paying so much attention to the rewards and sign on bonueses on our credit cards, aren’t you curious as to who pays for it and from where?

It is believed that credit card incentives are funded by interchange fees. Maybe now it makes sense why so many of the highly rewarding credit cards are now cutting back on their reward points?

The capping of interchange, thanks to the spurt of Rupay cards near zero MDR fees, has added a lot of stress on issuing banks, making those enviable rewards, a drain on the banks balance sheet. Something, markets hate, board hate, banks hate (but customer love).

Another avenue for funding rewards comes from, Interest and late fees, charged to what banks call Revolving customers, i.e. customers who don’t pay the full outstanding every month. Making issuers criminally inclined to their users defaulting!

Credit Card Debt -ly trap

If you’ve watched Confessions of a shopaholic, you’ll know what I mean!

And it isn’t just the US where such credit card debts exist. India too is no different

90 days delinquent accounts are the highest in credit cards as opposed to any other retail loan.

Rent Pay using Credits

One of the biggest reason behind this worry of mine? The spends pattern on credit cards.

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While no issuer publicly shares that split, The Morning Context did a beautiful piece on that .

And at least 15% of the outstanding goes to Rent Payment! Something that should be counted as fixed obligations, and what financial sense tells us to not put under discretionary spending.

Credit Report

Honestly, the current ways of curbing that aren’t sufficient. I feel the only way around would be

1.??????RBI restrictions

2.??????If the above isn’t feasible, penalising the users credit scores, for exhibiting irresponsible behaviour

And with so many FinFluencers talking about improving your credit score, I’m sure it’ll catch on.

Inflation, Job Cuts and rising Delinquency?

This picture wasn’t too different since 2020, so then why am I alarmed now?

Because the economy aint really rosy, and every where you go, you read projections of job cuts in 2024 and economic turmoil till 2025. That means, while previously customers would have had some income stream to pay off at least a part of the outstanding amount, as we head towards the future, those cahnces are getting slimmer.

The only way around will be for banks to increase their APR or annualised percentage rates.

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Retail Unsecured Lending and Why the RBI should be worried?

So, what is the RBI doing about all of this?

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One of the first steps RBI took was setting up of a Digital Lendign Guideline, to ensure BNPL and unstructured retail lending gets regulated.

Then there was the crackdown on Payment gateways who were providing solutions to questionable “Rent on Credit card” companies.

But this isn’t enough. Why? Well, in June 2023, the average spends on credit card per user stood at ?16,388. And the Average Per capita income ? ? 48,761. Meaning Indians were spending more than a third of their income!

If that isn’t an eye opener I do not know what else could be!

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