How are credit cards funded?

lr1277

I was going to post this on one of the Creation thread but decided that I would not sidetrack those threads. This is me speculating as I have no actual evidence. This post is countering the arguments made by those who say credit card companies are making lots of money from the interchange fees. As demonstrated below, I am not sure how that would work.

I am wonndering how UK credit cards are funded? And how can financial institutions afford that funding?

Financial institutions have to get the money from somewhere to pay for all the things bought by their credit card holders. Credit card money is not created out of thin air.

Banks and building societies have savers who are paid say 4% on their savings. They can use these savings to fund mortgages, loans and credit cards. The mortgages and loans charge more than 4% in interest so that difference is how financial institutions make money. Be it 0.1% or 3%.

But for credit cards, assuming the card holder pays no interest charges, then all the card provider might be getting is 0.3%. And out of this income they have to pay their staff salaries, other business expenses plus the cost of getting the money to lend out to the card holder. Whilst banks and building societies have access to funds I don't see how a 0.3% interchange rate pays for funding that is costing the bank or building society upwards of 1.5%.

And if you look at Creation, they have no savings accounts as far as I can tell that would help with funding. So I am guessing Creation have to go to the market to get their money where they maybe paying 4-7%. Which they can recoup with store loans etc but I don't see how they can recoup that with credit cards.

I know America has a different credit card model but here are some savings rates:

American Express are paying 4% on their savings accounts.

Capital One are paying 3.9% on their savings accounts.

For both these institutions, some of this money will be used by their credit card holders.

As a comparison, Bank of America is paying 0.02%. Let's say the interchange fee in America is 3% then it is easy to see how Bank of America is making money on its credit cards.

So perhaps this is why Creation and others are getting out of the credit card market?

On-the-coast

"assuming the card holder pays no interest charges"... is a very poor assumption.  That's where they make their profits

Hoenir

On-the-coast said:

"assuming the card holder pays no interest charges"... is a very poor assumption.  That's where they make their profits

What matters is that some accounts do pay interest. Whether an individual account is profitable or not is of no consequence. Little different to the UK current account market where many enjoy free personal banking. Enough customers pay fees, deposit money, borrow money etc to make the activity profitable. All comes down to scale of operation. 

lr1277

I am stuck on the idea that banks profitability is based on the difference in savings rates vs mortgage/loan rates.

Not many accounts charge fees. Whilst fees for overdrafts (both authorised and unauthorised) are high I have no idea if sufficient income is raised from these to pay for a bank's operation.

After the financial crisis in 2008 because the difference between the savings rate and the mortgage loan rate was something like  0.3%, I am under the impression banks made very little money during that period. As their income was down, they had to cut costs to match their income. Also banks are profit generating organisations so cutting costs is part of the way any business works.

In my view 0.3% is not enough to fund their fixed and variable costs for running the business plus the requirement to pay for the funding.

Any thoughts on where I might find a definitive answer?

k12479

On-the-coast said:

"assuming the card holder pays no interest charges"... is a very poor assumption.  That's where they make their profits

Indeed. This page has a lot of data - https://www.money.co.uk/credit-cards/credit-card-statistics and one of the eye-opening points is that only 8.5% of people pay back in full, incurring no interest, while a whopping 31.5% only pay the minimum.

35har1old

lr1277 said:

I am stuck on the idea that banks profitability is based on the difference in savings rates vs mortgage/loan rates.

Not many accounts charge fees. Whilst fees for overdrafts (both authorised and unauthorised) are high I have no idea if sufficient income is raised from these to pay for a bank's operation.

After the financial crisis in 2008 because the difference between the savings rate and the mortgage loan rate was something like  0.3%, I am under the impression banks made very little money during that period. As their income was down, they had to cut costs to match their income. Also banks are profit generating organisations so cutting costs is part of the way any business works.

In my view 0.3% is not enough to fund their fixed and variable costs for running the business plus the requirement to pay for the funding.

Any thoughts on where I might find a definitive answer?

A bankers view is a person that is in debt is a asset 

p00hsticks

lr1277 said:

Any thoughts on where I might find a definitive answer?

I suspect you'd be delving into the realms of commercial confidentiality there, but you could always try looking at individual banks financial reports to see how their profits and losses are broken down at a high level.  

jameswyper

Creation are owned by BNP Paribas, one of the largest deposit banks in Europe. Access to money shouldn't be a challenge for them.

Moreover interchange fees and annual interest are not directly comparable.

If I spend £1000/month on a card with a 0.4% interchange fee, the credit card company gets £48 a year through interchange. If I pay the debt off in full every month the *average* amount the company has to finance will (depending on my spending pattern) be somewhere in the region of £1000-£1500. That can be fully funded with interest at just under 3%. So the financial gap is easy to fill with even a small number of people who don't pay off in full each month.

DullGreyGuy

lr1277 said:

Financial institutions have to get the money from somewhere to pay for all the things bought by their credit card holders. Credit card money is not created out of thin air.

You may want to look into this statement... banks are not an intermediary between debtors and savers, they do not lend out savers money to others. 

https://www.investopedia.com/articles/investing/022416/why-banks-dont-need-your-money-make-loans.asp

WillPS

k12479 said:

On-the-coast said:

"assuming the card holder pays no interest charges"... is a very poor assumption.  That's where they make their profits

Indeed. This page has a lot of data - https://www.money.co.uk/credit-cards/credit-card-statistics and one of the eye-opening points is that only 8.5% of people pay back in full, incurring no interest, while a whopping 31.5% only pay the minimum.

Remember that 31.5% will also include a good chunk of customers paying 0 interest (myself included, although I always whack an extra £1 over on top of the minimum DD to ensure I technically pay a little more than minimum each month).

But yes, I agree with your point. In general I think people on this board often forget that the membership of this board skew far more financially savvy than the general populous. People elsewhere talk about 'the hardly ever' and the best car they can get finance for - interest-bearing credit usage is very culturally normalised.

WillPS

lr1277 said:

I was going to post this on one of the Creation thread but decided that I would not sidetrack those threads. This is me speculating as I have no actual evidence. This post is countering the arguments made by those who say credit card companies are making lots of money from the interchange fees. As demonstrated below, I am not sure how that would work.

I am wonndering how UK credit cards are funded? And how can financial institutions afford that funding?

Financial institutions have to get the money from somewhere to pay for all the things bought by their credit card holders. Credit card money is not created out of thin air.

Banks and building societies have savers who are paid say 4% on their savings. They can use these savings to fund mortgages, loans and credit cards. The mortgages and loans charge more than 4% in interest so that difference is how financial institutions make money. Be it 0.1% or 3%.

But for credit cards, assuming the card holder pays no interest charges, then all the card provider might be getting is 0.3%. And out of this income they have to pay their staff salaries, other business expenses plus the cost of getting the money to lend out to the card holder. Whilst banks and building societies have access to funds I don't see how a 0.3% interchange rate pays for funding that is costing the bank or building society upwards of 1.5%.

And if you look at Creation, they have no savings accounts as far as I can tell that would help with funding. So I am guessing Creation have to go to the market to get their money where they maybe paying 4-7%. Which they can recoup with store loans etc but I don't see how they can recoup that with credit cards.

I know America has a different credit card model but here are some savings rates:

American Express are paying 4% on their savings accounts.

Capital One are paying 3.9% on their savings accounts.

For both these institutions, some of this money will be used by their credit card holders.

As a comparison, Bank of America is paying 0.02%. Let's say the interchange fee in America is 3% then it is easy to see how Bank of America is making money on its credit cards.

So perhaps this is why Creation and others are getting out of the credit card market?

The basic answer to your question is they use reserves, deposits or borrowed funds as a float for credit cards. The size of that float will determine the amount of credit they can give out, which is why issuers manage credit limits in both directions - aiming to offer more to the customers they see as more likely to generate a profit for them (directly or indirectly)