How are credit cards funded?

DullGreyGuy

WillPS said:

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)

They can in principle print money but the reality is most of it is numbers in a spreadsheet rather than real currency. 

Nothing compared to the previous situation where a dealer did a short trade on NZ dollars for vastly more than the total amount of currency in circulation.