How does Credit Card works

Discussion in 'The ChitChat Lounge' started by suchin, Dec 31, 2005.

  1. suchin

    suchin New Member

    How a credit card works when you shop….??
    [A small situation to make us understand the funda…]

    Priya: I want to buy a Sony digital camera costing Rs.20,000, but I don?t have any cash right now.

    Raj: Why don?t you use your ICICI Bank credit card? Never heard them say ? Hum Hain Na ??

    Priya: I am quite skeptic about using these cards. I pay using the card, get a bill after 30 days and pay after another 20 days. This is a maximum of 50 days interest free loan. Why does any bank do it?

    If I borrow Rs.20,000 on personal loan at 11%.
    Interest to be paid for 50 days = Rs. 20,000 * 11% * (50/365) = Rs. 301.40.

    Here the bank is giving me a loan without interest when I use the credit card. Something is wrong somewhere!

    Raj: Well? let me tell you how it works when you use your card to pay for the camera.
    · You present your ICICI Bank credit card ? a VISA card.
    · Sony World swipes your card on a machine provided by Citibank. Lets call Citibank ? the acquirer bank and the process of Sony World swiping the card on that machine ? requesting authorization .
    · Citibank communicates with the card issuer ? ICICI Bank through VISA Network to check if the card is valid and has the required credit limit.
    · ICICI Bank reviews and approves / declines which is communicated back to Sony World.
    · You sign a receipt called Sales Draft given by Citibank. This is the obligation on your part to pay the money to ICICI Bank. Data on this receipt can be captured electronically and transmitted.

    At the end of day or at the end of some period Sony World chooses:
    o Sony World submits the receipt you signed to Citibank who pays Sony World the money. Sony World pays Citibank a fee called Merchant Discount . Let us say this is 6% of the sale value = 6% * 20,000 = Rs. 1200
    o Citibank sends the receipt electronically to a Visa data center which in turn sends it to ICICI Bank.
    o ICICI Bank transfers the money to a settlement bank which in turn transfers the funds to Citibank.
    o Citibank pays ICICI Bank an Interchange Fee of 4% of the sale value = 4% * 20,000 = Rs. 800
    o 20 to 50 days later ICICI Bank gets the money from you ? and you don?t pay the interest!!

    Priya: Interesting! So Sony World pays more than the interest that I should have paid for the loan that I take. I, as a cardholder have the following benefits

    1. Convenience of not having to carry cash.
    2. Credit availability ? free of interest.

    However what benefits does Sony World get for paying so much money? Isn?t it more profitable for them to take cash? They can save as much as Rs.1200.

    Raj: Certainly. Some retail outlets offer you discounts if you pay by cash, don?t they?

    However when you don?t count the money that you are spending, you tend to buy more! Cards encourage this ? called impulse purchase .

    If you did not have access to credit, you would not have bought the camera this month ? or may be not any time soon either. By accepting cards, the merchant is actually extending you credit at the risk of the card issuer. He pays money to the banks to carry that risk.

    Priya: So ICICI Bank uses this money to pay back to us when they announce 5% cash back. They insist that the Sales draft that I sign at the retailer should also be from ICICI Bank. This means they are saving on the Interchange Fee and also pay me a part of the Merchant Discount that they get.

    Raj: Exactly! If you have noticed, ICICI Bank gives you the cash back in the next credit card statement. They keep the ?cash back? money for a maximum of 60 days before passing on a part to you. This accrues them interest too.

    Say if ICICI Bank earns an interest of 6% per annum for the cash they carry ? they get Rs.1000 * 6% * (60/365) = Rs. 10

    That is not huge, but money nevertheless. And when you consider that almost everyone in this city shops with a credit card these days, it is a big sum.

    Priya: And that also explains why banks tie up with petrol pumps ? like ICICI Bank has tied up with HPCL and I could re-fuel there without having to pay the fuel surcharge of 2.5%. The card issuer and the acquiring bank is the same and that saves interchange fees.

    Raj: Good! You seem to have figured out how it all works! Let me summarize:

    Priya: Sooper! Toh ab shopping chalein?? Lets not miss this Christmas and New year Shopping Festival!

    [ All the numbers used to explain concepts in this article must be treated only as an example. Merchant Discounts may vary from bank to bank. Interchange Fee is regulated by VISA and MasterCard]
    vini likes this.
  2. vini

    vini Repeat Offender sure many people still r baffled wid these fundas..cleared my concept too
    reps for u
  3. suchin

    suchin New Member

    Thanks Vini...u r kind.
  4. vini

    vini Repeat Offender just JUST
  5. guitarangela

    guitarangela gran'ma

    ........too kind :p:
  6. guitarangela

    guitarangela gran'ma

    ........too kind. :p:
  7. guitarangela

    guitarangela gran'ma

    that was too much from me..// there a way u can take out one from it
  8. abhijitnath

    abhijitnath Fighting GAS frantically

    It's written by a batchmate of mine who works in IBM:).
    He wrote it for some internal memo and its now spread far and wide through the world of email forwards!
  9. suchin

    suchin New Member

    I got it through e-mail 2!
  10. ive got a credit card :cool:
  11. .:SpY_GaMe:.

    .:SpY_GaMe:. New Member

    i got 5 :p: :p:
  12. shantanukr

    shantanukr yEh DiL mAanGe m0rE

    Cool Funda ... Trying to understand ...

    :hitme: Ya got it ...

Share This Page