May 31, 2006 12:08 PM
4973 Views
(Updated May 31, 2006 12:08 PM)
OKEI FOLKS: DISCLAIMER FIRST:
I am not the person who made this article. Got it in a forward mail. Pretty interesting read, if you want to know how you get 45-50 days of credit on your purchases and how it translates into those'FREE' rewards!
Hope this helps.
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.
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Priya: I want to buy a Sony digital camera costing Rs.20, 000, but I dont have any cash right now.
Raj: Why don?t you use your XXXX Bank credit card? Never heard them say? Main hoon 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 XXXX Bank credit card? a VISA card.
Sony World swipes your card on a machine provided by YYYY Bank. Lets call YYYY Bank? the acquirer bank and the process of Sony World swiping the card on that machine? requesting authorization .
YYYY communicates with the card issuer's XXX Bank through VISA Network to check if the card is valid and has the required credit limit.
XXXX Bank reviews and approves / declines which is communicated back to Sony World.
You sign a receipt called Sales Draft given by YYYY. This is the obligation on your part to pay the money to XXXX 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:
Sony World submits the receipt you signed to YYYY who pays Sony World the money. Sony World pays YYYY a fee called Merchant Discount . Let us say this is 6% of the sale value= 6% * 20, 000= Rs. 1200
Citibank sends the receipt electronically to a Visa data center which in turn sends it to XXXX Bank.
XXXX Bank transfers the money to a settlement bank which in turn transfers the funds to YYYY.
YYYY pays XXXX Bank an Interchange Fee of 4% of the sale value= 4% * 20, 000= Rs. 800
20 to 50 days later XXXX Bank gets the money from you? and you dont 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, dont they?
However when you dont 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 XXXX 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 XXXX 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, XXXX 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 XXXX 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 CitiBank has tied up withIndian Oil 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!
Priya: Sooper! Toh ab shopping chalein? Lets not miss the Namma Bengaluru Shopping Festival!
