How Banks Benefit from Offering Higher Credit Card Limits Beyond Monthly Salary and Average Spending

As banks increasingly offer higher credit card limits, often exceeding an individual's monthly salary and average spending, a common question arises: How do these benefits work for the bank? This article delves into the specifics of the ways banks profit from credit card usage, providing insights into the business models behind these practices.

Revenue Streams for Banks from Credit Card Usage

Banks derive significant revenue from credit card usage through two primary methods:

1. Merchant Discount Rate (MDR)

Banks earn a substantial portion of their revenue through MDR, which is the fee deducted from the merchant for processing a credit card transaction. This fee can range up to 4%, with the bank retaining a significant share of the MDR, typically around 80%, while the remaining 20% goes to other parties involved in the transaction. Merchants often include this cost in the final price, or pass it on to customers through higher prices, especially in cases with low margin products like railway tickets, electronic goods, or fuel.

2. Interest Charges and Penalties

Another key revenue stream for banks comes from the imposition of interest charges and penalties when customers do not make full payments before the due date. If customers opt-out of paying the full amount, they are subject to various fees, including interest rates that are generally 3.5% per month and a flat fee of about Rs. 750. Ensuring customers do not pay the full amount on time allows banks to generate significant income through interest and penalty charges.

The Business Model Behind Higher Credit Card Limits

While higher credit card limits may seem like a boon for cardholders, they are strategically designed to increase the likelihood of card usage and, consequently, maximize bank revenue. By offering higher credit limits, banks encourage customers to spend beyond their monthly income or average spending levels, leading to increased usage and, therefore, more revenue through MDR and interest charges.

Enhanced Spending Power

Let's illustrate this with an example. Consider a person who can afford to spare Rs. 10,000 per month and has a credit card with a limit of Rs. 50,000. Without a credit card, purchasing a high-cost item such as a LED TV for Rs. 30,000 would be challenging. However, with a credit card, the individual can make an instant purchase, which they might not have been able to afford otherwise, unless they had saved up for several months.

The key point here is that without a full payment plan, customers are at risk of owing interest and penalties, which translates to more revenue for the bank. Therefore, offering higher credit limits is a strategic move to encourage spending and to ensure that the bank maximizes its profits through both MDR and interest charges.

Conclusion

In conclusion, banks benefit significantly from offering higher credit card limits beyond monthly salary and average spending. By providing access to higher credit limits, banks increase the likelihood of customers spending more, thereby enhancing their potential for earning revenue through MDR and interest charges. Understanding the business model behind these practices can help individuals make more informed decisions regarding their credit card usage and financial management.