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CHAPTER 1

RESEARCH METHODOLOGY

Objectives of the Project

The primary objective of the report is categorized into following sub-topics:

1. To study the demographic factors of credit card holders.

2. To know the using purpose of credit card by the holders.

3. To assess the behavioural changes of credit card holders.

4. To examine the consumption pattern of credit card holders.

5. To find out the satisfaction level of existing credit card holders.

6. To suggest measures to improve the credit card system in India

Data sources

Primary sources

Primary data has been collected through the structured questionnaireconsisting mainly of the closed ended questions.

Secondary sources

Secondary data has been collected from the internet, journals, reference booksetc.

Scope of the study

All the questions have been analysed by adding up the responses against each

alternative and answers from the various respondents. The collected data has

N. R. INSTITUTE OF BUSINESS MANAGEMENTBATCH 08-10


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been subject to statistical analysis to draw inferences and suitableconclusions. Statistical tools like chi-square and percentage are used. For calculating the table value for analysis with chi-square, 5% significance levelis used.

RESEARCH METHODOLOGY

The study is based on primary data, which has been collected from the creditcard users with the help of a well drafted and structured questionnaire (seeannexure). For the collection of primary data, we have confined ourselves toAhmedabad, India. Our sample consists of a total of 150 respondents. The

respondents are basically credit card users, who have been selected byfollowing the non-probabilistic sampling,simple purposive sampling andconvenience sampling techniques.Further, it is essential to mention two things: firstly, in convenience-sampling, respondents (who were seen using/have possession of credit cards)were selected because they happened to be in the right place at the right timeand secondly, convenience sampling technique is not recommended for descriptive or casual research, but they can be used in exploratory researchfor the generation of ideas (Malhotra, 2005). The questions inquired thechoice of credit card, and the users were given 28 statements. In addition, therespondents had to rate the credit cards according to the importance, on the`five-point Likert scale.

Sampling Plan

Target Population: Credit Card holders

Sample Size: 100 respondents

Sampling technique: Convenience sampling



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Beneficiaries

1. BanksBanks may come to know about the usage pattern of the credit card holders based on the demographics, purposes and consumption pattern and may aimto target new customers based on the derived facts.

2. Probable subscribers

New prospects may find it helpful in selecting the credit card company andthe bank issuing the credit based on the satisfaction level of the existingcredit card holders.

3. Researchers

Study gives the researchers the insight about the credit card system prevailing

and the usage pattern and satisfaction level of the existing credit card holders.

Research Design

The research design that has been used is Descriptive Research.

Involves gathering data that describe events and then organizes,tabulates, depicts, and describes the data.

Uses description as a tool to organize data into patterns that emergeduring analysis.

Often uses visual aids such as graphs and charts to aid the reader

Description Research takes a what if approach

Refers to the nature of the research question



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The design of the research

The way that data will be analyzed for the topic that will be researched

There are four methods of data collection under descriptive research. Theyare:

Surveys

Interviews

Observations

Portfolios

The methods used for this research would be mainly by the response to thequestionnaire by the credit card holders.

Limitations of the study

1. The study is confined to the city of Ahmedabad only.

2. The respondents were generally co-operative, yet some of them might have biased their reply for certain sensitive questions

3. The duration of the study is also in accordance with the academic objective of the course curriculum. So in pursuit of academic exercise, the restriction ontime has also brought into study some limitations.



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CHAPTER 2

INTRODUCTION TO BANKINGINDUSTRY

Banking in India originated in the last decades of the 18th century. The oldest

bank in existence in India is theState Bank of India, a government-owned bank that traces its origins back to June 1806 and that is the largest commercial bank in the country. Central banking is the responsibility of theReserve Bank of India , which in 1935 formally took over these responsibilities from the thenImperial Bank of India, relegating it to commercial banking functions. After India's independence in 1947, the Reserve Bank was nationalized and given broader powers. In 1969 the government nationalized the 14 largest commercial

banks; the government nationalized the six next largest in 1980.

The Indian Banking industry, which is governed by the Banking Regulation Actof India, 1949 can be broadly classified into two major categories, non-scheduled banks and scheduled banks. Scheduled banks comprise commercial banks and the co-operative banks. In terms of ownership, commercial banks can be further grouped into nationalized banks, the State Bank of India and its group

banks, regional rural banks and private sector banks (the old/ new domestic andforeign). These banks have over 67,000 branches spread across the country.

The first phase of financial reforms resulted in the nationalization of 14 major banks in 1969 and resulted in a shift from Class banking to Mass banking. Thisin turn resulted in a significant growth in the geographical coverage of banks.Every bank had to earmark a minimum percentage of their loan portfolio tosectors identified as priority sectors. The manufacturing sector also grewduring the 1970s in protected environs and the banking sector was a critical

http://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/State_Bank_of_Indiahttp://en.wikipedia.org/wiki/Reserve_Bank_of_Indiahttp://en.wikipedia.org/wiki/Reserve_Bank_of_India


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source. The next wave of reforms saw the nationalization of 6 more commercial banks in 1980. Since then the number of scheduled commercial banks increasedfour-fold and the number of bank branches increased eight-fold.

After the second phase of financial sector reforms and liberalization of thesector in the early nineties, the Public Sector Banks (PSB) s found it extremelydifficult to compete with the new private sector banks and the foreign banks.The new private sector banks first made their appearance after the guidelines permitting them were issued in January 1993. Eight new private sector banks are presently in operation. These banks due to their late start have access to state-of-the-art technology, which in turn helps them to save on manpower costs and provide better services.During the year 2000, the State Bank of India (SBI) and its 7 associatesaccounted for a 25 percent share in deposits and 28.1 percent share in credit.The 20 nationalized banks accounted for 53.2 percent of the deposits and 47.5 percent of credit during the same period. The share of foreign banks (numbering42), regional rural banks and other scheduled commercial banks accounted for 5.7 percent, 3.9 percent and 12.2 percent respectively in deposits and 8.41 percent, 3.14 percent and 12.85 percent respectively in credit during the year 2000.

Aggregate Performance of the Banking Industry

Aggregate deposits of scheduled commercial banks increased at a compoundedannual average growth rate (CAGR) of 17.8 percent during 1969-99, while bank credit expanded at a CAGR of 16.3 percent per annum. Banks investments ingovernment and other approved securities recorded a CAGR of 18.8 percent per annum during the same period.

In FY01 the economic slowdown resulted in a Gross Domestic Product (GDP)growth of only 6.0 percent as against the previous years 6.4 percent. The WPIIndex (a measure of inflation) increased by 7.1 percent as against 3.3 percent inFY00. Similarly, money supply (M3) grew by around 16.2 percent as against

14.6 percent a year ago.



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The growth in aggregate deposits of the scheduled commercial banks at 15.4 percent in FY01 percent was lower than that of 19.3 percent in the previousyear, while the growth in credit by SCBs slowed down to 15.6 percent in FY01against 23 percent a year ago.

The industrial slowdown also affected the earnings of listed banks. The net profits of 20 listed banks dropped by 34.43 percent in the quarter ended March2001. Net profits grew by 40.75 percent in the first quarter of 2000-2001, butdropped to 4.56 percent in the fourth quarter of 2000-2001.

On the Capital Adequacy Ratio (CAR) front while most banks managed to fulfillthe norms, it was a feat achieved with its own share of difficulties. The CAR,which at present is 9.0 percent, is likely to be hiked to 12.0 percent by the year 2004 based on the Basle Committee recommendations. Any bank that wishes togrow its assets needs to also shore up its capital at the same time so that itscapital as a percentage of the risk-weighted assets is maintained at the stipulatedrate. While the IPO route was a much-fancied one in the early 90s, the currentscenario doesnt look too attractive for bank majors.

Consequently, banks have been forced to explore other avenues to shore up their capital base. While some are wooing foreign partners to add to the capital othersare employing the M& A route. Many are also going in for right issues at pricesconsiderably lower than the market prices to woo the investors.

Interest Rate SceneThe two years, post the East Asian crises in 1997-98 saw a climb in the globalinterest rates. It was only in the latter half of FY01 that the US Fed cut interestrates. India has however remained more or less insulated. The past 2 years in our country was characterized by a mounting intention of the Reserve Bank of India(RBI) to steadily reduce interest rates resulting in a narrowing differential between global and domestic rates.



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The RBI has been affecting bank rate and CRR cuts at regular intervals toimprove liquidity and reduce rates. The only exception was in July 2000 whenthe RBI increased the Cash Reserve Ratio (CRR) to stem the fall in the rupeeagainst the dollar. The steady fall in the interest rates resulted in squeezedmargins for the banks in general.

Government initiatives

During 2008-09 (as per data up to November 18, 2008), as per RBI guidelines,scheduled commercial banks (SCBs) increased their deposit rates for various

maturities by 50-175 basis points. The interest rates range offered by publicsector banks (PSBs) on deposits of maturity of one year to three years increasedto 9.00-10.50 per cent in November 2008 from 8.25-9.25 per cent in March2008. On the lending side, the benchmark prime lending rates (BPLRs) of PSBsincreased to 13.00-14.75 per cent by November 2008 from 12.25-13.50 per centin March 2008. Private sector banks and foreign banks also increased their BPLR to 13.00-17.75 per cent and 10.00-17.00 per cent from 13.00-16.50 per cent and 10.00-15.50 per cent, respectively, during the same period.

Accordingly, the weighted average BPLR of public sector banks, private sector banks and foreign banks increased to 13.99 per cent, 16.42 per cent and 14.73 per cent, respectively. The number of automated teller machines (ATMs) hasrisen and the usage of ATMs has gone up substantially during the last few years.Use of other banks ATMs would also not attract any fee except when used for cash withdrawal for which the maximum charge levied was brought down toUS$ .409 per withdrawal by March 31, 2008. Further, all cash withdrawals fromall ATMs would be free with effect from April 1, 2009.

Bank initiatives

Since December 2008, the government has announced series of measures toaugment flow of credits to around US$ 2, 66,274 to SMEs. To improve the flowof credit to industrial clusters and facilitate their overall development, 15 banksoperating in Orissa including the public sector State Bank of India (SBI) and the



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Small Industries Development Bank of India (SIDBI) have adopted 48 clustersspecially in sectors like engineering tools, foundry, handloom, food processing,weaving, rice mill, cashew processing, pharmaceuticals, bell metals andcarpentry etc.

PSBs are now cashing in the auto loan segment after the exit of private playersowing to the slowdown. Auto loans usually have three components - car loans,two-wheeler loans and commercial vehicle loans. PSBs are primarily focusingon car and two-wheeler loans. Prevalent interest rates in the car loan segmentnow range between 11 per cent and 12.5 per cent per annum. For instance,according to the Union Bank of India Chairman and Managing Director, MV Nair, his bank had recently tied up with Maruti Suzuki India for financing thelatter's product and it has a US$ 163.84 million auto loan portfolio.

The government has told public sector banks (PSBs) to extend credit to fund-starved Indian industry, especially exporters and small and medium sector enterprises to address their credit needs. SIDBI would be lending US$ 1.33 billion out of US$ 1.47 billion credit from RBI to public sector banks. This is being provided to the PSBs at 6.5 per cent (SIDBI is getting the credit at 5.5 per cent) under the condition that the banks will have to lend this credit to themedium and small-scale industry units at an interest rate of 10 per cent beforeMarch 31, 2010.

According to SBI Chairman, O P Bhatt, contribution of small and mediumenterprises (SMEs) is nearly 40-50 per cent to GDP growth of the nation, and

this sector also accounts for 50 per cent of the industrial output. "Banks couldaccrue revenue of over US$ 5.73 billion by encouraging the SMEs," Bhatt saidadding, "SME's sector is to grow fastest in the next five years, with 14 per centgrowth in terms of revenue and 13 per cent in terms of profits." The bank inorder to help units tide over the current downturn, had introduced products likeSME Care specially in Jharkhand, which provides units to access 20 per centadditional funds over and above their existing overdraft limit. Already,

according to an official, the MSME ministry has proposed to RBI that the sector



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be given a mandatory 15 per cent share of the total priority sector lending. The banking industry is thereby now lending both strength and support in form of cash and policies majorly in putting back the economy into track.



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Recent Banking Development in IndiaThe Indian banking sector has witnessed wide ranging changes under the

influence of the financial sector reforms initiated during the early 1990s. Theapproach to such reforms in India has been one of gradual and non-disruptive progress through a consultative process. The emphasis has been on deregulationand opening up the banking sector to market forces. The Reserve Bank has beenconsistently working towards the establishment of an enabling regulatoryframework with prompt andEffective supervision as well as the development of technological andinstitutional infrastructure.Persistent efforts have been made towards adoption of international benchmarksas appropriate to Indian conditions. While certain changes in the legalinfrastructure are yet to be effected, the developments so far have brought theIndian financial system closer to global standards.

Statutory Pre-emptions

In the pre-reforms phase, the Indian banking system operated with a high levelof statutory preemptions, in the form of both the Cash Reserve Ratio (CRR) andthe Statutory Liquidity Ratio (SLR), reflecting the high level of the countrysfiscal deficit and its high degree of monetisation. Efforts in the recent periodhave been focused on lowering both the CRR and SLR. The statutory minimumof 25 per cent for the SLR was reached as early as 1997, and while the ReserveBank continues to pursue its medium-term objective of reducing the CRR to the statutory minimumlevel of 3.0 per cent, the CRR of the Scheduled Commercial Banks (SCBs) iscurrently placed at 5.0 per cent of NDTL (net demand and time liabilities). Thelegislative changes proposed by the Government in the Union Budget, 2005-06to remove the limits on the SLR and CRR are expected to provide freedom to theReserve Bank in the conduct of monetary policy and also lend further flexibilityto the banking system in the deployment of resources.



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Interest Rate Structure

Deregulation of interest rates has been one of the key features of financial sector reforms. In recent years, it has improved the competitiveness of the financialenvironment and strengthened the transmission mechanism of monetary policy.Sequencing of interest rate deregulation has also enabled better price discoveryand imparted greater efficiency to the resource allocation process. The processhas been gradual and predicated upon the institution of prudential regulation of the bankingsystem, market behaviour, financial opening and, above all, the underlyingmacroeconomic conditions.Interest rates have now been largely deregulated except in the case of: (i)savings deposit accounts; (ii) non-resident Indian (NRI) deposits; (iii) smallloans up to Rs.2 lakh; and (iv) export credit.After the interest rate deregulation, banks became free to determine their ownlending interest rates.As advised by the Indian Banks Association (a self-regulatory organisation for banks), commercial banks determine their respective BPLRs (benchmark primelending rates) taking into consideration:(i) actual cost of funds; (ii) operating expenses; and (iii) a minimum margin tocover regulatory requirements of provisioning and capital charge and profitmargin. These factors differ from bank to bank and feed into the determinationof BPLR and spreads of banks. The BPLRs of public sector banks declined to10.25-11.25 per cent in March 2005 from 10.25-11.50 per cent in March 2004.

With a view to granting operational autonomy to public sector banks, publicownership in these banks was reduced by allowing them to raise capital from theequity market of up to 49 per cent of paid-up capital. Competition is beingfostered by permitting new private sector banks, and more liberal entry of branches of foreign banks, joint-venture banks and insurance companies.Recently, a roadmap for the presence of foreign banks in India was released which sets out the process of the

gradual opening-up of the banking sector in a transparent manner. Foreign



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investments in the financial sector in the form 238 BIS Papers No 28 of ForeignDirect Investment (FDI) as well as portfolio investment have been permitted.Furthermore, banks have been allowed to diversify product portfolio and business activities. The share of public sector banks in the banking business isgoing down, particularly in metropolitan areas. Some diversification of ownership in select public sector banks has helped further the move towardsautonomy and thus provided some response to competitive pressures.Transparency and disclosure standards have been enhanced to meet internationalstandards in an ongoing manner.

Prudential Regulation

Prudential norms related to risk-weighted capital adequacy requirements,accounting, income recognition, provisioning and exposure were introduced in1992 and gradually these norms have been brought up to international standards.Other initiatives in the area of strengthening prudential norms include measuresto strengthen risk management through recognition of different components of risk,assignment of risk-weights to various asset classes, norms on connected lendingand risk concentration, application of the mark-to-market principle for investment portfolios and limits on deployment of funds in sensitive activities.Keeping in view the Reserve Banks goal to achieve consistency and harmonywith international standards and our approach to adopt these standards at a paceappropriate to our context, it has been decided to migrate to Basel II. Banks arerequired to maintain a minimum CRAR (capital to risk weighted assets ratio) of 9 per cent on an ongoing basis. The capital requirements are uniformly applied

to all banks, including foreign banks operating in India, by way of prudentialguidelines on capital adequacy. Commercial banks in India will startimplementing Basel II with effect from March 31, 2007. They will initiallyadopt the Standardised Approach for credit risk and the Basic Indicator Approach for operational risk. After adequate skills have been developed, at both bank and supervisory level, some banks may be allowed to migrate to theInternal Ratings-Based (IRB) Approach. Banks have also been advised to



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formulate and operationalise the Capital Adequacy Assessment Process (CAAP)as required under Pillar II of the New Framework.Some of the other regulatory initiatives relevant to Basel II that have beenimplemented by the Reserve Bank are: Ensuring that banks have a suitable risk management framework orientedtowards their requirements and dictated by the size and complexity of their business, risk philosophy, market perceptions and expected level of capital. Introducing Risk-Based Supervision (RBS) in select banks on a pilot basis. Encouraging banks to formalise their CAAP in alignment with their business plan and performance budgeting system. This, together with the adoption of RBS, should aid in fulfilling the Pillar II requirements under Basel II. Expanding the area of disclosures (Pillar III) so as to achieve greater transparency regarding the financial position and risk profile of banks. Building capacity to ensure the regulators ability to identify eligible banksand permit them to adopt IRB/Advanced Measurement approaches.With a view to ensuring migration to Basel II in a non-disruptive manner, aconsultative and participative approach has been adopted for both designing andimplementing the New Framework. A Steering Committee comprising senior officials from 14 banks (public, private and foreign) with representation fromthe Indian Banks Association and the Reserve Bank has been constituted. Onthe basis of recommendations of the Steering Committee, draft guidelines onimplementation of the New Capital Adequacy Framework have been issued to banks.In order to assess the impact of Basel II adoption in various jurisdictions and re-calibrate the proposals, the BCBS is currently undertaking the Fifth Quantitative

Impact Study (QIS 5). India will be participating in the study, and has selected11 banks which form a representative sample for this purpose. These banksaccount for 51.20 per cent of market share in terms of assets. They have beenadvised to familiarise themselves with the QIS 5 requirements to enable them to participate in the exercise effectively. The Reserve Bank is currently focusingon the issue of recognition of the external rating agencies for use in theStandardised Approach for credit risk.



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As a well-established risk management system is a pre-requisite for implementation of advanced approaches under the New Capital AdequacyFramework, banks were required to examine the various options available under the Framework and draw up a roadmap for migration to Basel II. The feedback received from banks suggests that a few may be keen on implementing theadvanced approaches. However, not all are fully equipped to do so straightawayand are, therefore, looking to migrate to the advanced approaches at a later date.Basel II provides that banks should be allowed to adopt/migrate to advancedapproaches only with the specific approval of the supervisor, after ensuring thatthey satisfy the minimum requirements specified in the Framework, not only atthe time of adoption/migration, but on a continuing basis. Hence, banks desirousof adopting the advanced approaches must perform a stringent assessment of their compliance with the minimum requirements before they shift gears tomigrate to these approaches. In this context, current non-availability of acceptable and qualitative historical data relevant to internal credit risk ratingsand operational risk losses, along with the related costs involved in building upand maintaining the requisite database, is expected to influence the pace of migration to the advanced approaches available under Basel II.

Exposure Norms

The Reserve Bank has prescribed regulatory limits on banks exposure toindividual and group borrowers to avoid concentration of credit, and has advised banks to fix limits on their exposure to specific industries or sectors (real estate)to ensure better risk management. In addition, banks are also required to observecertain statutory and regulatory limits in respect of their exposures to capital

markets.

Asset-Liability Management

In view of the growing need for banks to be able to identify, measure, monitor and control risks, appropriate risk management guidelines have been issued fromtime to time by the Reserve Bank, including guidelines on Asset-LiabilityManagement (ALM). These guidelines are intended to serve as a benchmark for

banks to establish an integrated risk management system. However, banks can



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also develop their own systems compatible with type and size of operations aswell as risk perception and put in place a proper system for covering the existing deficiencies and therequisite upgrading. Detailed guidelines on the management of credit risk,market risk, operational risk, etc. have also been issued to banks by the ReserveBank.The progress made by the banks is monitored on a quarterly basis. With regardto risk management techniques, banks are at different stages of drawing up acomprehensive credit rating system, undertaking a credit risk assessment on ahalf yearly basis, pricing loans on the basis of risk rating, adopting the Risk-Adjusted Return on Capital (RAROC) framework of pricing, etc. Some banksstipulate a quantitative ceiling on aggregate exposures in specified risk categories, analyse rating-wise distribution of borrowers in various industries,etc.In respect of market risk, almost all banks have an Asset-Liability ManagementCommittee. They have articulated market risk management policies and procedures, and have undertaken studies of behavioural maturity patterns of various components of on-/off-balance sheet items.

NPL Management

Banks have been provided with a menu of options for disposal/recovery of NPLs(non-performing loans). Banks resolve/recover their NPLs throughcompromise/one time settlement, filing of suits, Debt Recovery Tribunals, theLok Adalat (peoples court) forum, Corporate Debt Restructuring (CDR), sale tosecuritisation/reconstruction companies and other banks or to non-banking

finance companies (NBFCs). The promulgation of the Securitisation andReconstruction of Financial Assets and Enforcement of Security Interest(SARFAESI) Act, 2002 and its subsequent amendment have strengthened the position of creditors. Another significant measure has been the setting-up of the240 BIS Papers No 28 Credit Information Bureau for information sharing ondefaulters and other borrowers. The role of Credit Information Bureau of IndiaLtd. (CIBIL) in improving the quality of credit analysis by financial institutions

and banks need hardly be overemphasised. With the enactment of the Credit



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Information Companies (Regulation) Act, 2005, the legal framework has been put in place to facilitate the full fledged operationalisation of CIBIL and theintroduction of other credit bureaus.

Board for Financial Supervision (BFS)

An independent Board for Financial Supervision (BFS) under the aegis of theReserve Bank has been established as the apex supervisory authority for commercial banks, financial institutions, urban banks and NBFCs. Consistentwith international practice, the Boards focus is on offsite and on-siteinspections and on banks internal control systems. Offsite surveillance has beenstrengthened through control returns. The role of statutory auditors has beenemphasised with increased internal control through strengthening of the internalaudit function. Significant progress has been made in implementation of theCore Principles for Effective Banking Supervision. The supervisory ratingsystem under CAMELS has been established, coupled with a move towards risk- based supervision.Consolidated supervision of financial conglomerates has since been introducedwith bi-annual discussions with the financial conglomerates. There have also been initiatives aimed at strengthening corporate governance through enhanceddue diligence on important shareholders, and fit and proper tests for directors.A scheme of Prompt Corrective Action (PCA) is in place for attending to banksshowing steady deterioration in financial health. Three financial indicators, viz.capital to risk-weighted assets ratio (CRAR), net non-performing assets (net NPA) and Return on Assets (RoA) have been identified with specific threshold

limits. When the indicators fall below the threshold level (CRAR, RoA) or goabove it (net NPAs), the PCA scheme envisages certain structured/discretionaryactions to be taken by the regulator.The structured actions in the case of CRAR falling below the trigger point mayinclude, among other things, submission and implementation of a capitalrestoration plan, restriction on expansion of risk weighted assets, restriction onentering into new lines of business, reducing/skipping dividend payments, and

requirement for recapitalisation. The structured actions in the case of RoA



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falling below the trigger level may include, among other things, restriction onaccessing/renewing costly deposits and CDs, a requirement to take steps toincrease fee-based income and to contain administrative expenses, not to enter new lines of business, imposition of restrictions on borrowings from theinterbank market, etc.In the case of increasing net NPAs, structured actions will include, among other things, undertaking a special drive to reduce the stock of NPAs and containingthe generation of fresh NPAs, reviewing the loan policy of the bank, taking stepsto upgrade credit appraisal skills and systems and to strengthen follow-up of advances, including a loan review mechanism for large loans, following up suitfiled/ decreed debts effectively, putting in place proper credit risk management policies/processes/procedures/prudential limits, reducing loan concentration, etc.Discretionary action may include restrictions on capital expenditure, expansionin staff, and increase of stake in subsidiaries. The Reserve Bank/Governmentmay take steps to change promoters/ ownership and may even take steps tomerge/amalgamate/liquidate the bank or impose a moratorium on it if its position does not improve within an agreed period.

Technological Infrastructure

In recent years, the Reserve Bank has endeavoured to improve the efficiency of the financial system by ensuring the presence of a safe, secure and effective payment and settlement system. In the process, apart from performing regulatoryand oversight functions the Reserve Bank has also played an important role in promoting the systems functionality and modernisation on an ongoing basis.The consolidation of the existing payment systems revolves around

strengthening computerised cheque clearing, and expanding the reach of Electronic Clearing Services (ECS) and Electronic Funds.Transfer (EFT). The critical elements of the developmental strategy are theopening of new clearing houses, interconnection of clearing houses through theIndian Financial Network (INFINET) and the development of a Real-Time GrossSettlement (RTGS) System, a Centralised Funds Management System (CFMS), a Negotiated Dealing System (NDS) and the Structured Financial Messaging



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System (SFMS). Similarly, integration of the various payment products with thesystems of individual banks has been another thrust area.

An Assessment

These reform measures have had a major impact on the overall efficiency andstability of the banking system in India. The dependence of the Indian bankingsystem on volatile liabilities to finance its assets is quite limited, with thefunding volatility ratio at -0.17 per cent as compared with a global range of -0.17 to 0.11 per cent. The overall capital adequacy ratio of banks at end-March2005 was 12.8 per cent as against the regulatory requirement of 9 per cent whichitself is higher than the Basel norm of 8 per cent. The capital adequacy ratio was broadly comparable with the global range. There has been a markedimprovement in asset quality with the percentage of gross NPAs to grossadvances for the banking system declining from 14.4 per cent in 1998 to 5.2 per cent in 2005. Globally, the NPL ratio varies widely from a low of 0.3 per cent to3.0 per cent in developed economies, to over 10.0 per cent in several LatinAmerican economies. The reform measures have also resulted in animprovement in the profitability of banks. RoA rose from 0.4 per cent in theyear 1991-92 to 0.9 per cent in 2004-05. Considering that, globally, RoA was inthe range -1.2 to 6.2 per cent for 2004, Indian banks are well placed. The banking sector reforms have also emphasised the need to review manpower resources and rationalise requirements by drawing up a realistic plan so as toreduce operating cost and improve profitability. The cost to income ratio of 0.5 per cent for Indian banks compares favourably with the global range of 0.46 per cent to 0.68 per cent and vis-a-vis 0.48 per cent to 1.16 per cent for the worlds

largest banks. In recent years, the Indian economy has been undergoing a phaseof high growth coupled with internal and external stability characterised by pricestability, fiscal consolidation, overall balance of payments alignment,improvement in the performance of financial institutions and stable financialmarket conditions and the service sector taking an increasing share, enhancedcompetitiveness, increased emphasis on infrastructure, improved marketmicrostructure, an enabling legislative environment and significant capital



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inflows. This has provided the backdrop for a more sustained development of financial markets and reform.

CHAPTER 3

INTRODUCTION TO CREDIT CARDINDUSTRY

History

Our society was once upon a time functioning without money; it is again likely to

become moneyless. While ancient society was confronted with the problems of adjustingmutually satisfactory rates and basis of exchange, future society, with the help of computers, electronics and telecommunications, credit cards, telephone and other modern means of communications, would settle financial transactions instantly. Moneyas a medium of exchange will serve its function. The difference will be that in futurecoins, currency notes, cheques, etc., will be dispensed with in favour of records. Indiahas entered the stage of credit card system and credit cards are gaining increasing

relevance to facilitate industrial, commercial and agricultural transactions.

Credit was first used in Assyria, Babylon and Egypt 3,000 years ago. The Bill of Exchange the forerunner of bank notes - was established in the 14th century. Debtssettled by one-third cash and two-thirds bill of exchange paper money followed only inthe 17th century. The first advertisement for credit was placed in 1730 by Christopher Thornton who offered furniture that could be paid off weekly.



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these places, the take-up of credit cards was initially much slower. It took until the 1990sto reach anything like the percentage market-penetration levels achieved in the US,Canada or UK. In many countries acceptance still remains poor as the use of a creditcard system depends on the banking system being perceived as reliable.

In contrast, because of the legislative framework surrounding banking system overdrafts,some countries, France in particular, were much faster to develop and adopt chip-basedcredit cards which are now seen as major anti-fraud credit devices.

The design of the credit card itself has become a major selling point in recent years. Thevalue of the card to the issuer being related to the Customer's usage of the card. This hasled to the rise of Co-Brand andAffinitycards - where the cards design is related to the"affinity" (a university, for example) leading to higher card usage. In most cases a percentage of the value of the card is returned to the affinity group.

Concept of credit card

Progress in civilization in its turn has brought out radical changes in the manner of

trading. The need for something intrinsically useful and easily applicable in everydaydealing is clearly felt. Cash in the form of currency notes and coins makes up just oneform of the payment system. Development in banking while also giving inputs to thefurther development of cash brought about a second phase in payment namely paper instructions such as cheques and credit transfers. The requirement for greater flexibilityand convenience has led to electronic payments, and this is where plastic cards have proved their worth. It allows the card issuers to limit the sum of money the card-holderswish to spend. The spending of card-holders who have defaulted on payments or who areover their credit limit can be restricted until the balances are cleared.

Definition of credit card

A credit card is a credit-token within the meaning of section 14(1), Consumer Credit Act1974 of the UK which defines a credit-token as a card, cheque, voucher, coupon, stamp,form booklet or other document or thing given to an individual by a person carrying on aconsumer credit business, who undertakes:- that on the production of it (whether or notsome other action is also required), he will supply, cash, goods and services (or any of

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them) on credit, or that were, on the production of it to third party (whether or not anyother action is also required), the third party supplies cash, goods and services (whether or not deducting any discount or commission), in return for payment to him by theindividual.

In very simple words credit card can be termed as an unsecured personal loan offered tocustomers by the banks where the card-holder could purchase goods and services fromauthorized merchant or merchant establishments (MEs) of the bank up to a fixed limit oncredit. Such credit is normally made available for a period of 30 to 45 days. This is turnhelps earn income by way of commission from its merchant establishments; the scheme provided large scope for sale and increased turnover with assured and prompt payment.

In 1951, the Franklin National Bank in New York issued the first modern credit card.Unsolicited credit cards were sent to prospective card-holders who were not subject tocredit screening prior to being sent a card. Merchants signed agreements to accept thecards. When a purchase was made, the card-holder presented the card to the merchant,who would copy the information on the merchants account at Franklin Bank in theamount of the transactions, less the discount rate. If a purchase exceeded the merchantsfloor limit, the merchant was required to call the bank for approval. Franklin NationalBanks Credit Card programme was copied by hundreds of other banks in the late 1950sand early 1960s.

The Bank of America issued Bank Americard in 1958 and eight years later, in 1966, the banks comprising the Western State Bank Card Association issued the Master ChargeCard. Bank America and Master charge card became the focal points for the eventual

groupings of all bank cards throughout the world. The VISA and the MASTER thelargest credit cards today appeared in market in 1966. These two international cards arevery popular and are accepted and honored all over the world in 170 countries. Thesetwo independent card companies led to latest innovations in the credit card business. Now the credit card system has become universally popular throughout the worldincluding the Communist countries. At the end of 1995 and 1980 a million cards wereused in the world. The total number of credit card users in India is currently in excess of

80 lakh and now more than 30 banks are chasing customers with their cards.



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A credit card allows consumers to purchase products or services without cash and to payfor them at a later date. To qualify for this type of credit, the consumer must open anaccount with a bank or company, which sponsors a card. They then receive a line of credit with a specified dollar amount. They can use the card to make purchases from participating merchants until they reach this credit limit. Every month the sponsor provides a bill, which tallies the card activity during the previous 30 days. Depending onthe terms of the card, the customer may pay interest charges on the amount that they donot pay for on a monthly basis. Also, credit cards may be sponsored by large retailers(such as major clothing or department stores) or by banks or corporations (like VISA or American Express).

Credits cards are a relatively recent development. The VISA Company, for example,traces its history back to 1958 when the Bank of America began its BankAmerica program. In the mid-1960s, the Bank of America began to license banks in the UnitedStates the rights to issue its special BankAmericards. In 1977 the name Visa was adoptedinternationally to cover all these cards. VISA became the first credit card to berecognized worldwide.

The banks and companies that sponsor credit cards profit in three ways. Primarily theymake money from the interest payments charged on the unpaid balance, but they also canmake money by charging an annual fee for the use of the card. The income from this fee,which is typically only $50 or $75 per customer per year, can be substantial consideringthat the larger companies have tens of millions of customers. In addition, the sponsorsmake money by charging merchants a small percentage of income for the service of the

card. This arrangement is acceptable to the merchants because they can let their customers pay by credit card instead of requiring cash. The merchant makesarrangements to participate in a credit card program with a merchant bank, which in turnworks with a card-issuing bank. The merchant bank determines what percentage of thetotal purchase value has to be paid by the merchant to the card-issuing bank. The amountvaries depending on the volume and type of business, but in general it is between 1-2%.A percentage of that amount is kept by the merchant bank as a transaction-processing

fee. For companies like American Express which sponsor cards, the processing fee may

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be significantly higher. Furthermore, sponsors may generate income by leasing creditcard verification equipment to merchants (especially if the merchants cannot afford to purchase the equipment themselves.) Finally, sponsors may profit by charging servicefees for late payments

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CREDIT CARDS IN INDIA

Credit card or the plastic money, as it is popularly referred to, was slow to enter theIndian market because of the high sentimental value that Indian consumers attach to hardcash. Prevalence of small value transaction, credit shy culture and inadequate bankinghabits of the population were other hindrances.

Credit cards arrived in India about two decades ago. In the early stages its growth was

very slow in terms of number and value. Even the number of players was limited andmainly foreign banks like HSBC, Citibank and Standard Chartered Bank dominated themarket. Indian banks did not show much interest in the product in the initial stages. Thisis evident from the fact that it took State Bank of India (SBI), Indias largest bank,almost a decade to begin dealing in credit cards. SBI, despite its widespread reach, hasaggressively started promoting credit cards only three years ago.

However, in the recent past the scenario has changed dramatically. The number of nationalized and private banks issuing credit cards has increased significantly. Creditcards are now not only integral parts of the consumers life in metros, but even residentsof smaller cities and towns have taken to them. This can be attributed to the aggressivestrategy of nationalized and private banks to promote card products in smaller town andcities. These banks have far wider reach and depth in smaller cities and town ascompared to foreign banks. They have capitalized on this advantage to play a major rolein expanding the credit card base in terms of number and usage in smaller cities andtown.

Transactions using plastic money involve the payment of a small fee to the issuing bank in the form of an application/joining fee and an annual fee. Consumers collect a percentage-based commission in the form of reward points for card usage atshops/establishments. The usage of credit card is very simple and easy. The consumersdo not have to carry cash and can use the card to pay their shopping/restaurant bills. Allyou are required to do is give your credit card at the payment counter, the person



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handling the counter swipes the card into the system to check the details of the card andyou need to sign on the bill. The payment is done electronically. With only a signatureyour payment is taken care of. Isnt it very simple?

Yes it is, but everyone isnt eligible for a credit card. There are certain requirements,varying across banks, to get a credit card. Typically credit card companies (or issuing banks, as they are known) require the applicant to have a minimum income level beforehe can apply for the card. Proof of income is given by way of documents. Thesedocuments could be a copy of tax return filed; salary slips if applicable, balance sheetand profit and loss account detail if you are self-employed. These serve as the starting point while applying for a card. The minimum income level varies from bank to bank and fluctuates between Rs 60,000 - 150,000 per annum depending upon your risk profileand the type of card. This requirement helps the issuing bank to assess whether or notyou will be able to repay the expenses incurred through your credit card. In addition toincome eligibility, you need to be at least 21 years of age (maximum 65 years).

There is no doubt that credit cards are very convenient, especially in case of dailyexpenses. In addition you earn bonus points while you spend via the card. It is becauseof these reasons that in the recent past card usage has increased dramatically. In fact, plastic currency has almost wiped off hard currency from the US, resulting in far lessexpenditure associated with cash transactions.

Currently, four major bishops are ruling the card empire - Citibank, Standard CharteredBank, HSBC and State Bank of India (SBI). The industry, which is catering to over 3.8million1 card users, is expected to double by the fiscal 2003. According to a study

conducted by State Bank of India, Citibank is the dominant player, having issued 1.5million cards so far. Standard Chartered Bank follows way behind with 0.67 million,while Hongkong Bank has 0.3 million credit card customers. Among the nationalized banks, SBI tops the list with 0.28 million cards, followed by Bank of Baroda at 0.22million.



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The credit card market in India, which started out in 1981, is on the verge of anunprecedented boom. Between 1987 and 2000, the market has virtually grown to over 3.8 million cards with almost 25-30 per cent growth in new card-holders.

India is generating more credit card spenders than spending places. While card-base andappends are growing at a spiffy 25-30 per cent2 annually, the number of merchantestablishments which accept cards is growing selectively sluggish. The figure was put at75,00080,000 a couple of years ago, and now stands at 100,000 on both the Visa andMasterCard loops. As opposed to that, there are 2.5 million card-holders and 3.3 millioncards (some, obviously, have more than one) and the numbers are growing very strongly.

The seven million Indian credit card industry has been growing over 25 per cent3annually and has now more than 30 banks chasing customers with their cards. Still,credit cards in India have made business sense only to a few.

The annual growth rate is good, but it is only 20 per cent of the card base, that isgenerating revenue, says Roopan Asthana, manager, Card Products Division of HSBC. Nearly 45-50 per cent of the card-holders are estimated to be inactive, while another 30 per cent use the card as a charge card without using the revolving facility cards areexpected to account for 33 per cent of all purchases by 2000 and 43 per cent by 2005.

The credit card embodies two essential aspects of the basic banking function - thetransmission of payments and the granting of credit. Therefore, in its true sense, acredit card must offer the opinion of revolving credit. This is very akin to the overdraft

facility offered by banks to their account holders. A credit card holder does notnecessarily have to settle his entire account at the end of the month for he has the optionto make partial payment in subsequent months. In fact, when the card-holder makes thefull payment at the end of the month he is said to be using his credit card as a chargecard. Incidentally, the interest paid by the card-holder on the credit utilized by him iswhat makes the business of credit cards profitable from the point of view of the bank issuing the card.



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Indians are still not sure of the plastic money. Credit cards spend as a proportion of thetotal expenditure by Indians is one of the lowest in the world. While Indians swiped plastic money worth $6 billion in 2006, credit card users in Korea cumulatively spent$136 billion.

Indians spend just 1% of their total purchases through credit cards while the Koreansmake one-fifth of their total purchases through credit cards. The world average hoversaround 9%.

The very low levels of penetration in India offer immense potential for credit cardcompanies. Also, there are fewer credit card companies than those in other parts of theworld. The high growth in spending is attracting a lot of entrants into the segment. Whatis drawing a large number of companies and financial institutions including LifeInsurance Corporation of India (LIC) to India is the 61% year-on-year growth beingwitnessed in retail spending, the highest in the world.

Interestingly, even among the rich, credit card ownership in India is the lowest in theworld. While 90% of the affluent in Hong Kong have credit cards and the correspondingfigure for Sydney stands at 87%, in India, only 28% of the affluent have credit card.

Manila, Jakarta, Taipei , Hong Kong have 48-76% of the affluent population owningcredit cards, according to Visa research in Asia. Seoul has 84% of its affluent populationowning a credit card. Korea, however, has a history of defaults on credit cards where thegovernment had to bail out the credit card companies.

Sources in the industry say with such low penetration levels there are at least half adozen companies that are looking to roll out credit card operations in India. AIG,Barclays, and LIC are some of the companies eager to enter the Indian market. Punjab National Bank (PNB) is also learnt to be in negotiations to launch another credit card.



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Credit Card Operations of banks- Guidelines Dated21st Nov 2005

Pursuant to the announcement made in the Annual Policy Statement 2004-05, theReserve Bank of India had constituted a Working Group on Regulatory Mechanism for Cards. The Group has suggested various regulatory measures aimed at encouraginggrowth of credit cards in a safe, secure and efficient manner as well as to ensure that therules, regulations, standards and practices of the card issuing banks are in alignment with

the best customer practices. The following guidelines on credit card operations of bankshave been framed based on the recommendations of the Group as also the feedback received from the members of the public, card issuing banks and others. All the creditcard issuing banks / NBFCs should implement these guidelines immediately.

Each bank / NBFC must have a well documented policy and a Fair Practices Code for credit card operations. In March 2005, the IBA released a Fair Practices Code for credit

card operations which could be adopted by banks / NBFCs. The bank / NBFC's Fair Practice Code should, at a minimum, incorporate the relevant guidelines contained inthis circular. Banks / NBFCs should widely disseminate the contents thereof includingthrough their websites, at the latest by November 30, 2005.

Guidelines for Implementation

Issue of cardsa. Banks / NBFCs should independently assess the credit risk while issuing cards to

persons, especially to students and others with no independent financial means. Add-oncards i.e. those that are subsidiary to the principal card, may be issued with the clear understanding that the liability will be that of the principal cardholder.

b. As holding several credit cards enhances the total credit available to any consumer,

banks / NBFCs should assess the credit limit for a credit card customer having regard to



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c. The bank / NBFC should not levy any charge that was not explicitly indicated to thecredit card holder at the time of issue of the card and getting his / her consent. However,this would not be applicable to charges like service taxes, etc. which may subsequently be levied by the Government or any other statutory authority.

d. The terms and conditions for payment of credit card dues, including the minimum payment due, should be stipulated so as to ensure that there is no negative amortization.

e. Changes in charges (other than interest) may be made only with prospective effectgiving notice of at least one month. If a credit card holder desires to surrender his credit

card on account of any change in credit card charges to his disadvantage, he may be permitted to do so without the bank levying any extra charge for such closure.

Wrongful billing

a. The card issuing bank / NBFC should ensure that wrong bills are not raised andissued to customers. In case, a customer protests any bill, the bank / NBFC should provide explanation and, if necessary, documentary evidence to the customer within amaximum period of sixty days with a spirit to amicably redress the grievances.

b. To obviate frequent complaints of delayed billing, the credit card issuing bank / NBFC may consider providing bills and statements of accounts online, with suitablesecurity built therefore.

Use of DSAs / DMAs and other agents

a. When banks / NBFCs outsource the various credit card operations, they have to beextremely careful that the appointments of such service providers do not compromisewith the quality of the customer service and the bank / NBFCs ability to manage credit,liquidity and operational risks. In the choice of the service provider, the bank / NBFCs

have to be guided by the need to ensure confidentiality of the customers records, respectcustomer privacy, and adhere to fair practices in debt collection.



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b. The Code of Conduct for Direct Sales Agents (DSAs) formulated by the IndianBanks Association (IBA) could be used by banks / NBFCs in formulating their owncodes for the purpose. The bank / NBFC should ensure that the DSAs engaged by themfor marketing their credit card products scrupulously adhere to the bank / NBFCs ownCode of Conduct for credit card operations which should be displayed on the bank / NBFCs website and be available easily to any credit card holder.

c. The bank / NBFC should have a system of random checks and mystery shopping toensure that their agents have been properly briefed and trained in order to handle with

care and caution their responsibilities, particularly in the aspects included in theseguidelines like soliciting customers, hours for calling, privacy of customer information,conveying the correct terms and conditions of the product on offer, etc.

Redressal of Grievances

a. Generally, a time limit of sixty (60) days may be given to the customers for preferring

their complaints grievances.

b. The card issuing bank / NBFC should constitute Grievance Redressal machinerywithin the bank / NBFC and give wide publicity about it through electronic and printmedia. The name and contact number of designated grievance redressal officer of the bank / NBFC should be mentioned on the credit card bills. The designated officer shouldensure that genuine grievances of credit card subscribers are redressed promptly without

involving delay.

c. The grievance redressal procedure of the bank / NBFC and the time frame fixed for responding to the complaints should be placed on the bank / NBFC's website. The name,designation, address and contact number of important executives as well as theGrievance Redressal Officer of the bank / NBFC may be displayed on the website. Thereshould be a system of acknowledging customers' complaints for follow up, such as

complaint number / docket number, even if the complaints are received on phone.



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d. If a complainant does not get satisfactory response from the bank / NBFC within amaximum period of thirty (30) days from the date of his lodging the complaint, he will

have the option to approach the Office of the concerned Banking Ombudsman for redressal of his grievance/s. The bank / NBFC shall be liable to compensate thecomplainant for the loss of his time, expenses, financial loss as well as for theharassment and mental anguish suffered by him for the fault of the bank and where thegrievance has not been redressed in time.

Internal control and monitoring systems

With a view to ensuring that the quality of customer service is ensured on an on-going basis in banks / NBFCs, the Standing Committee on Customer Service in each bank / NBFC may review on a monthly basis the credit card operations including reports of defaulters to the CIBIL, credit card related complaints and take measures to improve theservices and ensure the orderly growth in the credit card operations. Banks / NBFCsshould put up detailed quarterly analysis of credit card related complaints to their TopManagement. Card issuing banks should have in place a suitable monitoring mechanism

to randomly check the genuineness of merchant transactions.

Right to impose penalty

The Reserve Bank of India reserves the right to impose any penalty on a bank / NBFCunder the provisions of the Banking Regulation Act, 1949 for violation of any of theseguidelines.



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How credit cards work

An example of the front of a typical credit card:

1. Issuing bank logo2. EMV chip3. Hologram4. Card number 5. Card brand logo6. Expiry Date7. Cardholder's name

An example of the reverse side of a typical credit card:1. Magnetic Stripe2. Signature Strip

3. Card Security CodeA user is issued credit after an account has been approved by the credit provider, and isgiven a credit card, with which the user will be able to make purchases frommerchants accepting that credit card up to a pre-establishedcredit limit. Often a general bank issuesthe credit, but sometimes a captive bank created to issue a particular brand of credit card,such asChase, Wells Fargo or Bank of Americaissues the credit.When a purchase is made, the credit card user agrees to pay the card issuer. The

cardholder indicates their consent to pay, by signing areceiptwith a record of the card

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details and indicating the amount to be paid or by entering aPersonal identification number (PIN). Also, many merchants now accept verbal authorizations via telephoneand electronic authorization using the Internet, known as a Card not present (CNP)transaction.

Electronic verificationsystems allow merchants to verify that the card is valid and thecredit card customer has sufficient credit to cover the purchase in a few seconds,allowing the verification to happen at time of purchase. The verification is performedusing a credit card payment terminalor Point of Sale (POS) system with acommunications link to the merchant'sacquiring bank . Data from the card is obtainedfrom amagnetic stripeor chip on the card; the latter system is in the United Kingdom commonly known asChip and PIN, but is more technically anEMVcard.

Other variations of verification systems are used byecommercemerchants to determineif the user's account is valid and able to accept the charge. These will typically involvethe cardholder providing additional information, such as thesecurity codeprinted on the back of the card, or the address of the cardholder.

Each month, the credit card user is sent a statement indicating the purchases undertakenwith the card, any outstanding fees, and the total amount owed. After receiving thestatement, the cardholder may dispute any charges that he or she thinks are incorrect (seeFair Credit Billing Actfor details of the US regulations). Otherwise, the cardholder must pay a defined minimum proportion of the bill by adue date, or may choose to pay ahigher amount up to the entire amount owed. The credit provider chargesintereston theamount owed (typically at a much higher rate than most other forms of debt). Some

financial institutions can arrange for automatic payments to be deducted from the user's bank accounts.

Credit card issuers usually waive interest charges if the balance is paid in full eachmonth, but typically will charge full interest on the entire outstanding balance from thedate of each purchase if the total balance is not paid.For example, if a user had a $1,000 outstanding balance and pays it in full, there would

be no interest charged. If, however, even $1.00 of the total balance remained unpaid,

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interest would be charged on the $1,000 from the date of purchase until the payment isreceived. The precise manner in which interest is charged is usually detailed in acardholder agreement which may be summarized on the back of the monthly statement.The general calculation formula most financial institutions use to determine the amountof interest to be charged is APR/100 x ADB/365 x number of days revolved. Take theAnnual percentage rate (APR) and divide by 100 then multiply to the amount of theaverage daily balance divided by 365 and then take this total and multiply by the totalnumber of days the amount revolved before payment was made on the account.

Financial institutions refer to interest charged back to the original time of the transactionand up to the time a payment was made, if not in full, as RRFC or residual retail financecharge. Thus after an amount has revolved and a payment has been made that the user of the card will still receive interest charges on their statement after paying the nextstatement in full (in fact the statement may only have a charge for interest that collectedup until the date the full balance was paid...i.e. when the balance stopped revolving).

The credit card may simply serve as a form of revolving credit, or it may become acomplicated financial instrument with multiple balance segments each at a differentinterest rate, possibly with a single umbrella credit limit, or with separate credit limitsapplicable to the various balance segments. Usually this compartmentalization is theresult of special incentive offers from the issuing bank, either to encourage balance transfers from cards of other issuers, or to encourage more spending on the part of thecustomer. In the event that several interest rates apply to various balance segments, payment allocation is generally at the discretion of the issuing bank, and payments willtherefore usually be allocated towards the lowest rate balances until paid in full before

any money is paid towards higher rate balances.

Interest ratescan vary considerably from card to card, and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card or anyother credit instrument, or even if the issuing bank decides to raise its revenue. As therates and terms vary, services have been set up allowing users to calculate savingsavailable by switching cards, which can be considerable if there is a large outstanding

balance (seeexternal linksfor some on-line services.

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Because of intense competition in the credit card industry, credit providers often offer incentives such as frequent flier points,gift certificates, or cash back (typically up to 1 percent based on total purchases) to try to attract customers to their program.

Low interest credit cards or even 0% interest credit cards are available. The onlydownside to consumers is that the period of low interest credit cards is limited to a fixedterm, usually between 6 and 12 months after which a higher rate is charged. However,services are available which alert credit card holders when their low interest period isdue to expire. Most such services charge a monthly or annual fee.

Grace periodA credit card's grace period is the time the customer has to pay the balance beforeinterest is charged to the balance. Grace periods vary, but usually range from 20 to 30days depending on the type of credit card and the issuing bank. Some policies allow for reinstatement after certain conditions are met. Usually, if a customer is late paying the balance, finance charges will be calculated and the grace period does not apply. Financecharge(s) incurred depends on the grace period and balance, with most credit cards thereis no grace period if there's any outstanding balance from the previous billing cycle or statement (i.e. interest is applied on both the previous balance and new transactions).However, there are some credit cards that will only apply finance charge on the previousor old balance, excluding new transactions.

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The merchant's side

An example of street markets accepting credit cardsFor merchants, a credit card transaction is often more secure than other forms of

payment, such as checks, because the issuing bank commits to pay the merchant themoment the transaction is authorized, regardless of whether the consumer defaults ontheir credit card payment (except for legitimate disputes, which are discussed below, andcan result in charge backs to the merchant). In most cases, cards are even more securethan cash, because they discourage theft by the merchant's employees.

For each purchase, the bank charges a commission (discount fee), to the merchant for

this service and there may be a certain delay before the agreed payment is received bythe merchant. The commission is often a percentage of the transaction amount, plus afixed fee. In addition, a merchant may be penalized or have their ability to receive payment using that credit card restricted if there are too many cancellations or reversalsof charges as a result of disputes. Some small merchants require credit purchases to havea minimum amount (usually between $5 and $10) to compensate for the transactioncosts, though this is not always allowed by the credit card consortium.

In some countries, like the Nordic countries, banks guarantee payment on stolen cardsonly if anID cardis checked and the ID card number/civic registration number is writtendown on the receipt together with the signature. In these countries merchants thereforeusually ask for ID. Non-Nordic citizens, who are unlikely to possess a Nordic ID card or driving license, will instead have to show their passport, and the passport number will bewritten down on the receipt, sometimes together with other information. Some shops usethe card's PIN code for identification, and in that case showing an ID card is notnecessary.

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Parties involved Cardholder: The owner of the card used to make a purchase; theconsumer .

Card-issuing bank: The financial institution or other organization that issued thecredit card to the cardholder. This bank bills the consumer for repayment and bears therisk that the card is used fraudulently. American Express and Discover were previouslythe only card-issuing banks for their respective brands, but as of 2007, this is no longer the case.

Merchant: The individual or business accepting credit card payments for products or services sold to the cardholder

Acquiring bank : The financial institution accepting payment for the products or services on behalf of the merchant.

Independent sales organization: Resellers (to merchants) of the services of the

acquiring bank.

Merchant account provider : This could refer to the acquiring bank or the independentsales organization, but in general is the organization that the merchant deals with.

Credit Card association: An association of card-issuing banks such asVisa,MasterCard, Discover , American Express, etc. that set transaction terms for merchants,card-issuing banks, and acquiring banks.

Transaction network: The system that implements the mechanics of the electronictransactions. May be operated by an independent company, and one company mayoperate multiple networks. Transaction processing networks include: Cardnet, Nabanco,Omaha, Paymentech, NDC Atlanta, Nova, Vital, Concord EFSnet, and VisaNet. Affinity partner: Some institutions lend their name to an issuer to attract customersthat have a strong relationship with that institution, and get paid a fee or a percentage of

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The main advantage over secured credit cards is that you are not required to come upwith $500 or more to open an account. Also most secured credit cards still charge youinterest even though you are not actually "borrowing" any money. With prepaid creditcards you are not charged any interest but you are often charged monthly fees after anarbitrary time period. Many other fees also usually apply to a prepaid card.

Prepaid credit cards are often marketed to teenagers for shopping online without havingtheir parents complete the transaction.

Because of the many fees that apply to obtaining and using credit-card-branded prepaidcards, the Financial Consumer Agency of Canadadescribes them as "an expensive wayto spend your own money". The agency publishes a booklet, "Pre-paid cards", whichexplains the advantages and disadvantages of this type of prepaid card.

Features

As well as convenient, accessible credit, credit cards offer consumers an easy way totrack expenses, which is necessary for both monitoring personal expenditures and thetracking of work-related expenses for taxationandreimbursement purposes. Credit cardsare accepted worldwide, and are available with a large variety of credit limits, repaymentarrangement, and other perks (such asrewards schemesin which points earned by purchasing goods with the card can be redeemed for further goodsandservicesor credit card cashback ).Some countries, such as theUnited States, the United Kingdom, and France, limit theamount for which a consumer can be heldliabledue to fraudulent transactions as a resultof a consumer's credit card being lost or stolen.

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Security

A smart card, combining credit card and debit cardproperties. The 3 by 5 mm security chipembedded in the card is shown enlarged in the inset. The gold contact pads on the card enableelectronic access to the chip.

The low security of the credit card system presents countless opportunities for fraud.This opportunity has created a huge black market in stolencredit card numbers, whichare generally used quickly before the cards are reported stolen.

The goal of the credit card companies is not to eliminate fraud, but to "reduce it tomanageable levels", such that the total cost of both fraud andfraud preventionisminimized. This implies that high-cost low-return fraud prevention measures will not beused if their cost exceeds the potential gains from fraud reduction.

Most internet fraud is done through the use of stolen credit card information which isobtained in many ways, the simplest being copying information from retailers, either onlineor offline. Despite efforts to improve security for remote purchases using creditcards, systems with security holes are usually the result of poor implementations of cardacquisition by merchants. For example, a website that uses SSL to encrypt card numbersfrom a client may simply email the number from the web server to someone whomanually processes the card details at a card terminal.

Naturally, anywhere card details become human-readable before being processed at theacquiring bank, a security risk is created. However, many banks offer systems such asClear Commerce, where encrypted card details captured on a merchant's web server can be sent directly to the payment processor.

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Controlled Payment Numbersare another option for protecting one's credit card number:they are "alias" numbers linked to one's actual card number, generated as needed, validfor a relatively short time, with a very low limit, and typically only valid with a singlemerchant.

The Federal Bureau of Investigationand U.S. Postal Inspection Serviceare responsiblefor prosecuting criminals who engage incredit card fraudin the United States, but theydo not have the resources to pursue all criminals. In general, federal officials only prosecute cases exceeding US $5000 in value. Three improvements to card security have been introduced to the more common credit card networks but none has proven to helpreduce credit card fraud so far. First, the on-line verification system used by merchants is being enhanced to require a 4 digitPersonal Identification Number (PIN) known only tothe card holder. Second, the cards themselves are being replaced with similar-lookingtamper-resistant smart cardswhich are intended to makeforgery more difficult. Themajority of smartcard (IC card) based credit cards comply with theEMV (EuropayMasterCard Visa) standard. Third, an additional 3 or 4 digit code is now present on the back of most cards, for use in "card not present" transactions. SeeCVV2 for moreinformation.

The way credit card owners pay off their balances has a tremendous effect on their credithistory. All the information is collected bycredit bureaus. The credit information stayson the credit report, depending on the jurisdiction and the situation, for 1, 2, 5, 7 or even10 years after the debt is repaid.

Profits and losses

In recent times, credit card portfolios have been very profitable for banks, largely due tothe booming economyof the late nineties. However, in the case of credit cards, suchhigh returns go hand in hand with risk, since the business is essentially one of makingunsecured (uncollateralized) loans, and thus dependent on borrowers not to default inlarge numbers.

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