How banks make money off of credit cards

PART TWO OF TWO
Credit cards remain a mystery to many individuals. While it is assumed by many that credit card companies earn revenue based solely on interest paid by consumers, truth be told there’s a lot more that brings companies such sizable benefits.  
Many know that Mastercard and Visa show up on banking cards from Bank of America, Wells Fargo and Chase, and that if not paid off one will then be charged an interest rate on the balance of their card. Often times an individual will come across hidden fees in their billing statement. But where does all this money go?
Let’s look at Bank of America. Bank of America bears the risk that customers won’t pay their monthly balance, so they set interest rates and fees. If one doesn’t pay off the balance, then Bank of America begins to bring in the wealth. But what if you’re the responsible individual who sensibly pays off their card every month? Does that mean Bank of America fails to make any money off of you? Of course not.

These companies will squeeze in revenue by charging fees, soliciting warranties and advocating additional identity theft protection packages. According to CreditCards.com, the nine largest credit card issuers earned a combined profit of about $3.85 billion in 2010 from a total of more than 1 billion issued cards. Evidently, the credit card industry is doing a fine job at making money, even through their most responsible customers.

In order to really comprehend how credit card companies make money, one must first factor in all the players. There’s the credit card company (like Mastercard), the customer, the credit card issuer (Capital One), the merchant (say Qdoba for instance) and the merchant’s bank (Wells Fargo). You’re heading to Qdoba to pick up a late-night burrito with some friends and the total bill comes to $8.  You hand over your Capital One Mastercard and the cashier swipes the card. In the blink of an eye Qdoba has their money and you have your stuff. But what just happened?
In a matter of seconds, the card reader recognized who you were and contacted Capital One. Capital One sent $8 to Wells Fargo (Qdoba’s bank) and Wells Fargo added the $8 to Qdoba’s merchant account. Capital One then increased the balance of your credit card by $8. So it should be obvious how all of them made money, but what about Mastercard? Companies like Mastercard and Visa are “retail network managers”.  Betty Riess, senior vice president of Bank of America in the San Francisco Bay Area, explained it like this, “If all the other participants are driving down the highway to make these transactions, Mastercard is the paved road. Like a toll road, you have to pay to play.”

The way this works in the example is Wells Fargo won’t give Qdoba the full $8, they’ll subtract 20 cents and give Qdoba $7.80. In other words, for an $8 purchase Capital One charges your account $8, but only gives $7.80 to Qdoba via Wells Fargo. That 20 cents is given to Capital One who then splits it with Mastercard.   
Aside from the small fees that exist in every transaction with credit card use, many know that companies also charge interest rates. Tanisha Warner, an experienced financial counselor with Consumer Credit Counseling Services of Linn Benton, says that “the greatest benefit of issuing credit cards for companies and banks is the ability to collect interest revenue from cardholders. With so many people failing to make their monthly payments, the interest paid by millions of cardholders really adds up.”

In addition to interest earnings, credit card issuers often collect additional income through fees from cardholders that are not associated with any type of expenditure, which allows banks to make a pure profit on these amounts. Retailer fees are the most common. Every business that accepts credit cards must pay a commission on the sale to the issuing bank. This fee is usually a compensation for the technological procedure necessary to process the charges from business customers.

The benefits received by credit card companies and banks have outweighed the benefits to cardholders in recent years, so much that in 2009, President Barack Obama signed the Credit Card Accountability, Responsibility and Disclosure Act. This law is intended to favor cardholders by increasing the clarity of credit card terms and agreements and eliminating the ability of card issuers to make unannounced changes in interest rates and other conditions, while still encouraging greater responsibility on the part of cardholders.

Gabriella Morrongiello, reporter
news@dailybarometer.com
On Twitter: @gabriellahopem