How Banks Derive Revenue from Credit Card Transactions

Banks, specifically credit card issuing banks, generate significant revenue from every credit card transaction. However, it's not always clear to cardholders how these earnings are made. This article aims to demystify the various sources of revenue for banks, including transaction fees, joining fees, MDR charges, and more.

Transaction Fees: A Revenue Stream for Issuing Banks

When a cardholder uses their credit card to make a purchase, the issuer bank typically charges a percentage of the transaction amount as a fee. Merchants are often charged between 1.99% to 3.5% per transaction for processing these payments. This fee is not communicated to the cardholder at the time of purchase, but instead is deducted from the merchant’s settlement.

Breaking Down the Revenue Share

The fees collected from the merchant are shared among multiple parties:

The card company, which usually receives the largest share. Card networks such as Visa, Mastercard, or American Express. The acquiring bank, which captures and processes the payment from the merchant. The issuing bank, which provides the card to the customer and assumes the credit risk.

For a $100 transaction, the acquiring bank might receive around $1, with the issuing bank receiving a larger share of about $1.50 for bearing the financial risk. This set-up ensures that the issuing bank benefits from the credit they provide, even when the funds are not immediately available to the merchant.

Additional Fees: Joining Fees, MDR Charges, and Annual Fees

In addition to transaction fees, banks also derive revenue from several other sources:

Joining Fees

These are one-time fees cardholders pay when they join a credit card program. These fees can range from a few dollars to several hundred dollars, depending on the card’s type and features.

Merchant Discount Rate (MDR) Charges

Mercant discount rate (MDR) charges are fees paid by merchants for accepting credit cards. These fees can vary widely and are typically higher for transactions with higher risk, such as cash advances or foreign transactions.

Interest and Annual Fees

Cardholders can also incur interest charges if they do not pay their balance in full each month. Additionally, there are annual fees associated with many credit cards, which are charged as a recurring fee regardless of usage.

Management Challenges and Potential for Profit

Despite these revenue streams, bank management faces significant challenges in managing their resources and turning operational profits. Credit cards serve as a strategic avenue for banks to generate substantial earnings.

For instance, issuing banks can structure different types of fees to maximize their revenue. They may offer rewards to certain co-branded cards, which allows the bank to benefit from both legs of the transaction—both as the issuing bank and the acquiring bank. This practice can result in higher overall earnings for the bank.

Conclusion

Banks derive a significant portion of their revenue from credit card transactions through various fees and charges. Understanding these fees can help cardholders make more informed decisions about their credit card usage. It is important to be aware of the hidden costs associated with using credit cards to ensure responsible financial management.

References: ICICI Bank fees structure available at: cc.pdf