Explained: How credit card issuers and partner merchants benefit from cashback, discounts

Credit cards have become an important part of our lives lately - inundating consumers with tempting offers, cashback, discounts, zero to low-interest rates, and bonus rewards offers. However, have you ever wondered how credit card companies benefit from these?

These credit card issuers often enter into tie-ups with merchants to offer higher reward points, cashback, and discounts on select card transactions. Such tie-ups, according to Sahil Arora - Senior Director, Paisabazaar, benefit card issuers by allowing them to attract card users to spend more through their credit cards.

For partnering merchants, these tie-ups help in the promotion of their goods and services offered among the users.

“While the cashback and discount offer directly reduce the transaction cost for the card user, the reward points accumulated on making credit card transactions can be used for buying merchandise or services from partner brands of credit card users. Many credit card issuers also allow cardholders to use accumulated reward points for buying flight tickets, making hotel bookings, buying fuel, or repaying the outstanding credit card bills, depending on the reward point program of the individual card. Hence, if used judiciously, these offers can greatly help the card users in reducing their overall transaction costs,” Arora said.

While merchants accept payment via credit card, they are required to pay a percentage of the transaction amount as a fee to the credit card company.

If the cardholder has a cashback, the credit card shares some of the merchant fees with the consumer. With cashback, issuers try to attract customers for using their credit cards rather than cash or debit cards, which earns them no rewards.

The more a consumer uses a credit card, the more merchant fees the credit card company can earn.

Additionally, for credit card companies, the biggest revenue comes from the finance charges, which include interest and penalties on late payments.

“Considering credit cards charge as much as 2-4 percent per month on the unpaid amount in addition to penalties, this comes to a hefty amount. Even if users convert their outstanding to an EMI, the interest rate is usually higher than the personal loan rate. Plus, the issuer can charge a processing fee for the conversion,” Adhil Shetty, CEO at Bankbazaar explained.

In India, on average, Shetty stated that 28-30 percent of customers revolve their outstanding balance and the banks charge higher rates to cover risks.

However, the typical delinquency rate is around two percent. “This makes credit cards a viable model for issuers,” Shetty said.