Credit Card lending is the most profitable business vertical of Indian Bank / Financial services company. High profitability is driven largely by the high yielding unsecured credit business. While share of fee income is high in total revenues (~50% of total income net of interest expenses), most of the fees (penalties, etc.) are credit-linked. The credit card penetration in India is quite low at 62 Cards per 1,000 working people.
Fees such as annual subscription charges are also largely recovered from customers that are borrowers or who have very low spending. The affluent customers, normally the transactors, account for most of the spending and help the credit card issuers screen as a potent marketing channel to manufacturers / traders. This enables the credit card issuer to get better terms from the manufacturer and in turn offer these gains in part or full to customers, thereby drawing in more customers – both transactors and revolvers (borrowers).
Do Credit Card Companies Make Money by Charging MDR (Merchant Discount Rate) ?
We think profitability on transactors is likely to be negligible, as a lot of the fees (merchant discount rate (MDR), etc.) are spent in cash-backs and rewards to customers, as well as on marketing and administrative expenses.
Profitability and Returns of a Credit Card Lending Business in India
Despite being a capital-consuming balance sheet business, the high ROA (i.e internal generation of capital) enables internal support to high levels of balance sheet growth without having to raise capital. ROE levels are also significantly higher than those in other lending segments, and hence the contribution to overall profits is much higher as compared with contribution to balance sheet. In fact, we believe that it would be fair to say that the credit card business tends to help lift the overall organizational ROEs and helps make the other businesses look better.
Key Risks faced by Credit Card Companies in India
Rapidly Expanding Electronic UPI / Wallet Payment Ecosystem – India has developed alternative payment options like UPI which is taking away share from credit cards. Our view is that given a superior customer proposition, credit card holders are likely to use credit cards wherever they are accepted. While it is quite likely that in the near to medium term, UPI payments grow much faster than credit card spends owing to the low penetration of credit cards and also because UPI is better suited to smaller merchants (zero infrastructure cost and MDR), it doesn’t impact the target market for credit cards.
Buy Now Pay Later NBFC Offerings – We believe that over the medium term there is significant opportunity in consumer credit for many players to co-exist and grow. Many small fintechs and NBFCs struggle to scale up beyond a certain level owing to asset quality challenges which translate in to funding challenges. Ultimately they end up expanding the market to the advantage of stronger banks and NBFCs. Credit Card Company has an edge in terms of assured funding access owing to Bank’s parentage, and also opportunity to grow profitably in new to credit and new to credit card customers while maintaining reasonable asset quality by tapping bank’s customer base.
Attractive APR Competition – Thus far, none of the banks have resorted to cutting APR (Interest Rates) on Credit Cards which are as high as 30% p.a. However, with the advent of disruptor like IDFC First Bank offering lower interest rates on credit cards for it’s affluent customers will lead to competition between the banks leads them to take cuts in loan yields and fees, this could result in lower structural profitability for the industry.
Regulatory Risk – There is precedent of regulators in other markets capping yields and fees for credit cards. It is difficult to predict the probability, timing and magnitude of impact of such an event.