How your credit card works

Harsh, CEO of apnaloan.com, is the co-author of 'Complete Home Loan Guides'. Through his columns he will take you through all the nuances of loans and credit cards.


The Basics
When you apply for a credit card, the bank you apply to carefully screens your application. You cant blame them given that there is always a crook around the corner.

A credit limit is worked out for you, based on your financial capability and other parameters like income levels, educational qualifications, age etc. The bank that issues you the card is called the 'issuing bank'.

The Business
From the bank's point of view, credit cards are good business for two reasons.

Banks make money through fees from merchant establishment.

The higher than normal interest rate paid by cardholders for the balance in their card.

So what are these merchant establishments? These form the heart of the business. Merchant establishments can be hotels, shops, travel agencies or any place where money transactions are made. The banks that enroll merchant establishments are called 'acquiring banks'.

The relationship between the bank and the merchant establishments is run via international networks such as Visa and Master card.

Your credit card is valid in any merchant establishment that accepts your network (ie Master Card or Visa), irrespective of the issuing bank. Most Indian card issuing banks are part of either Master Card network or Visa network, or both. There are others credit card networks like American Express and Diners Club too.

The merchant establishment finds the credit card a safer and efficient payment mode, and brings more business. The merchant establishment pays a fee to the bank that enrolled it for the service.

The Transaction


When you use a card at an establishment to purchase a product or service, your card is swiped on a swipe-machine. The swipe machine is connected to a central computer belonging to the network, which in turn is connected to all issuing banks.

The system verifies with your issuing bank whether you have sufficient credit to cover the purchase in a few seconds, and approves or rejects the transaction. As soon as approval comes through, you are asked to sign the charge slip. The merchant then verifies your signature with the one at the back of the card.

The charge slip is then forwarded to the acquiring bank, which in turn settles the transaction with the merchant. The issuing bank also proceeds to bill you for payment as per the cardholder agreement. The acquiring bank will settle the transaction with your issuing bank through the network.

Sounds pretty straightforward? Then you're wondering why credit cards are such accursed instruments? That happens when you delay payments and get caught in an interest cycle. When you use a credit card you have the option to pay only a part of the total amount spent and carry forward the balance. But in such a case you will have to pay interest on all your purchases without any free credit period.

You can save yourself only if you are prompt in paying the balance by the due date. Credit card users get a free period of credit before they reimburse the credit card issuing bank. This may vary from 15 days to 40 days depending on the issuing banks.