Decoding the World of Debit and Credit Cards: A Comprehensive Guide
Welcome to the Corporate Treasury 101. In today’s fast-paced digital world, credit and debit cards have become integral to our daily lives. Whether making a quick purchase at a store or booking flights online, debit and credit cards offer convenience and flexibility in managing our finances. Understanding how these cards work and their differences is essential for making informed financial decisions.
This article will dive deep into credit and debit card payments. We will explore credit cards and how they differ from debit cards. Additionally, we will demystify the inner workings of card payment networks such as Visa and Mastercard. Understanding how banks profit from credit card transactions will also be a focal point of our discussion.
Expect to learn:
- The Fundamental Concepts of Credit and Debit Cards
- The Role of Card Payment Networks and Their Impact on Transactions
- How Banks Generate Revenue Through Credit Card Transactions
- The Implications of Credit Card Usage for Corporate Treasury Departments
- And Much More.
Corporate Treasury oversees payments, receives money, and ensures everything runs smoothly. In this article, we’ll explore the impact of credit card usage on treasury departments. We’ll discuss challenges like managing collections, negotiating fees, and choosing banking partners. You’ll have the information to make smart decisions and improve your organization’s finances.
So, grab a cup of coffee, sit back, and join us as we embark on this journey to unravel the intricacies of credit and debit card payments.
Understanding Debit and Credit Cards
As we continue our journey through the landscape of various types of payments, we now turn our attention to bank cards. Guest Guillaume breaks down the basic definitions and workings of two common types: debit and credit cards.
Debit Cards
Let’s start with debit cards. This card, typically a piece of plastic (but nowadays, it can be made of metal, too), is directly linked to a bank account. When you use it to pay for something, the money is taken from your account, sometimes instantly or within a few hours or days.
One advantage of using debit cards over paper-based instruments like cash and checks is their convenience. You don’t need to have cash on hand or write out checks. But this convenience comes with a limit: a daily debit limit. This means there’s a cap on how much money you can spend each day with your debit card, which can prevent you from making large purchases.
Additionally, debit cards allow you to withdraw cash from ATMs, sometimes for a small fee. So, if you’re at a place that doesn’t accept card payments, you always have the option to withdraw cash and pay that way.
Credit Cards
Credit cards work somewhat similarly to debit cards but with a crucial difference. When you use a credit card, the money isn’t directly withdrawn from your bank account. Instead, you have a credit limit, a predetermined amount of money you can spend. Every time you make a purchase, the cost is deducted from this credit limit, but your bank account isn’t touched.
So, you’re essentially spending money you don’t necessarily own yet – you’re borrowing against your credit limit. The size of this limit can vary greatly depending on your credit risk.
Understanding Credit Risk
So, what exactly is credit risk? It’s a term that describes the probability of a borrower failing to repay a lent sum of money. This risk is evaluated based on several factors, including the borrower’s income relative to their debt (known as the debt-to-income ratio), their history of timely payments, and their credit utilization ratio (the proportion of available credit they use), among other factors.
The higher the perceived credit risk, the less willing financial institutions are to provide a large credit limit or loan. The interest to be paid on the borrowed amount is also typically higher. Therefore, to secure better-borrowing terms, it’s essential to demonstrate good financial behaviour, such as making regular, on-time payments and keeping credit utilization under the credit limit.
The credit limit linked to a card can reset after a certain period, often one month, during which the cardholder can make purchases up to the limit. At the end of this period, the cardholder has to repay the money used from the credit limit. This period can be longer or shorter, depending on the cardholder’s credit risk and the specific terms of their credit card.
The Significance of Interest Rates in Debit and Credit Cards
As Guillaume enlightens us, interest rates form a critical part of our understanding of financial transactions, especially when dealing with bank cards. Borrowing money isn’t just about the sum we receive; it’s also about the cost we pay for this privilege, which comes in the form of interest. Guillaume underscores this point, explaining how interest rates come into play, particularly when borrowing through credit cards.
Understanding Interest Rates on Credit Cards
A significant aspect of credit cards is the accompanying interest. When the bank or financial institution grants you a credit limit, it advances your money. You can pay for things without the sum being instantly withdrawn from your bank account. You’re expected to repay this amount by the end of a defined period, typically a month. This borrowed money almost always comes with interest, typically higher than that for other types of loans, such as consumer loans.
Although the interest rate is higher, credit cards offer flexibility that is difficult to rival. The ability to borrow money instantly for any purpose gives you the convenience that other loan types may not offer.
What is a Consumer Loan?
When asked about consumer loans, it’s essential to know that these are loans made to individuals for personal expenditures. They’re distinct from mortgages, small businesses, or small farm loans. Each loan is specific – a mortgage is for buying a house, a business loan is for funding business operations, and so on.
On the other hand, consumer loans come with no particular constraints on their use. For instance, if a bank lends you $10,000 as a consumer loan, you can use it however you like – whether going on a trip, financing a wedding, or something else.
Risk and Interest in Consumer Loans
A unique aspect of consumer loans is that they don’t typically involve collateral. For instance, when you take a mortgage, the house acts as collateral – if you fail to repay the loan, the bank can seize the house to recoup its losses. However, with consumer loans, there’s no such collateral. This lack of security leads to higher risk for the lender, which is typically offset by higher interest rates.
In conclusion, a credit card essentially functions as a consumer loan, granting you money without tying it to a specific purpose. On the other hand, loans like mortgages or car finance loans are purpose-specific. The lender grants you money for a particular purpose – buying a house or a car, for instance.
Comparing Credit Limits: Consumer Loans vs Credit Cards
Our expert, Guillaume, furthers us into the interconnections between credit limits, consumer loans, and credit cards. Despite their common usage for personal expenses, there are crucial differences between these financial tools.
Understanding the Difference
Guillaume points out a key difference – credit cards have an open-ended credit limit. This means you can reuse the credit limit after repaying your dues at the end of the billing cycle (such as 30 days or three months). This ongoing cycle of borrowing and repayment is known as a revolving credit facility.
On the other hand, a consumer loan has a more structured repayment schedule. You pay off part of the principal amount and interest each month. Once the loan is fully repaid, you cannot reuse the money. Unlike a credit card, the loan has reached its end, where the credit limit is replenished after repayment.
While you can refresh your credit limit on a credit card each month, it’s not the case with a specific loan such as a home loan. After you’ve repaid your home loan, you don’t automatically receive more money. You’ll have to apply for a new loan.
The Concept of Interest-Free Periods
Moving on, Hussam inquires about the meaning of “interest-free periods” often seen in credit card advertisements. Guillaume explains that some credit cards offer a grace period during which using the credit card doesn’t incur any interest charges.
For instance, if you repay your dues at the end of each 30-day billing cycle, you won’t have to pay any interest on the borrowed amount. However, this grace period has its constraints. If you don’t repay on time, high-interest rates start to apply, especially for larger amounts. Also, the availability of this interest-free period can vary based on your credit risk rating or geographic location.
Variety and Differences in Debit and Credit Cards
In this section, Guillaume demystifies the world of debit and credit cards, addressing Hussam’s question about the different types of these cards.
How Many Types Are There?
Surprisingly, Guillaume points out that there aren’t as many types of debit and credit cards as you might think. The main differences lie in the card providers and their payment networks.
Debit Cards: It’s About the Provider and Network
Regarding debit cards, the major difference lies in the spending limit associated with the card. But the main choice you’ll have to make is between different card providers. The goal is to find a debit card accepted in as many places as possible, making transactions more convenient and eliminating the need for cash or checks.
Examples of these providers include globally recognized brands like Visa and Mastercard. There are also more localized providers like Maestro or BAM Contact (especially popular in Belgium). However, the differences between these cards mostly boil down to the provider, not the type of debit card itself.
Credit Cards: A Similar Story
The situation with credit cards is much the same. The main players are the same globally recognized brands: Visa and Mastercard. Other providers, like Discover and American Express, are popular, particularly in the United States.
Yet, there’s a key point to remember. Major providers like Visa and Mastercard don’t issue cards directly to individuals. They work through banks, credit unions, and other financial institutions. These institutions issue the cards to consumers, thus acting as a bridge between the card provider and you, the cardholder.
In summary, while there may seem like a dizzying array of choices regarding debit and credit cards, the differences are often more about the provider and payment network than the card type itself.
Importance of Card Acceptance and Understanding the Cost Implications
Selecting a suitable credit or debit card for personal or corporate use has significant implications. Hussam and Guillaume reveal some crucial details about accepting certain credit cards worldwide and the associated costs.
One of the crucial factors is how widely the card is accepted. For instance, despite their popularity, cards like American Express are not widely accepted in regions like Europe, leading to possible inconveniences.
It’s essential to understand that the acceptance of a card can greatly influence its utility. Companies need to consider the card’s global reach when implementing a uniform credit card policy for their operations across different regions.
The Hidden Price of Card Transactions
A significant aspect of card transactions often overlooked is the associated costs borne by businesses. Though not directly paid by cardholders, these fees become a substantial expense for businesses that accept card payments. This fee is typically a percentage of the total transaction value.
In perspective, if a business processes $100,000 worth of transactions annually via card payments and the card provider charges a 2% fee, it pays $2,000 in fees alone. Though not visible to the cardholder, this expense impacts the overall cost structure for businesses.
Balancing the Advantages and Costs
Choosing a payment method isn’t just about convenience but also involves assessing costs. The task for treasury professionals becomes one of balancing convenience and cost-effectiveness. The convenience of handling cashless transactions through cards is undeniable. However, the associated costs, both visible and hidden, need to be factored into the decision.
In summary, decisions on corporate payment methods involve careful consideration of various factors. These include the card’s global acceptance, the associated transaction costs, and how these balance with the convenience offered by the card. The ultimate goal is to provide convenience while maintaining cost efficiency.
The Additional Benefits of Credit Cards: Rewards and Credit Scores
Credit cards are not only a convenient payment method, but they also come with other valuable advantages that can sweeten the deal for individual and corporate cardholders.
Rewards and Insurance Benefits
Credit cards often have reward programs, including air miles, cashback, and hotel points. This means that you accumulate rewards you can later redeem as you spend money. It’s a feature that distinguishes credit cards from their debit counterparts and can make a substantial difference to individuals and businesses.
Additionally, credit cards often provide insurance benefits, such as travel insurance and fraud liability protection. If you or your employees travel frequently, these insurance benefits can add substantial value and peace of mind.
Building Credit and Financial Flexibility
Another advantage of using credit cards is that they can help build a good credit score. Regularly paying off your credit card balance demonstrates to financial institutions that you can manage and repay borrowed money. This can improve your credit score, which can, in turn, enhance your ability to secure loans or mortgages in the future.
Furthermore, credit cards offer financial flexibility. When you use a credit card, you’re essentially borrowing money from the financial institution that issued the card. If you repay the borrowed money within the grace period (when no interest is charged), you can effectively use someone else’s money for your expenses while your cash remains in your bank account. This cash can earn interest in periods of higher interest rates, essentially giving you additional income.
However, it’s vital to remember the importance of using credit cards responsibly. Overspending or failing to repay the balance on time can lead to a poor credit score and high-interest charges. So, while credit cards can offer great benefits, they must be used cautiously and carefully.
The Process of Credit Card Payments: What Happens Behind the Scenes?
A lot happens behind the scenes when you purchase using a credit card. Guillaume breaks down what occurs from when you swipe or tap your card to when the money lands in the merchant’s bank account.
Card Networks and Associations
Card networks or associations like Visa, Mastercard, American Express, and Discover play a crucial role in this process. They maintain and upgrade IT infrastructures, policies, and servers, making card payments possible. These networks connect banks, merchants, and card users to facilitate smooth transactions.
The Bank’s Role
Banks are at the core of the credit card payment process. When you open a bank account, it often comes with a debit card. This lets you directly use the money you have in your bank account. On the other hand, credit cards are part of the bank’s offer, as they represent a good source of revenue for the banks.
When you use a debit card, the money is directly deducted from your bank account. But when you use a credit card, you’re borrowing money from the bank up to an approved credit limit. This is why it’s called a ‘line of credit’, and it’s regenerative, unlike a one-time loan like a mortgage.
How Banks Profit from Credit Cards
Now, you may wonder how banks profit from this. The bank charges a fee for providing you with the credit card, typically an annual fee ranging from around 30 to 50 dollars or euros. However, these fees are just a fraction of the banks’ income from credit cards.
The real money for the bank comes from the interest they charge if you don’t pay your balance in full each month and from transaction fees charged to merchants. When a customer uses a credit card in a shop, the merchant must pay a fee to the bank to process the payment. So, every time you use your card, the bank earns little money.
In conclusion, credit cards are a convenient payment method for users and a lucrative business for banks and card networks. However, as a user, it’s crucial to understand how they work to use them responsibly and avoid unnecessary charges.
How do Banks, Networks, and Card Users Interact in a Transaction?
Hussam and Guillaume discussed how banks, credit card networks, and end users interact during a transaction. Let’s explore how banks, networks, and card users interact in a transaction.
The Role of Banks and Networks
When you go to a bank and ask for a credit card, it’s usually issued through a network, such as Visa, MasterCard, American Express, or Discover. Why? These networks serve as bridges, linking banks, merchants, and end users together for seamless transactions.
For a bank to be a part of these networks, it has to meet certain criteria. Once accepted, they can issue cards under the network’s name, making it a part of their customer offerings. This card-issuing entity is referred to as the “issuing bank”.
The Involvement of End Users
End users, meaning you and me, become indirect members of these networks when we obtain a credit card. Our bank gives us a card, say Visa or MasterCard, and we use it to pay for our purchases.
How Transactions Work: A Simple Example
Let’s consider an example for clarity. Suppose you visit a café and pay for your order using a Visa credit card. The café owner accepts card payments, so it’s a win-win. But how does this transaction work?
To accept your payment, the café needs a point of sale (POS) terminal – the hardware you swipe or insert your card into. This POS is connected to the café’s bank account. The bank that enables the café to accept these card payments is known as the “Acquirer bank” or “Merchant bank”.
So when you pay, the POS terminal communicates with the café’s bank, which, in turn, communicates with your bank via the network – in this case, Visa. This connection between all parties is crucial for the transaction to go through. This is why being part of a network is so important.
If you’re wondering, yes, if the café only accepts MasterCard and you have a Visa, you won’t be able to pay using your card. Most banks and merchants, however, accept multiple networks to avoid this issue.
In summary, banks, networks, and end users interact seamlessly during a transaction, thanks to the power of credit card networks.
The Inter-Compatibility Between Different Card Networks
According to Guillaume, the quick answer is no. There isn’t any inter-compatibility between different card networks. This means that if you, as a merchant, have a card machine on the MasterCard network, it won’t accept a Visa card. It needs to be on the same network as the customer’s card. But why is this the case? And wouldn’t it be simpler if there was just one global card network?
The Need for Multiple Card Networks
Guillaume points out that in an ideal world, there would be just one network everyone uses. It would make things a lot simpler. However, it’s not that simple. Here’s why:
- Competition: The first reason is competition. Visa and MasterCard don’t offer their services for free. Costs are involved, and having multiple card networks helps keep those costs competitive.
- Different Markets: Different card networks may develop their businesses in different parts of the world. This ensures that people everywhere can make and receive card payments, even if certain networks aren’t active in their region.
- Local Networks: Some countries have their local card networks, like Maestro in Belgium. While these networks may be smaller, they’re still widely used within their countries.
Hence, while it would be easier if there were just one global card network, the reality is much more complex. So as a merchant, you need to ensure that your card machine supports the card networks your customers are likely to use. While it might seem more logical for a single global network, the existence of multiple card networks reflects the complexity of the global financial system.
What Happens When a Card Payment Is Made, Who Is Involved, And How Are They Compensated?
In a card payment, there are several steps and various participants who all play crucial roles in ensuring the successful transfer of funds from the payer to the payee. Guillaume breaks down each step and each participant’s Role and compensation.
The Process of Card Payment
When you make a payment using your card, it’s not as simple as handing over cash. Instead, there are a few technical processes that happen behind the scenes:
- Authorization: After you swipe your card at the point of sale, a message is sent to your bank (the issuing bank) via the merchant’s bank (the acquiring bank) and the card network (like Visa or Mastercard). This message asks if you have enough credit available to cover the purchase.
- Payment confirmation: Your bank doesn’t look at the money in your account; it checks your credit limit instead. Your bank confirms that you can pay if you have enough credit to cover the purchase. This authorization travels back through the card network and the merchant’s bank to the point of sale.
- Money transfer: After your bank authorizes the transaction, it takes the payment amount out of your credit limit and sends the money. But not the full amount reaches the merchant because various parties involved take a cut. This cut, typically around 2% of the transaction amount, is called the “discount rate.”
The Stakeholders and Their Compensation
Now, let’s look at who gets paid and how much from this transaction:
- The issuing bank: This is the bank which gave you the credit card. It provides you with credit and services like customer support. Out of the 2% discount rate, your bank takes the lion’s share – around 1.70 euros for a 100 euro transaction, or more than 80% of the total fee.
- The card network: Companies like Visa and Mastercard enable us to make payments using their network. They also offer some additional services, such as insurance and fraud prevention.
- The acquiring bank: The merchant’s bank provides the point of sale system and enables the merchant to receive card payments from customers.
Though it might seem unfair to the merchant, as they receive less than the total transaction amount, this is how the card payment system operates. The issuing bank takes the most significant risk in this scenario, and the fee it receives is considered payment for this risk and the services it provides.
Moreover, the banks do not decide the interchange fee that the acquiring bank pays the issuing bank. Instead, it is set by the card payment network (like Visa or Mastercard) and is non-negotiable.
How Is The 2% Transaction Fee on Credit Cards Distributed Among Network, Issuing Banks, And Acquiring Banks?
In this part of the podcast, Guillaume explains how a typical 2% transaction fee on credit cards is distributed among the main players: the issuing bank, the acquiring bank, and the network (Visa, in this case).
- Issuing Bank’s Share: It gets the largest slice – about 1.7% of the total fee. This is the bank that gave you your credit card.
- Network’s Share: Visa takes a smaller portion, around 10 cents for every transaction. Despite its vital Role, why does it take the least share?
- Acquiring Bank’s Share: The remaining 20 cents goes to the acquiring (merchant’s) bank. This bank also charges additional fees to the merchant, like terminal leasing and associated financial services.
Why does Visa take a smaller share?
So, Why does the network, in this case, Visa, take the smallest share if none of this would be possible without them?
Guillaume explains that Visa benefits from every transaction that passes through its network. While it takes a smaller cut per transaction, the sheer volume of transactions (billions every year) means it still makes much money. Furthermore, Visa aims to have as many people as possible using its network. It incentivizes credit card use through benefits like cashback and insurance to boost transaction volume.
By giving a bigger share to the issuing bank (1.70% of all transactions), Visa encourages banks to promote their credit cards to customers. This strategy keeps the entire system flowing with more transactions, generating revenue for all involved parties.
How Does the Acquiring Bank Benefit?
Hussam then moves on to the acquiring bank’s share. The acquiring bank is key to the network as it needs to receive and process the messages from the network. But its earnings aren’t limited to the 20 cents cut from the transaction. They also generate income from renting or leasing the payment terminal to the merchant and providing other related financial services.
What About Debit Cards?
Guillaume explains that the process is similar to credit cards, with one significant difference: the issuing bank checks the account balance instead of the credit limit. The transaction fee remains around 2%, distributed among the stakeholders similarly. However, the issuing bank tends to earn less from debit cards as it can’t charge for credit card services or penalties for late repayment.
Credit and debit card transactions are a complex dance involving multiple parties, each with its unique role and revenue stream. These insights are critical for treasury professionals to comprehend the interplay between stakeholders and their earnings in the payment network system.
How Does the Use of Credit and Debit Cards Impact Corporate Treasury?
Now Let’s learn about how credit and debit cards affect corporate Treasury. Hussam and Guillaume discuss the roles of various stakeholders involved in card transactions and who benefits from each transaction.
Rare use of Cards for Corporate Payments
Guillaume points out that corporate treasury departments seldom use credit cards to pay suppliers or employees. In the corporate world, other forms of payment, such as electronic transfers, are more common. This is because, unlike consumers who use cards frequently for convenience, corporations deal with larger transaction volumes and amounts that often make electronic transfers more practical and cost-effective.
Focus on Collections
So, where does corporate Treasury come into the picture concerning credit and debit cards? It’s mostly linked to collections. If you’re a company that sells directly to consumers (B2C), you’re likely accepting payments via credit and debit cards from your customers. This makes the treasury department responsible for managing these incoming funds and ensuring they’re processed and accounted for correctly.
The Role of Corporate Credit Cards
Hussam then brings up corporate credit cards, which are issued to employees for business-related expenses, such as travel. This is another area where credit cards touch the corporate treasury function.
Guillaume agrees, noting that while companies rarely pay their business partners with credit cards, providing employees with corporate credit cards for business expenses is common practice. However, he distinguishes this from the company paying stakeholders directly with credit cards, referring to these arrangements as “credit card programs.”
These programs allow employees who frequently travel for business to have their expenses covered by the company, but they’re not the same as the company paying suppliers or partners directly via credit card. These credit card programs could be an interesting topic for future discussion, but they aren’t the main focus of this episode.
So, while corporate treasury departments don’t often use credit cards for outgoing payments, they’re involved in the processing and managing of incoming card payments from customers and managing corporate credit card programs for employees.
How Does a Company’s Treasury Deal with Collecting Card Payments?
In the final part of the podcast, Hussam and Guillaume discuss the Role of corporate Treasury when businesses, especially those in retail, collect payments through credit and debit cards.
Retail Businesses and Card Payments
Businesses generally avoid paying their suppliers or partners through credit cards because it’s expensive and inconvenient. However, in the retail industry, like your neighborhood café, accepting credit and debit cards is essential. Why? Because customers mostly use these forms of payment.
Gathering Card Payments
So, the big question is – how can businesses gather card payments effectively? Guillaume suggests that you must pick a bank part of many payment networks as someone responsible for corporate Treasury. This way, you can accept payments from a larger pool of customers.
Lowering Fees
Talking about the cost, Hussam and Guillaume discuss the importance of negotiating fees. If your business is bigger, you have more power to negotiate and reduce these costs. This becomes a key part of managing your corporate Treasury, as these fees can greatly impact your profits.
Choosing the Right Bank
Picking the right bank is very important, according to Guillaume. You want to make sure your costs are as low as possible, but you also want to be able to take payments from as many networks as possible. Keep in mind different countries might have different preferred payment networks.
Using Card Machines
The chat then turns towards machines that accept card payments, also known as Point of Sale (POS) systems. While some banks offer these, others might use third-party providers, which can add extra costs. So, it’s better to pick a bank that offers an in-house solution for collecting card payments.
Understanding Fees
Hussam compares the fees associated with card payments to taxes. Guillaume agrees with this comparison. These fees are a percentage of your sales, which means the more you sell, the more you pay. This is why you might prefer a payment method with a fixed fee instead of a percentage. But remember, accepting cards is unavoidable if your business deals directly with customers.
Regularly Checking Fees
Finally, Guillaume emphasizes the importance of frequently checking and negotiating these fees. These costs can add up over time and can be a significant amount. Regularly reviewing and negotiating these costs can help you get the best deal for your business.
To summarize, if you’re in a B2C business, accepting card payments is a necessity, and as a corporate treasurer, managing these payments efficiently is a key responsibility. This involves choosing the right banking partner, negotiating fees, managing POS systems, and reviewing costs regularly.
Conclusion:
In conclusion, understanding the intricacies of payment processing, particularly regarding credit and debit cards, is crucial for corporate treasury professionals. While credit cards are convenient and widely used in retail businesses, they come with higher fees that can impact profitability. On the other hand, debit cards provide a simpler payment method but involve various stakeholders and transaction costs.
To effectively navigate these complexities, corporate treasury professionals must consider several factors. They must choose banking partners with broad network memberships, enabling them to collect payments from a wide range of customers. Negotiating fees becomes essential, especially for larger businesses with more leverage. Additionally, selecting banking partners that offer in-house solutions for card payments can help minimize additional costs associated with third-party providers.
By understanding the Role of different stakeholders, the authorization process, and the distribution of fees, treasury professionals can effectively manage their collections and payment processes. This knowledge allows them to make informed decisions, select the most suitable banking partners, and mitigate potential financial impacts on their businesses.
Ultimately, successfully navigating the world of card payments requires a combination of strategic decision-making, fee negotiations, and diligent oversight. By staying informed and proactively managing these aspects, corporate treasury professionals can optimize their collections and payment processes, ensuring their organizations’ financial stability and growth.
