Most of us will only get our first credit card when we start working due to the income requirements. A credit card gives you a line of credit that allows you to pay for items in advance and payment is only required at the end of the billing period. The merchant pays a small percentage of their revenue to accept credit cards. The usage of credit cards has indirectly increased the prices we pay at the stores. In this blog, we will take a closer look at the credit card ecosystem and the dilemma of using credit cards.
Credit Card Ecosystem
Besides the consumer and the merchant, there are multiple participants in the credit card ecosystem. You can take a look at the infographic below for a summary of how the different participants interact with each other.
On the credit card, we can see three of the participants in the credit card ecosystem.
Consumer
They are either individuals or businesses that purchase a product or service using credit cards.
According to MAS’s statistics, there are more than 5 million principal cardholders and 1 million supplementary cardholders. The average credit card debt each individual holds in Singapore is about S$900.
Merchant
Merchants are the parties that sell the product or service.
Examples of merchants would include retailers that we are familiar with like FairPrice, KFC, Courts.
Source of revenue: sale of products and services
Acquirer
An acquirer is a financial institution that is a partner of the credit card network in processing transactions. They enter into a contract with the merchant and provide them with services like providing a credit card terminal that accepts multiple payment types and methods and processing chargebacks.
Source: imgur
Here is the list of acquirers by Visa and Mastercard that you can contact to open your merchant account to start accepting payments.
Source of revenue: credit card merchant fees, set up fees(merchant), terminal fees(merchant)
Credit Card Network
A credit card network is a middle man that connects the acquirer with the credit card issuer. It allows the two parties to send secure messages across its network to process the transaction. You might ask why don’t the two parties cut out the middle man and save on fees?
The acquirer and credit card issuer usually do not contact each other directly as they will then need to maintain the integration, upkeep and upgrading of the network. The networks need to keep up with the latest technologies to make sure the network works smoothly and is secure.
American Express and Discover are exceptions where they are networks that also issue credit cards.
Examples of credit card networks would include Visa, Mastercard and American Express.
Source of revenue: credit card merchant fees
Credit Card Issuer
Credit card issuers are usually financial institutions like banks. When you take a look at your credit cards, the credit card issuer is printed either at the top left or right. When a consumer receives a credit card statement, it is sent from the credit card issuer. Payment is also made to the issuer.
They will need to handle the numerous features of credit cards, from the application and approval process to distributing cards, deciding terms and benefits (such as annual fees and rewards), collecting cardholder payments and more.
Examples of credit card issuers would include familiar names like POSB, OCBC, UOB.
Source of revenue: credit card merchant fees, annual fees (consumer), currency conversion fees (consumer), late fees (consumer), interest on the unpaid balance (consumer)
Loyalty Programme
Many people sign up for credit cards for attractive rewards like points, cashback and miles. All these cost money and are paid for by the fees that the credit card issuer collects. The purpose is to encourage spending with them.
Examples of loyalty programme partners would include KrisFlyer (miles) and F&B outlets (vouchers)
Source of revenue: payment from the credit card issuer in exchange for rewards to distribute to cardholders
Affiliates
Affiliates help attract consumer sign-ups by creating content. They can either directly write articles on credit cards or include a banner on their website. Being an affiliate is part of their business model that helps generate income for the websites.
Source: Dollars And Sense
You can see a list of affiliates that have a banner on their websites by searching “singsaver affiliatewidget” on Google.
Some websites like Seedly and SingSaver even provides a service for consumers to compare between different credit cards. If we look at the terms of SingSaver, we can see that they earn a fee or sign-ups that goes through their platform.
Our comparison service is free. We earn money by charging the concerned third-party provider a fee and/or commission for the leads / business generated.
Moneysmart also allows paid ads to allow certain credit cards to appear on top of their list. In this case, ads are an additional source of income for Moneysmart.
Source: MoneySmart
Here is a list of affiliates
- Singsaver
- Valuechampion
- Moneysmart
- Seedly (affiliate of SingSaver)
- Dollarsandsense (affiliate of SingSaver)
SingSaver is an affiliate of credit card issuers while also having its own affiliate programme. This means that there is an additional layer of payment. For every sign-up, the credit card issuer pays affiliate 1 (SingSaver) and then affiliate 1 pays affiliate 2 (Seedly).
Source of revenue: Referral fees (credit card issuer), Advertising/Sponsored posts (credit card issuer)
Payments By Consumers From Using Credit Cards
Here are the five types of payments that consumers pay when we use credit cards.
Annual Fees
Most credit cards have an annual fee that is paid in advance to use the credit card for the year ahead. We should always try to waive the annual fees unless paying for the annual fees provide some reward like miles.
For some credit cards, when you pay the annual fee, you get miles in exchange at a very favourable rate. This rate can be multiples of the miles you can earn normally during normal spending.
For example, the Citi PremierMiles card provides 1.2 – 2.0 miles per dollar spent but if you pay the annual fee (S$192.60) for the first time, you get 10,000 miles (51.9 miles per dollar).
This is how they attract you to sign up with them and hope you are too lazy to switch credit cards.
Cash Advances
If you do not have enough cash on hand, you can withdraw money using your credit card. You are basically taking a loan from the bank. The fees are notoriously high with cash advance fees PLUS interest. You also don’t receive the full amount as there is a cash advance fee deducted from the amount you plan to withdraw.
For example, when you take a cash advance of S$5,000 from DBS, you will only receive S$4,600 (8% cash advance fees) but you will be paying the interest on the full S$5,000. Interest is also accrued daily starting from the day you receive the cash. DBS charges 28% per year for cash advances on top of an 8% cash advance fee.
Late Fees And Interest On Outstanding Unpaid Balance
When you do not pay your credit card in full on time, you will get hit with late fees plus interest on the unpaid balance.
If you pay the minimum sum, you will need to pay interest on the unpaid balance.
Late fees are usually a flat fee of (e.g. S$100) and interest is mostly higher than 25% an annum. If you do not pay your credit card on time or only pay the minimum sum, it can quickly snowball out of control.
This is an example taken from MoneySense.
| Initial Credit Card Balance | S$5,000 |
| Monthly Minimum Sum Payment | S$50 or Minimum 3% of principal owed (Take whichever is higher) |
| Interest Rate On Outstanding Debt | 25% per annum |
| Time take to Pay Off All Debt | 175 months (14.5 years) |
| Total Amount Paid Eventually | S$13,500 (almost 3 times the original debt) |
Minimum payments are like an anchor to show you that you can spend above what you can afford at a low price and this makes it harder to pay off your bills.
This will also affect your credit score and affect your eligibility and interest for future loans.
Foreign Exchange Spread And Fees
When you use your credit card overseas or purchase items online in foreign currency, the credit card will use its own exchange rates which is usually less favourable than the spot rate. They can earn from the spread as they have access to cheaper exchange rates than what they charge credit card users.
This is why there is a rise of companies like YouTrip and Wise that has more favourable exchange rates but they are debit cards that need you to top up a balance before using them.
On top of unfavourable rates, most credit cards also charge a transaction fee of 2.5% – 3% on the transactions made overseas or with an online overseas merchant.
Higher Prices
The merchant fees that are charged to the merchant does not magically go away. It is priced into the final price. If a merchant needs to receive a certain margin to have a healthy profit, they will increase the prices accordingly.
| Base Case | |
| Price Of Item | S$100 |
| Less: Cost Of Item | (S$80) |
| Profit By Merchant | S$20 |
| With Credit Card | |
| Price Of Item | S$103 (increased by S$3 to cover fees) |
| Less: Cost Of Item | (S$80) |
| Less: Merchant Fees | (S$3) |
| Profit By Merchant | S$20 |
| Without Credit Card, Paid Using Cash | |
| Price Of Item | S$103 (not reduced as prices are standardised) |
| Less: Cost Of Item | (S$80) |
| Profit By Merchant | S$23 |
Consumers are the ones that lose out, especially those that pay with cash. Consumers that pay with cash pay the same increased amount as credit card users without enjoying the benefits of using credit cards. Cash users are indirectly subsidizing the costs of merchant fees for credit card users.
There are arguments that merchants will choose to absorb the charges in order to stay competitive. However, when almost every merchant starts accepting credit cards, I believe merchant fees have been included when the merchant comes up with the pricing for their products and services.
This is not to say collecting cash is better than credit cards. It is also costly to process cash due to
- Collecting the wrong amount
- Giving the wrong change
- Need to keep physical cash safe
- Need to spend manhours counting and depositing periodically
Payments By Merchants That Accept Credit Cards
Here are some of the fees that merchants pay to accept credit card payments
- One time setup fee (paid to acquirer)
- Annual/monthly fee (paid to acquirer)
- Terminal rental fee – security collateral may also be required (paid to acquirer)
- Service fees for installation or maintenance of terminal (paid to acquirer)
- Merchant fees (paid to credit card issuer, network, acquirer)
- Statement fee (paid to acquirer)
- Cancellation fee (paid to acquirer)
Where Do The Merchant Fees Go?
We can take a look at the infographic below on how the merchant fees get distributed between the credit card ecosystem players.
Source: Based on Gendal.me
- Consumer pays $100 for an item
- Credit card issuer receives $100 and pays network $98.20
- Fee received – $1.80
- Network receives $98.20 and pays Acquirer $98.09
- Fee received – $0.11
- Acquirer receives $98.09 and pays merchant $97.76
- Fee received – $0.33
- Merchant receives $97.76 for revenue of $100
- Overall fees paid – $2.24 (S$1.80 + S$0.11 + S$0.33)
The fees received by the credit card issuer also pays for the loyalty programmes (cashback, miles etc) and affiliates.
Why Do Merchants Still Accept Credit Cards?
Since there are so many costs involved in accepting credit card payments, why do so many merchants still accept payments via credit cards?
Profits Outweighs The Costs
One of the answers is that even after accounting for the costs, there are still more profits to be made.
There are multiple studies done to prove that using credit cards instead of cash increases spending. In an MIT study, students pay 50% – 100% more for tickets to sporting events when they use a credit card as compared to cash.
When using credit cards, we are spending future money that is paid only at the end of the month so there is a delayed and disassociating effect of feeling the “pain” of deduction from their account. When only the minimum sum is paid, the effect is even greater as the consumer can enjoy the value of the purchase as a fraction of the cost.
In comparison, if we pay using cash or debit, every purchase is immediately deducted from our accounts.
Also, with the use of credit cards, it is possible to spend more than what you have.
This video above is on “How The Economic Machine Works” by Ray Dalio. From 3:27 onwards, he talks about how credit help boosts the economy via increased consumption. I recommend watching the entire video if you have time.
Source: Principles By Ray Dalio
This is how the credit cycle works to increase spending
- With credit, there is increased spending power
- The spending of one party is transformed into income for the counterparty
- With more income for the counterparty, he will have access to additional credit
- And the cycle repeats itself
When consumers receive miles, cashback and points while spending, it is easier to rationalize making that purchase.
Most of the time, the profits brought by accepting credit cards will outweigh the costs of accepting credit cards.
Trust
Accepting credit cards and displaying credit card logos at the cashier increases a merchant’s trustworthiness. Consumers trust their credit card brands (networks) and that trust is psychologically linked to the merchant. The major credit cards also help protect both merchants and consumers from data breaches and identity theft.
Convenience
This is not specific to credit cards but for cashless options like mobile and debit payments. The merchant will not have to deal with change, which saves time both during checkout and banking in huge sums of cash at the end of the day.
Less cash also reduces theft and security concerns at the store.
Why Don’t Merchants Have A Surcharge For Credit Card Users?
Merchant fees reduce profits so why don’t merchant pass of the cost by adding a surcharge to prices?
Pricing Strategy
It works the same as the free shipping issue. When everything is included in the price, the consumer is prepared to pay the amount that they see and if they see any additional charges during the bill, it doesn’t feel good.
Which of the following prices look more attractive to you?
S$100 or
S$97 + S$3 credit card surcharge
Although they are the same price, the one without the surcharge looks more attractive to most people. In the first option, they feel that they bought a product with S$100 value but in the second option they feel that the product they bought has a S$97 value but they are paying S$100 for it. We tend to not place a value on shipping or transaction fees as it is not something tangible that we can touch.
Next, credit card users will be repelled if they see that they pay more than those paying by cash.
In the long run, these will lead to lower sales. It is easier to include merchant fees in the pricing so consumers don’t consciously see that using credit cards has increased the prices for the item we are buying.
Surcharges Are Sometimes Disallowed
When I bought my computer at Sim Lim, I was given a small discount when I paid using cash. It was not offered outright and I had to ask for it as I saw on forums that you can ask for a lower price if you are paying in cash.
However, this might not be possible in some cases. In the FAQs for DBS merchant services, it is specifically mentioned that surcharges are disallowed.
Can I pass on the costs to customers paying with credit cards?
Merchants are not allowed to impose any minimum spend or pass any surcharge to customers paying with their credit cards.
However, this might change soon as some big players like Amazon have started to add a surcharge for Visa holders. With Mastercard and Visa contemplating increasing their fees, more merchants and big players might start implementing surcharges or use some other way to pass on the costs to the consumer.
The Dilemma Of Using Credit Cards
So we finally reach the topic at hand, the dilemma of using credit cards. Although the existence of credit cards increases the overall prices that consumers have to pay, it might not be wise to stop using credit cards on the individual level. If you stop using credit cards, the non-credit card users will be subsidizing the cashback and miles for credit card users indirectly.
It is a “damned if you do and damned if you don’t” situation with credit cards.
Stop Subsidizing Others And Own Rewards
Credit card companies use the fees received to fund their loyalty programme (e.g. giving cashback, points, buying miles) Merchant fees are just one of the fees that credit card issuers receive. Rewards are also funded through the interest and penalties paid by cardholders who cannot pay in full on time.
You need to pay your credit card in full AND on time to enjoy the credit card rewards at the lowest cost. Late fees and interest are avoidable if you pay in full on time. A tip is to treat your credit card like cash and never spend more than what you have in your account.
When you pay avoidable fees like late fees and penalties, it reduces the net value you receive from rewards. If the fees paid exceed the rewards given, you start subsidizing the rewards from other users and the bonuses of the credit card issuers.
So Should You Own A Credit Card?
If you are able to qualify for a credit card, go for it. The caveat is that you should own a credit card only if you can spend responsibly. Credit card interest is one of the highest out there. If you are unable to pay on time, you will be hit with late fees plus interest on the outstanding debt. Additionally, if you continue spending on the card, the credit card debt and penalties will just keep snowballing. Although credit cards provide more spending power, we shouldn’t buy things on impulse, without thinking. Pay extra attention during shopping holidays created by corporations and not fall prey to their marketing tactics.
An OCBC survey shows that about 30% of credit cardholders often only pay the minimum sum, which means these individuals are spending more than they can or want to pay back. This is exacerbated by the covid situation by many have their incomes and ability to pay off debt affected.
Never get dependant on using credit cards. Make sure that if one day the credit card terms become unfavourable (e.g. unwaivable annual fees), you have the ability to switch cards to stop using credit cards immediately.
I only got a credit card a year into working as I believe owning one would increase my spending. When my friend told me that public transport can be charged to the credit card plus it can help fulfil the credit card spending criteria in my savings account, I then decided to get my first credit card. I prefer cards that allow for easy annual fee waivers as I don’t really make use of miles and rewards.
The Future Of Credit Payments
Spending on credit won’t be going away anytime soon as our economy is built on ever-increasing spending. This means that we can only work on the business model or technology in between the consumer and merchant.
Buy Now Pay Later
There is a rise of Buy Now Pay Later companies that provides credit to consumers just like credit cards. Their business model is similar where consumers use it for “free” with penalties if they pay late plus they charge the merchant fees for using this service.
Source: Grab PayLater
7 out of 10 Grab’s userbase in South East Asia don’t have access to financial services like credit cards. This is a big untapped sector to give individuals access to credit.
Source: Grab PayLater
Grab also states that this BNPL service increases the order value, checkout rate and number of new customers.
BNPL merchant fees are potentially higher than credit card fees. This additional cost will eventually be passed onto the consumer.
Blockchain
Digital payments via a blockchain ledger might help lower the costs but cutting away some of the middlemen in the payments chain. The technology is still in the nascent stage so we might only see them adopted in the next decade. There are also some projects providing credit based on the assets you own. You can get access to liquidity without selling off your assets.
Private Credit Scores
China has Zhima Credit by Ant Group that tracks your interactions online (e.g. credit history, purchases, user profile, interactions with other users) and gives you a score to determine your credit limit on Huabei, Alibaba’s consumer loan department. This can potentially reduce the default risk of consumers, lowering the overall cost of credit. The risk is that you need to trust that the scoring system is fair and they won’t penalize you unfairly. They are the ones who determine what actions are “good” and “bad”. They also recently faced pressure from the Chinese regulators to amend the credit limits for young borrowers to promote more rational spending habits, curbing the easy unsecured loans given to millions of people.
TL, DR
Credit cards allow for overspending and result in an overall increase in prices. There are many players in the credit card ecosystem and they are funded by the merchant fees and other fees the consumer directly or indirectly pays. The dilemma of using credit cards is that it increases prices but if you stop using them, others won’t. Credit cards are not going away so make use of it responsibly and make use of the benefits while minimizing the suffering from the negative effects like overspending and penalties from not paying in full on time.
Do let me know your thoughts on owning credit cards in the comments below.
