A credit card system is a type of retail transaction settlement and credit system, named after the small plastic card issued to users of the system. A credit card is different from a debit card in that the credit card issuer lends the consumer money rather than having the money removed from an account. It is also different from a charge card (though this name is often used to describe credit cards by the public) in that charge cards do not extend the user credit -- the charges must be paid each month in full. Most credit cards are the same shape and size, as specified by the ISO 7810 standard.

How they work

A credit card user is issued the card after approval from a provider (often a general bank, but sometimes from a captive bank created to issue a particular brand of credit card, such as American Express Centurion Bank), in which they will be able to make purchases from merchants supporting that credit card up to a prenegotiated credit limit. When a purchase is made, the credit card user indicates his/her consent to pay, usually by signing a receipt with a record of the card details and indicating the amount to be paid. More recently, electronic verification systems have allowed merchants (using a strip of magnetized material on the card holding information in a similar manner to magnetic tape or a floppy disk) to verify that the card is valid and the credit card customer has sufficient credit to cover the purchase in a few seconds, allowing the verification to happen at time of purchase. Some services can be paid for over the telephone by credit card merely by quoting the number embossed onto the card (the credit card number), and they can be used in a similar manner to pay for purchases from online vendors.

Each month, the credit card user is sent a statement indicating the purchases undertaken with the card, and the total amount owing. The cardholder must then pay a minimum proportion of the bill by a due date, and may choose to pay more or indeed pay the entire amount owing. The credit provider charges interest on the amount owing (typically at a much higher rate than most other forms of debt). Credit card issuers may waive interest charges if the balance is paid in full each month, which allows the credit card to serve as a form of revolving credit, or they may choose to apply any payments toward recent rather than previous debt. Interest rates can vary considerably from card to card, and the interest rate on a particular card may jump dramatically if the card user is late with a payment on that card or any other credit instrument. As the rates and terms vary, services have been set up allowing users to calculate savings available by switching cards, which can be considerable if there is a large outstanding balance (see external links for some on-line services).

Because profit margins in the credit card industry can be quite high, credit providers often offer incentives such as frequent flier miles, gift certificates, or cash back (typically 1 percent) to attract customers to their program.

Secured credit cards

A secured credit card is a special type of credit card in which you must first put down a deposit between 100% and 200% of the total amount of credit you desire. Thus if the holder puts down $1000, he or she will be given credit in the range of $500–$1000. This deposit is held in a special savings account. The owner of the secured credit card is still expected to make regular payment, as he or she would with a regular credit card, but should he or she default on a payment, the card issuer can deduct payments on the card out of the deposit. Secure credit cards are an advantage to anyone with poor or no credit history. They are often offered to people as a means of rebuilding one's credit. Secured credit cards are available with both Visa and MasterCard logos on them.

Features

As well as convenient, accessible credit, the cards offer consumers an easy way to track expenses, which is necessary both for monitoring personal expenditures and the tracking of work-related expenses for taxation and reimbursement purposes. They have now spread worldwide, and are offered in a huge variety of permutations with differing credit limits, repayment arrangements (some cards offer interest-free periods, while others do not but compensate with much lower interest rates), and other perks (such as rewards schemes in which points "earned" for purchasing goods with the card can be reclaimed for further goods and services).

In addition, some countries such as the United States limit the amount that a consumer can be held liable for fraudulent transactions, which shifts the liability to the merchant. This encourages the use of credit cards for electronic and mail order transactions, collectively called "card not present" transactions. For further security, some banks are offering one-time numbers for use in these transactions. They have spread far and wide beyond their initial market of the wealthy businessman and are now ubiquitous amongst the middle class of most Western countries.

Security

The relatively low security of the credit card system presents many opportunities for fraud. However, this does not imply that the system is broken. The goal of the credit card companies is not to eliminate fraud, but to reduce it to manageable levels, such that the total cost of both fraud and fraud prevention is minimized. This implies that high-cost low-return fraud prevention measures will not be used if their cost exceeds the potential gains from fraud reduction. This opportunity for fraud has created a black market in stolen credit card numbers, which must generally be used quickly before the cards are reported stolen.

Three improvements to card security are being introduced to the more common credit card networks at the time of writing. First, the on-line verification system used by merchants is being enhanced to require a 4 digit Personal Identification Number (PIN) known only to the card holder, Second, the cards themselves are being replaced with similar-looking tamper-resistant smart cards which are intended to make forgery more difficult. The majority of smartcard (IC card) based credit cards comply with the EMV (Europay Visa MasterCard) standard. Third, an additional 3 or 4 digit code is now present on the back of most cards, for use in "card not present" transactions. See CVV2 for more information.

Profits and losses

Credit card issuers (banks) cover their costs (including the interest costs for the money that is paid to merchants prior to the bank being paid by customers), and earn profits, by:

• Interchange fees. Interchange fees are charged by the merchant's acquirer to a card-accepting merchant as component of the so-called merchant discount fee. The merchant pays a merchant discount fee that is typically 2 to 3 percent (this is negotiated), which is why some merchants prefer cash, debit cards, or even checks. The majority of this fee, called the interchange fee, goes to the issuing bank, but parts of it go to the processing network, the card brand (Visa, MasterCard, etc.), and the merchant's acquirer. The interchange fee that applies to a particular merchant is a function of many variables including the type of merchant, whether the cards are physically present and the card's magnetic stripe is read, the specific type of card, etc. For a typical credit card issuer, interchange fee revenues may represent about fifteen percent of total revenues.

• Charging interest on outstanding balances. Customers who do not pay in full the amount owed on their monthly statement (the "balance") by the due date (that is, at the end of the "grace period") owe interest ("finance charges"). These customers are known in the industry as "revolvers". Those who pay in full (pay the entire balance) do not. These customers are known in the industry as "transactors". Interest charges vary widely from card issuer to card issuer. Often, there are "teaser" rates in effect for initial periods of time (as low as zero percent for, say, six months), whereas rates for those with poor credit can be as much as 29.74 percent (annualized). In the U.S. rules governing interest rates are set at the state level; some banks have chosen to establish their credit card operations in states such as South Dakota that have less restrictive limits on interest rates.

• Fees charged to customers. The major fees are for (1) payments received late (past the "grace period"); (2) charges that result in exceeding the credit limit on the card (whether done deliberately or by mistake); (3) cash advances and convenience checks (often 3 percent of the amount); (4) transactions in a foreign currency (as much as 3 percent of the amount; a few financial institutions charge no fee for this); and (5) an annual payment.

Credit card companies generally do provide a guarantee the merchant will be paid on legitimate transactions regardless of whether the consumer pays their credit card bill. However, credit card companies generally will not pay a merchant if the consumer challenges the legitimacy of the transaction and will fine merchants who have a large number of chargebacks.

In recent times, credit card portfolios have been exceedingly profitable to banks, largely due to the booming economy of the late nineties. However in the case of credit cards, such high returns go hand in hand with risk, since the business is essentially one of making unsecured (uncollateralized) loans, and thus dependent on borrowers to not default in large numbers.

In some areas, such as Ireland, governments profit from credit cards through the imposition of a stamp duty or credit card tax. This is usually done where a cheque tax previously existed. This tax is taken automatically from the account, just like a purchase, by the bank on behalf of the government annually. This tax - unlike its cheque counterpart - is payable in arears so no refund is possible.

History

The credit card was the successor of a variety of merchant credit schemes. It was first used in the 1920s, in the United States, specifically to sell fuel to a growing number of automobile owners. In 1938 several companies started to accept each others cards.

The concept of paying merchants using a card was invented in 1950 with Diners Club's invention of the charge card, which is similar but required the entire bill to be paid with each statement; it was followed shortly thereafter by American Express.

Bank of America created the BankAmericard in 1958, a product which eventually evolved into the Visa system ("Chargex" also became Visa). MasterCard came to being in 1966 when a group of credit-issuing banks established MasterCharge.

There are now countless variations on the basic concept of revolving credit for individuals (as issued by banks and honored by a network of financial institutions), including organization-branded credit cards, corporate-user credit cards, store cards and so on.

Controversy

Credit card companies do not want merchants to charge credit card users more than they charge other customers, even though the merchant pays a fee of 2 to 3 percent (merchants negotiate an exact percentage with their banks) to process credit payments. If customers were responsible for this fee, it would often discourage credit card usage. In many places, governments have passed laws (at the urging of the credit card industry) to make this illegal. Some critics have observed that this results in what is effectively a hidden tax on all transactions conducted by merchants who accept credit cards since they must build the cost of transaction fees into their overall business expense. The end result is that cash consumers are essentially subsidizing credit card holder purchases. The cost of the convenience enjoyed by card holders and the profits taken from transaction fees by the card industry (which has come to rely increasingly on this revenue stream over the years) is partially offloaded onto the backs of the cash consumer. Critics go on to say that further compounding the issue is the fact that the consumers most likely to pay in cash are the least able to afford the additional expense (card holders are more likely to be affluent, non-card holders less so). Australia is currently acting to reduce this by allowing merchants to apply surcharges for credit card users.

However, there also exists an economic argument that credit card use increases the "velocity" of money in an economy, the result, higher consumer spending rates and higher GDP. Given there are many a sad story of credit card abuse, the trend is increasing use, with some predicting a cashless society in the not so distant future. There is some controversy about credit card usage in recent years. Credit card debt has soared, particularly among young people. The major credit card companies have been accused of targeting a younger audience, in particular college students, many of whom are already in debt with college tuition and loans, and who typically are less experienced at managing their own finances. Credit card usage has tripled since 2001 amongst teenagers as well. The United Kingdom is the world's most credit-card-intensive country, with 67 million credit cards for a population of 59 million people.[1]

Since the late 1990s, lawmakers, consumer advocacy groups, and college officials and other higher education affiliates, have become increasingly concerned about the rising use of credit cards among college students. A recent study has shown that both the number of students owning a credit card as well as the amount of credit card debt held by students has risen in the last couple of years. Since eighteen year-olds in many countries and most U.S. states are eligible for a card without parental consent or employment, many have been concerned that students will use credit unwisely because of their financial inexperience and suffer the long-term consequences of carrying high debt.

Some credit card companies, including Providian and Capital One, are well known for pursuing legal judgments against borrowers, garnishing wages and forcing sales of homes, adding in the cost of legal fees, often exceeding the original balance several times. This practice has encouraged numerous class actions seeking redress for borrower's rights.

An example of a credit card class action was where issuers were "rolling back" posting times to extract more late fees. The following banks are listed (with the amounts penalized).

• Providian: $405m
• Citibank: $15.5m
• Chase: $22.2m
• Bank One: $40m

Another controversial area is the universal default feature of many North American credit card contracts. When a cardholder is late paying a particular credit card issuer, that card's interest rate can be raised, often considerably. Given this circumstance with one credit card, universal default allows other card issuers to raise the cardholder's interest rates on other accounts, even if those other accounts are not in default. In the USA, Congress has been slow to introduce credit card reform legislation.

Credit card numbering

The numbers found on credit cards have a certain amount of internal structure, and share a common numbering scheme.

The card number's prefix is the sequence of digits at the beginning of the number that determine the credit card network to which the number belongs. The card number's length is its number of digits.

The prefixes and lengths for the most common card types are:

*US cards are now being issued as MasterCards and using their numbering scheme.

In addition, the first 6 digits of the credit card number are known as the Bank Identification Number (BIN). These identify the institution that issued the card to the card holder.

Some credit card issuers choose to restrict the card numbers they issue to those which pass a checksum test, where the final digit of the card number is used to confirm the initial digits. This has two benefits of preventing casual attempts to invent credit numbers (only one in ten will be valid), and also prevent mistakes when the card number is manually recorded. The checksum test for credit card numbers is the Luhn formula, described in Annex B to ISO/IEC 7812, Part 1.

American Express, in particular follows the following specific algorithm:

• First 4 numbers, country code, currency code and card type (ie charge or credit card)
• Next 2, card type (ie gold, platinum)
• Next digit, billing cycle
• Next 4 digits, account number
• Fourth from last, card issue (begins at 1 and will go up if it's replaced because it the card is lost or stolen)
• Next two, card issued under the account (ie if there are additional card holders. begins at 00 and increments)
• Last number, Luhn-10 check digit (used for verification purposes)

Credit card organizations

• American Express
• Citi
• Diners Club
• Discover
• JCB
• MasterCard
• VISA

Collectible credit cards

A growing field of numismatics (study of money), or more specifically Exonumia (study of money-like objects), credit card collectors seek to collect various embodiments of credit from the now familiar plastic cards to older paper merchant cards, and even metal tokens that were accepted as merchant credit cards. Early credit cards were made of celluloid, then metal and fibre, then paper and are now mostly plastic.

See also

• Credit card debt
• Credit history
• Credit score
• Debit card
• Electronic money
• Loan
• Stored-value card
• Credit card fraud

External links

• Secret History of the Credit Card (PBS/Frontline/New York Times documentary on Credit Cards)
• Article from Evolt Validating a Credit Card Number with JavaScript
• Beachnet Information on credit card validation
• Credit Card Articles Articles about credit cards
• Ericdigests.org Card Usage and Debt among College and University Students
• "Who killed Richard Cullen?" by Jon Ronson, The Guardian, 16 July 2005.
  • Article discussing marketing strategies of credit selling companies in the UK.
• Rules and Ranges ISO Document on Google