Tuesday, September 29, 2009

Operational Problems in Offering Credit Cards

Banks and other companies offering credit cards must solve several significant operational problems. First, the break-even point in card operations appears to be relatively high, placing pressure on credit card companies to sign up enough merchants to accept the cards and enough individuals to use them. The two problems are, of course, interrelated. Merchants are willing to accept a card only if they believe there will be sufficient customers using it to make the program worthwhile. Similarly, individuals are willing to make use of their cards only if a large number of merchants will accept them in payment for goods and services. One problem that has plagued credit-card operations for many years is losses due to customer fraud. Recent estimates by the Federal Reserve System find that fraud losses represent 15 to 20 percent of total card charge-offs for most plans.
During the late 1960s some U.S. banks tried to overcome the card-acceptance barrier by mass mailing of unsolicited cards, resulting in large-scale credit and fraud losses. Fearing that the safety and soundness of the banking system might be jeopardized and public confidence in banks shaken, Congress Passed the Consumer Credit Protection act, which prohibits unsolicited mailing of credit cards. Moreover, once the card-issuing company has been notified, the customer is no longer liable for any unauthorized use of his or her card. Prior to notification, the cardholder can only be held responsible for a maximum of $50 in unauthorized charges per card. Moreover, the customer cannot be held liable for unauthorized use of his or her credit card if the card was not requested or used, if it carries a means of identifying the authorized user (such as a signature or photograph), or if the customer was not notified of the $50 maximum liability. In addition, card issuers must provide the customer with a means of notifying them in case of card loss or theft.
Federal legislation has done much to enhance public acceptance of credit cards. Most cards are issued to customers today only after a careful analysis of their credit standing. That is why cardholders frequently are able to use their cards as a credit reference to aid in the cashing of checks or to obtain other forms of credit. Most merchants know that charge-card holders tend to have higher incomes and better payment record than the general population.
The most profitable credit-card accounts from the point of view of the issuing companies are those with high balances which are not paid off immediately (I.e., those held by installment users). However, less than half the sales volume experienced by most card programs winds up as carry-over balances subject to finance charges. Most card users are convenience users, who pay off their credit purchases within the normal billing cycle. Banks have found that they cannot make significant profits on their credit card operations when over half their cardholders are only convenience users. Moreover, cards users with the highest incomes and best repayment records typically economize on their cash balances and delay payment as long as possible, which further reduces the earnings from card operations. However, the performance of credit-card programs does improve with experience. Card companies become more skillful at identifying profitable groups of customers and at minimizing fraud and bad-debt losses. In addition, credit card programs bring in customers who may purchase other financial services from the same institution, such as installment loans and savings plans.

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