Ever wondered how Amazon Pay ICICI Bank Credit Card and Flipkart Axis Bank Credit Card can offer 5% cashback for purchase transactions on Amazon and Flipkart respectively? 5% is a lot of money. While I am not privy to internal arrangements between the banks and these retailers, 5% is still a hefty cashback.
In this post, let us try to see how banks make money from credit card transactions. How is the cash back scheme structured so the bank can strike a balance?
How Do Banks Make Money When You Use Your Credit Card?
It is a fair question because as a customer, you are getting all the benefits. You get an interest-free credit period and discounts, cashbacks, and reward points. And the bank is offering you all the above benefits.
For a long-term sustainable arrangement, it must be a well-oiled engine. Unless the banks make money on your card transactions, you will not get the benefits. Hence, the banks must make money and they do.
When you make a payment of say Rs 5,000 to a merchant using your debit card or credit card, the merchant does not get to keep the entire Rs 5,000. The merchant must share a commission or the cut with the payments system. This commission is called merchant discount rate (MDR) or the interchange fee/rate.
The MDR or the interchange fee may depend on multiple factors including but not limited to
- Card type (debit cards, credit cards, or different types of cards). Debit cards have lower charges. Premium or more rewarding credit cards may have higher interchange.
- Card network (Rupay, Visa, Mastercard, American Express). American Express charges more. That’s why many merchants do not accept American Express cards.
- Transaction mode (online, physical, NFC).
- Type of purchase (determined from merchant category code or MCC). This is extremely important because customer rewards vary depending on the type of purchase).
- Merchant size (bigger merchants can negotiate lower MDR).
The MDR can vary but tends to be 2-3% for credit card payments.
Assuming it is 2%, when the merchant swipes your card for Rs 5,000, he/she gets to keep only Rs 4,900. The 2% (or Rs 100) goes to the payment facilitators.
How Is MDR Split?
Continuing with the above example, it is split in the following manner.
- The issuing bank (bank of the customer)
- Network (Visa, Mastercard, American Express)
- The acquiring bank (the bank of the merchant) and the payment processor
The lion’s share of the MDR (or the interchange rate) goes to the issuing bank. Makes sense too because the issuing bank is taking the credit risk and providing interest-free credit period to the customer. Smaller portions go to the acquiring bank and the card network.
Here is an interesting conjecture. With Amazon Pay ICICI Bank Credit Card and Flipkart Axis Bank Credit Card, we know that ICICI and Axis are the issuing banks. These banks may be the acquiring banks for Amazon and Flipkart respectively. This way, these banks become both the issuing and acquiring banks and get to keep the cut on both sides (acquirer and issuer). From the customer and from the merchant. This enhances the economics of the credit card for the bank. As these banks get a greater cut from the transactions, they can also offer better rewards/cashbacks to their customers. There is also a possibility that there is a higher MDR negotiated for these cards.
While my assessment may be misplaced here, I think that’s also why we do not see other banks offering similar benefits on their credit cards for purchases on Amazon and Flipkart. It is also possible that the banks (ICICI, Axis) and the retailers (Amazon, Flipkart) have exclusivity built in their agreement. In that case, while other bank credit cards can also offer similar benefits (Amazon and Flipkart would be happy), the co-branding is only with ICICI and Axis (Amazon with ICICI and Flipkart with Axis).
Still, 5% cashback seems like a lot. And this brings us to the cashback scheme.
These Cards Do Not Offer 5% Cashback on All Transactions
Let us consider Amazon Pay ICICI Bank Credit Card.
- 5% for Prime members on all purchases on Amazon. 3% for non-prime members
- 2% for bill payments and travel booking on Amazon
- 1% for all other payments (except fuel)
- No cashback for EMI purchases
As you can see, these cards don’t offer 5% cashback on all transactions. And once you become fond of a credit card, you will not just use it for shopping on Amazon or Flipkart. You may use the card for other purchases too. That’s where the banks stand to make a lot of money.
There is no cashback for EMI transactions on either Amazon Pay ICICI Bank Credit Card or Flipkart Axis Bank Credit Card. This even applies to EMI transactions done on Amazon and Flipkart. Now, if you look, the banks are making money in multiple ways.
- % of transaction from the merchant (their portion of the interchange fee or the MDR)
- Processing fee for conversion into an EMI (almost all banks now charge the processing fee)
- Interest on the loan
- Over and above, these cards do not offer any cashback on EMI transactions. Hence, such EMI transactions are extremely rewarding for the banks.
From a bank’s perspective, it is NOT possible to know upfront how a particular card offering will work out. If the bank later works out that the card is not sufficiently rewarding for them, they can always cut down on benefits. For instance, the bank may cap the quantum of cashback you can earn. The maximum cashback can be capped at say Rs 1,500 per month. Or 5% can become 4% for Prime members.
Such Co-Branded Relationship Benefits Both Parties
If you shop frequently on Amazon, you can save a lot by owning an Amazon Pay ICICI Bank Credit Card. And if you own one, you may not use it just for purchases on Amazon.
Plus, credit cards are an extremely rewarding business and the banks fight with each other to get more card holders on their books. Amazon is a big retailer. If the bank can ride on Amazon’s popularity to get more customers, this partnership can be extremely enriching for the bank. Hence, the bank clearly benefits.
To summarize, the banks make money (or spend less money) in the following manner.
- Merchant discount rate or interchange fee
- Interest on EMI purchases: No cashback. Processing fee and interest income
- Earnings from revolving debt: If the card holder revolves the debt (not settle the bill in full), the banks charge an extremely high rate of interest on such debt and take away interest-free credit period.
Additionally, as discussed, the banks do not offer 5% cashback on all transactions. Only purchase transactions on the primary retailer get you 5% cashback. Other transactions earn a much lower cashback. EMI transactions do not earn any cashback.
And once you own Amazon Pay ICICI Bank Credit Card, you are more likely to shop on Amazon than on Flipkart. In addition, the cashback is in the form of Amazon Pay Balance, and you must spend that money on Amazon only. Hence, the retailer benefits too.
Hence, a mutually rewarding partnership. It is quite possible that the bank may later figure the economics of the card are not working out due to any reason. Not enough people are using the card outside of Amazon. Not many people are making EMI purchases or rolling over card debt. In such a case, the bank can roll back benefits.
At times, I have seen a prominent travel aggregator offering discount on ICICI Bank credit cards, but that discount is not applicable to Amazon Pay ICICI Bank Credit Card. This is a way to reduce benefits on Amazon Pay ICICI Bank Credit Card.
Do the numbers add up? What do you think?
I think the numbers must add up if such arrangements have to last without reducing benefits for the customers. At the same time, these banks have strong balance sheets. They can afford to lose money in the short-term if it serves their long-term interests.
Additional Links
I listened to an interesting podcast on how Visa (the card network) came into existence. The podcast gives fascinating insights into how payment networks evolved and how this is a lucrative business for the banks and the card network.