What Makes Credit Card Business Lucrative For Banks

SBI Cards & Payments Services Ltd.’s initial public offering gives investors a chance to bet on a business that could serve as a proxy to high-margin credit card lending.

While most banks offer cards, SBI Cards is the nation’s only pure-play card issuer and the second-largest behind HDFC Bank Ltd. And Indian lenders are aggressively pushing such unsecured loans as credit demand from the stressed corporate sector is yet to pick up.

Here’s why Indian lenders are chasing this business:

How A Credit Card Issuer Earns Money

Credit card debt is the costliest for consumers with lenders charging 1.5-3.5 percent a month or 18-42 percent annually on outstanding amount beyond the interest-free period. And the interest rates could go even higher if a borrower misses or delays payments. For SBI Cards, this contributes half of the revenue from operations.

A card company also earns fee, a more stable source of revenue.

• Spend-based inter-change fees or merchant discount rate from merchants where credit cards are used.
• Subscription and instance-based cash withdrawal and processing fees.

What Drives Profitability

Macquaire’s DuPont model showed that fee income contributes more to the return on assets in its base, bull and bear-case scenarios for a credit card business. But this income is prone to regulatory risks such as the government capping the merchant discount rate—what merchants pay banks for receiving digital payments.

Higher interest rates on credit card debt increase the net interest margin, or what banks earn through loans over the cost of borrowing. The net interest income drives up return on assets and equity—measures of how a company uses its resources and investments to generate profits, respectively.

SBI Cards’ return on assets stood at 4.8 percent in 2018-19, according to its IPO prospectus. The industry average for the cards business stands at 3.5 percent.

While individual banks didn’t share RoAs of cards business, analysts and executives told BloomberQuint that return ratios of HDFC Bank are even higher. Most large private sector banks would have post-tax RoA of 4.5-6 percent, they said on the condition of anonymity as the data isn’t public, while mid-sized lenders would be earning 1.5-2 percent.

That’s better than RoA of banks’ overall business that stood between 0.3 and 2 for State Bank of India and five of its top private peers as of September.

Also Read: Five Things SBI Cards IPO Prospectus Tells Us About Payments Industry

According to Equirus, SBI Card’s healthy net interest income and RoA are driven by 20-25 percent of card debt getting rolled over. But the brokerage expects that to come down as it enters super premium category as such wealthy consumers have lower revolver or debt rollover rate.

Growth Potential Of Card Business

Overall, India’s credit card spends grew at an annualised rate of 35.6 percent in the last three years and credit card outstanding rose 25.6 percent, according to data from the Reserve Bank of India.

As of September, 31 million Indians had 53 million cards, according to Macquarie, and the brokerage sees it growing to 100 million cards in the medium term as the growth returned after a phase of consolidation.

Despite the strong growth in the last five years, India still remains largely underpenetrated, both by number of credit cards and spend per card, said Macquaire.

Crisil Research forecasts the digital payments to more than double by value by the fiscal ending March 2024, growing at an annualised rate of 20 percent.

Still, cash transactions constitute 80 percent of all transactions in India as against China where almost all transactions are done digitally. And credit card spends contribute just 6 percent of cashless payments.

Also Read: The Consumption Dichotomy In India

According to Crisil, unsecured loans grew at a faster pace than overall retail loan growth to reach about Rs 6 lakh crore as of March 2019. It expects it to grow 2.5 times to Rs 15 lakh crore by March 2024. And within unsecured loans, credit card outstanding is forecast to grow at the fastest annualised rate of 23 percent in the next five years, driven by the rising issuance of cards in smaller cities, increasing organised retail penetration and growth in payments infrastructure.

Risks For Credit Card Industry

UPI Threat: Crisil Research forecasts the digital payments to more than double by value by the fiscal ending March 2024, growing at an annualised rate of 20 percent. In the last couple of years, Unified Payment Interface has emerged as a threat.

But according to Macquarie, it’s a misnomer that card spends compete with new payment modes such as UPI, wallets and mobile banking. Consumers prefer UPI or Paytm for smaller payments and these transactions have resulted in a shift from cash and were never a competition to cards, it said.

In fact, it said, UPI and wallets over time increase users’ chances of choosing debit and credit cards, said Macquarie quoting HDFC Bank.

Equirus, however, sees UPI accelerating adoption of mobile, wallet, and QR code-based payments—similar to China. New customer acquisition may be tougher for credit card players as customers need to have a profile, income and credit score to own a credit card, it said, citing steep penalties in case of defaults and annual membership fees as hurdles. Equirus expects credit cards to continue growing as a payment category but to lose market share.

Some banks are also exploring the possibility of issuing credit cards based on UPI. While UPI will have a cap on the MDR, Equirus expects acceptance with merchants will be materially higher.

Also Read: MDR Waiver: RBI May Have To Shell Out Rs 1,800 Crore To Banks

Retail Asset Quality: So far, banks have maintained the retail asset quality but a downturn in the segment can negatively affect the industry. Macquarie cited the example of the global financial crises when ICICI Bank Ltd. was one of the worst affected with its retail non-performing loans going up from 2 percent to 8 percent.

Based on inferences from India’s own history and earnings from global crisis in the past, Macquarie said provisions can increase to two-three times from the base case of approximately 6 percent of assets in such an event. This can plunge the RoA into a negative territory. In a bull case, the RoE of cards business can be as high as 41 percent and go down to -10 percent in the bear case.

Regulatory Caps, Competition: The finance ministry asked bankers not to charge merchant discount rate on payments via RuPay and UPI from Jan. 1 to boost digital payments. The RBI already regulates MDR on debit cards and UPI but there is no cap on MDR on credit cards.

In India, MDR rate is 1.6-2.5 percent, while in China it is capped at 60 basis points, said Macquarie, adding that India’s neighbour also caps credit card interest rates at 12-18 percent.