On Agenda: Who ultimately pays for credit card rewards?

As credit card competition climbs to another higher level, banks are packing their cards with more and more features. These offerings are rewarding as long as the customer uses the card as a payment convenience and not as a rollover credit facility.

Local credit card competition has been marked by certain phases, in which one particular bank adds an innovative feature, which soon becomes a standard by default. The lowest rate in town, for instance, was the key differentiator for some banks for some time. But by and by banks brought down their rates to match the best offers.

Buy-out of other banks' cards with the outstanding was the next big thing, and here again, the number of banks offering this facility kept increasing. In the next situation what mattered was the terms at which the outstanding amounts were acquired, and in some cases the additional credit limits offered to those who crossed over.

The subsequent rounds were mostly about one-upmanship in rewards. The past few months have seen the banks line up a series of reward offerings, ranging from free air tickets to new card members and trips to exotic locations to insurance protection of various kinds to card-holders and even complimentary quick-passage eGate cards for use at Dubai International Airport.

Air miles programmes that give card users air miles for every dirham or block of dirhams spent on the card is now a fairly standard offering and what makes one bank's scheme better than the other is often the number of airlines on which such credits can be utilised. One bank recently announced that its air miles programme can be redeemed on any airlines instead of just one or a limited number, as is generally the case.

Funding the incentives

The constantly evolving rewards programme certainly makes the card user happy; but even while claiming the benefits one cannot help wonder how the banks fund these incentives. For banks, credit card is a business and they have to make their money off their cards. It is no business if the money has to come from their own coffers. Does that mean that the cardholders are paying from their pockets for these extras? Not
really.

Whenever a customer makes any purchase on the card, the issuing bank collects 1.1 per cent of the transaction as a kind of service charge.

Banks use a part of this resource to promote their cards through various incentive programmes. The amount spent on promotion was generally half a per cent, which meant that the banks still retained 0.6 per cent of the total transaction value.

But recently, one of the more aggressive Dubai banks announced that it was earmarking as much as one per cent of the commission that it earned on credit card transactions for its rewards programme. On a cards volume of 20,000 cards that the bank claims to have achieved in a short span of time, the resources available for the bank for apromotion will be substantial.

This might still apparently leave the question of who ultimately funds the service fee unanswered, but in reality it is a trade-off against the cost of handling cash, which is quite high compared to the cost of deferred payment.

What, however, remains a valid question for all times is how best to use a credit card and the question has only one answer. Credit on the card is only meant to be a payment convenience. Any use of it beyond that involves a heavy cost, which no incentive package, however liberal, can match.

One hears of rollover veterans who use the credit on one card to pay off the debt on another. Technically it sounds good, but it is a dangerous game to practise, and it will exact a heavy price in the end.

For those who can use it judiciously, a credit card is a great facility; but for those who can't, it is a trap very difficult to get out of.

The writer is a UAE-based journalist.