Banks which offer credit card services have overall remained very profitable; however the risk is very high, because the credit card business is all about giving unsecured (uncollateralized) loans. The bank is dependant on the borrower not to default in large numbers. Banks incur several costs, some of which are given below:
1. Interest Expenses: Banks generally borrow the money from other forms at very low interest rates from other firms. They borrow the amount the customer requires, and lend this money to the customer at high interest rates. For example, if the card issuer charges 15% on money lent to customers, and it costs 5% to borrow the money to lend, and the balance sits with the cardholder for a year, the issuer earns 10% on the loan. This 5% difference is the “interest expense” and the 10% is the “net interest margin”. Normally, if the customer pays back the entire amount borrowed on credit within the first billing period, no interest is charged. This depends upon different bank policies.
2. Charge Offs: Some customers simply never pay their credit card bill. A considerable amount of money which banks loan on credit to customers...
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