Credit cards have been an integral part of UK personal finance for around 50 years. Most adults will have, or will have had, a credit card.
Yet, despite their popularity, few people know exactly how their credit cards work. What goes on behind the scenes to make credit cards the simple and straightforward financial tool used by millions daily?
What are Credit Cards?
In the simplest terms, credit cards are embossed plastic (polyvinyl chloride) cards, containing one or more electrical chips, a magnetic strip and measuring 85.60 x 53.98 millimetres. Those who hold them can use them to make purchases anywhere a merchant has secured the technology required to accept card payments.
Yet credit cards are much more; a modern day incarnation of the lending businesses which can be traced back through the ages to ancient Mesopotamia, and the earliest human civilisations.
In many respects the 'card' element of 'credit cards' is secondary. The fact that the cards have always used the latest technology to speed and simplify payments helps makes them popular, but their primary function has always been in facilitating agreements between lenders and borrowers, establishing lines of 'credit'.
Indeed, now credit card companies are at the forefront of technological advances that will ultimately see 'digital credit' replace cards. So physical plastic cards will be consigned to history, but the businesses that offered them will remain; agnostic regarding means of delivery, but committed to offering consumers access to the benefits of credit.
A brief history of credit cards
In the United Kingdom, credit cards have been available for around 50 years, when they were adopted from the United States. The term "credit card" was first coined by the American writer Edward Bellamy in his novel Looking Backwards, and although the card he described is closer in function to a modern day gift or benefits card, the broader concept of credit would not have been unfamiliar to him.
Since the late 1800s some US department stores and oil companies had issued Charge Plates to enable purchases on credit. Charge plates were metal plates embossed with the customer's name and address, store branding, and with a card on the reverse for the customers signature.
Charge Coins were also issued from around 1865. Instead of customer details, these coins displayed a unique customer number, together with the store's logos or another identifying symbol.
From the early 1900s department stores started to replace charge plates and coins with cards. These cards were only accepted in the store which issued them, or within small store groups (like present day store cards). However, these cards were not primarily designed as vehicles for credit, they were loyalty card products intended to encourage repeat business from the stores' most loyal customers.
Nearly fifty years later (in 1946) the Flatbush National Bank of Brooklyn, New York (now part of JPMorgan Chase Bank) issued the first bank issued credit card, 'Charg-It'. It could only be used locally and was only available to existing bank customers, but it was the first credit card as we understand them today.
Original Diners Club Card Some other banks followed suit, but the cards remained limited to specific banks and locations. It was not until Frank McNamara and Ralph Schneider founded Diners Club International in 1950 that the concept of a universally accepted payment card was born (although it started with just 200 cards and 14 restaurants).
Diners Club proved popular and new entrants (American Express, Carte Blanche) moved quickly to enter the fledgling charge card industry. However, these cards were not the 'revolving' credit products we know today, where customers can choose whether they clear a balance in full or simply pay a monthly minimum. Charge cards, as is still the case today, had to be cleared in full at the end of every month, or the account could be cancelled and high fees applied.
In 1959 the traditional credit card was born when BankAmericard (once part of Bank of America, now independent and known as Visa) enabled users to roll their balance on until they chose to pay it off. The card was designed to help the bank reduce the processing costs associated with the millions of cheques for small amounts that customers would write every year. Cards replaced cheques by using carbon paper payment slips to record the embossed details from a card, standardising the presentation of information and eliminating issues like poor handwriting.
Although losses on BankAmericard were five times the expected level (the company initially lost twenty million dollars), within a year it had over two million holders, who could use their cards to pay with over twenty thousand merchants in California. The credit card concept was clearly popular, but it was restricted to California because the McFadden Act (1927) had made multi-state banking illegal. So, in 1965 it was decided to licence BankAmericard for use by other US banks (as well as banks in Canada, France and UK). In 1977, as international expansion continued, it was decided to rebrand the product from BankAmericard to "Visa".
Of course, the licencing of the BankAmericard left those without a licence at a serious competitive disadvantage, so it was no surprise that rival banks cooperated in the development of a competitor to BankAmericard. The Interbank Card Association (ICA) credit card first launched in 1966, and was backed by Bank of California, Wells Fargo and Crocker National Bank. As other banks joined the network the brand was changed to Master Charge and it adopted its familiar logo of two overlapping circles. In 1979 Master Charge became MasterCard.
In the UK, Barclays were the first to launch a credit card in 1966, under the Barclaycard brand (a brand with seemingly similar roots to "BankAmericard"). As in the US, competitors quickly realised that they needed to issue competitor products as the 'credit card' put Barclays' consumer banking at a considerable advantage. In 1977, Lloyds, Midland (now part of HSBC) and NatWest launched the Access Card, to compete in the revolving credit space with Barclaycard. In 1996 the Access brand was replaced with MasterCard, as part of a merger with the larger MasterCard group.
How credit is made available via cards?
Credit card applications
Credit Card Application Although when BankAmericard first launched credit cards to the world they simply sent unsolicited cards to people (activated and ready to use), the process for obtaining credit is now far more stringent and robust. In the United Kingdom, individuals who want a credit card must select a product they wish to apply for, and then complete the application form associated with it.
Application forms are designed to capture all of the information an issuer requires to make an educated decision about whether or not they extend credit to a particular individual, including;
- Name, date of birth and other personal details
- Address and residential status
- Employment details and income
- Bank details
Application forms also include terms and conditions which customers must agree to in order to progress with the application. These terms include applicant consent for the issuer to search various data sources to score their application, including credit reference agency data.
Once the application form has been completed and been submitted, which can be done online, over the phone or via a written application, the issuer starts to process the application.
Credit scoring & 'decisioning'
Processing of card applications can now be completed within a matter of seconds, but this belies the fact that it is a complex process with numerous steps and various checks being undertaken.
Issuers take the information contained with the application form, together with third party data (credit reports) to understand an applicant's situation. The exact information used depends on the inputs required to inform the particular issuer's scoring model, but it broadly breaks down into 2 main areas;
- Payment history
- Length of credit history
- Current indebtedness (amount owed)
- Credit mix
- Employment status
- Residential status
- Time at address
- Electoral role record
Issuers can quickly reject applicants who do not meet the fixed eligibility criteria for a product (age, income, residency status etc) and the inputs for the remaining applicants can be applied to sophisticated models, built using regression analysis of past customer behaviour to decide whether an applicant presents a good business risk and should be approved, or not.
If applicants are approved, further steps are then undertaken to determine the specifics of the product they will be offered. This could result in changes to the mechanics of promotional offers, adjustments to product interest rate pricing to reflect risk (risk based pricing), and will also inform decisions regarding the credit limit a particular customer is offered.
In most instances the entire 'decisioning' process is undertaken automatically, but in some cases manual decisions are needed. This means that within a matter of seconds an applicant can be informed that their application has any one of three statuses.
- Accepted - the applicants application has been successful
- Declined - the applicants application has been unsuccessful
- Referred - the application has been referred for manual processing. This may mean that further information, or documentary evidence, is required from the applicant to support their application. Applicants are also referred if links to third party data are not active, and the scoring process cannot be competed.
Once referred, applicants are manually assessed and every applicant is given a binary decision; their application is either accepted or rejected.
Regardless of outcome, if a full credit application is made for a product the application is recorded within the credit file of the applicant concerned.
Individuals declined for credit are notified that they have been unsuccessful, but are usually given little additional information as the rationale. This could be seen as unfair, but the process for scoring applications is complex and numerous factors could easily contribute to an individual decision. The specifics of scoring are also much guarded by credit card issuers, as it can give them considerable competitive advantage. Issuers can be more selective when assessing who makes a good risk and conversely be more accepting of seemingly risky business if their decisioning models are better than their competitors. This in turn means they can be more profitable, price their products more attractively or do both.
Accepted applicants are sent the specifics of their particular credit agreement which must be signed to confirm that they accept the terms, before a credit agreement takes effect. If an applicant chooses not to accept the terms (which is entirely within their rights) they will not sign the agreement. This is of particular importance given that issuers increased their use of risk based pricing in the wake of the regulatory changes induced with the Consumer Credit Directive, 2011. This has meant more applicants than ever before being offered an alternative product, rather than the product they initially applied for (often with less advantageous terms).
Traditionally credit agreements were posted to individuals. They then signed them (or not) and returned them in the post. Modern developments, including the increased use of online application forms, have led most issuers to replace posted agreements with digital agreements, which can be signed electronically. This helps speed up the application process, and improve the card issuer's conversion rate (from proposed agreement to signed contract), increasing the performance of customer acquisition marketing activities.
Once an accepted credit agreement is received by the issuer they are in a position to undertake the account set up process, assigning customer account numbers and issuing the physical credit card. This part of the process still predominately relies on traditional post, although account details can be issued digitally by some issuers for immediate use, and some issuing banks with branch networks can manufacture cards in branch.
Credit Card activation
When the card is initially issued it is deactivated, to help prevent credit card fraud where cards are intercepted in the post. On receipt applicants are required to immediately sign the signature strip on the reverse of their card and activate the card. The process for activating a credit card is usually automated. Customers are directed to undertake one of three methods for activating their card.
- Online banking activation - where a customer has secure online banking, there is often a link to enable cards to be activated
- ATM - perhaps the safest method for activating a card since a fake credit card will be quickly identified and retained by an ATM (to prevent further use)
- Phone - calling a specific number on the face of the card is the traditional method for card activation, but as it becomes easier for criminals to fake credit cards it is perhaps less secure, since victims can easily be directed via a fake activation number and may disclose account details. To avoid doubt customers should call their credit card issuer via a number they source independently to establish the correct activation number, before calling it.
Once a credit card has been activated it is ready for use.
Ongoing customer analysis
There is a common misconception that scoring and assessment of applicants is only undertaken when they apply for a given product, but this is not the case. Credit card issuers are just as interested (if not more interested) in current customers as they are new prospects. As such, they use behavioural analysis to understand their current customers and, where necessary, adjust the terms of their credit agreements in line with changing circumstances. Changing circumstances aren't always directly associated with the customer; they are equally likely to be changes to the wider Macroeconomic environment.
How do credit cards facilitate payments?
Although credit cards are available from hundreds of different issuers from all over the world, they all have common characteristics. All credit cards are 85.60 x 53.98 millimetres with corners rounded to a radius of 2.88-3.48 mm, contain one or two microchips, a signature strip and a magnetic strip, but this was not always the case. Early credit cards were made of different materials, such as paper, card or celluloid, and were available in numerous different shapes, albeit similar to the modern credit cards.
Of course, one of the main benefits of credit cards, since their first inception has been their universality and ability to enable cross border trade and purchases abroad. Without standardisation this benefit would be much reduced. Individuals from one country or with one issuer might find their card incompatible with payment terminals from another, limiting the card's use and making it more akin to a store card.
To remove these barriers, common standards were adopted by all credit card issuers that govern most aspects of card design. Numerous international standards bodies exist, but in the payment card space it is the ISO (International Organization for Standardization) which has formalised the required international standards.
Established in London in 1947, and based in Geneva, the ISO is an NGO (non-governmental organisation) with over two hundred and fifty technical committees, who shape and steer the development of common standards across a range of areas, from Currency Codes (ISO 4217) to Occupational Health and Safety (ISO 45001). They also collaborate with other standards organisations, such as the International Electrotechnical Commission (IEC), where fields of expertise cross over and there is common interest in deeper cooperation.
In the payment cards space (identification cards for ISO purposes) there are a number of standards which determine the design of a card, which include;
- ISO/IEC 4909 - specifies how magnetic strips can be used to facilitate payments
- ISO/IEC 7810 - determines the size and shape cards identification cards
- ISO/IEC 7811 - details how data can be recorded on identification cards
- ISO/IEC 7812 - defines the numbering system for all identification cards
- ISO/IEC 7816 - prescribes how smart cards (chip & pin) can store and encrypt data
- ISO/IEC 14443 - sets common standards for contactless payment chips
These standards cover most aspects of card design, enabling people to transact seamlessly with their cards, but they also go further; requiring minimum standards which ensure that cards are safe for use by the end user, including;
- Chemical resistance
Credit card design features
Early credit cards were simple objects. They included the payment processor, the name, number and signature of the account holder, together with an expiry date. Essentially this was the only data required to process credit card transactions.
However, with a simple signature being the only requirement to validate sales, credit cards were prone to fraud - fraud that card issuers were ultimately liable for. As such, issuers have always been keen to improve the security of their products to help minimise their losses. This has resulted in credit cards designed to incorporate a number of security features, together with features designed to improve their convenience for users. These features include:
The account numbers used on credit cards are typically 16 digits long and the standard detailed in ISO/IEC 7812. The first few numbers are specific to the type of credit card it is.
- American Express/Diners Club/JCB
- Discover/China UnionPay
Prefixes 1 and 2 are reserved for Airlines, 7 for petrochemical businesses, 8 for healthcare, and 9 is reserved for allocation by national standards bodies (not to be used internationally).
All but one of the remaining numbers specifies the issuing organisation and the customer account the card is associated with. The final number is a validation check for the preceding numbers (especially useful where they have been given over the phone or typed in).
This number is the output of an algorithm (originally patented) which was developed by an IBM engineer called Hans Peter Luhn (the Luhn algorithm). With only numbers 0-9 available most would assume there to be a 10% chance that the preceding numbers were still incorrect, but the Luhn algorithm picks up all single digit errors - so very useful for ensuring card numbers have been entered correctly before a transaction is processed.
Given that early credit cards that were stolen were easily exploited with forged signatures, but counterfeit cards all but removed a criminals need to forge. They could easily recreate a simple card with details obtained from a 'zip-zap' swipe (carbon copy paper) and sign in their own hand. In 1983, MasterCard were the first payment network to use holograms to add considerable complexity the credit card counterfeiter.
Invented by the Hungarian scientist Dennis Gabor in 1947 as a by-product of his endeavours to improve the electron microscope, holograms took some time to reach the mass market. The complex optical behaviour of holograms (including the ability to animate simple movements) made them almost impossible for counterfeiters to reproduce, but it was not until the invention of the laser in 1960 that techniques for their mass production could be developed.
In 1985 Visa followed MasterCard in introducing holograms as a security feature to their cards, and within a decade holograms were a universal of all credit cards.
Magnetic tape was developed during World War II for recording sound, but it was only used reel to reel. It was IBM engineer Forrest Parry who developed the process for affixing tape to cards (originally for CIA identity cards), enabling it to be used for data storage.
Standards for the use of magnetic strip data storage are defined in ISO/IEC 4909. For payment cards the magnetic strip can be up to three tracks (although the third is rarely used). Tracks 1 and 2 can be used to contain a variety of alpha and numeric data pertaining to the account and account holder.
Magnetic strips where first included on credit cards in 1970 when American Express, American Airlines and IBM jointly tested the technology. By 1973 it was ready for full deployment and the magnetic strip has been a feature of credit cards ever since, allowing merchants to dispense with the traditional 'zip-zap' carbon copy machines, and enabling development of the Automatic Teller Machines (ATMs) which remain ubiquitous to this day.
Despite widespread use, magnetic strips are fallible. Data stored on them is not encrypted, so can be easily read. Also, strong magnetic fields can interfere with the data stored on cards and even wipe all information contained on them.
EMV Chip EMV is the global standard for the chip & pin technology that has largely replaced the customer signature for authentication purposes.
Named after the businesses that initially developed the current technology (Europay, MasterCard and Visa) it is now also managed in conjunction with American Express, Discover, JCB and China UnionPay - although the standards are administered by the ISO and IEC (ISO/IEC 7816).
EMV chips differ from the traditional 3 track magnetic strip because they are integrated circuits which exchange multiple data points (sometimes encrypted) via the payment processor to facilitate a transaction. The security of EMV is only as good as the people using it (and their ability to not disclose their pin number), but its widespread introduction to the UK was credited with card fraud dropping by over a third within a year.
The Card Verification Value (CVV) was a major development designed to reduce the increasing levels of fraud associated with online (card not present) transactions.
Developed in the UK by the credit reference agency Equifax, CVV numbers started to appear on cards from the mid-1990's when APACS (Association of Payment Clearing Services) adopted the standard.
The idea behind the CVV number was simply to add additional data element required to complete a 'card not present' transaction. Much of the data required for 'card not present' transactions could easily be obtained from the magnetic strip of the card, but having a discreet number on the signature panel of cards forced criminals to gain further details before they could use a card online, or on the phone.
RFID (Contactless) Chips
RFID (Radio-frequency identification) is a system which uses radio-frequencies for identification. RFID chips are attached to items for tracking. These chips then return a signal, which is read by a receiver, when activated by radio-frequency energy.
A by-product of War World II radar technology, RFID chips were developed extensively through the 1950s and 60s. Commercial use in anti-theft systems for retail stores and unit tracking for manufacturers was quickly adopted.
The RFID "Oyster Card" was introduced on London Transport in 2003, by it was not until 2008 that the first UK payment cards incorporating the technology were deployed.
More commonly known as 'Contactless', RFID enables those with cards supporting it to tap a terminal with their card to make a contactless payment of up to Â£30.00. The technology was extensively promoted by Visa and Barclaycard (with the popular "waterslide" advert) and is now widely supported with major fast food outlets, supermarkets and TfL (Transport for London) all offering payment 'contactlessly'.
Paying with a credit card
Assuming an individual has not surpassed their credit limit, credit cards can be used anywhere displaying the logo of the payment processor featured on the card.
- Visa accepted by around thirty million merchants
- MasterCard accepted by around twenty eight million merchants
The American Express merchant figure is undisclosed
In the western world, coverage for Visa and MasterCard is fairly ubiquitous, and typically where one is accepted the other is likely to be as well. The exception to this tends to be when an event has been sponsored by one or other organisation, and they preclude other payment networks from being used. An example of this was the London Olympics where only Visa cards could be used in the Olympic venues and when purchasing event tickets from the official website.
To make payments card holders simply inform merchants that they wish to use their card to complete the purchase. The merchant would then use the card presented to them to submit a request via their merchant processor (payment card terminal) to the payment network. The payment network then contacts the issuer* to establish whether they will permit the transaction to be completed. If the issuer rejects the request the payment cannot proceed. If the issuer is happy for the payment to progress, they authorise the payment network, who in turn authorise the merchant processor to complete the transaction. The user is then required to authenticate the purchase to complete the process.
*American Express miss steps involved with contacting the issuer as they are always the issuer for their cards, operating what is called a 'closed loop'.
There are a number of ways a customer can, or may be required, to authorise a payment with their card, depending on the merchant processing equipment. Popular methods for authentication include;
The traditional way of authenticating a credit card transaction was by signing a slip, which the merchant retained, to confirm the transaction was valid. Merchants would check the signature on the slip matched the signature on the reverse of the card. If it did not match the transaction would not be processed and the customer would need to find another method to make the payment.
Chip & Pin
In the UK the most common form of payment process is via a chip & pin terminal. A card is simply inserted into the slot for EMV payments, chip first. The user is then required to enter their four digit pin number to confirm the purchase.
When an issuer is suspicious of a particular transaction they may require a card holder to speak to them to confirm security details. This is unusual and card holders should note that they will never be asked to disclose their pin number - if they are asked for this, the call is almost certainly bogus.
If a user makes a purchase online they are usually required to complete an additional step beyond simply entering their card details and CVV. Major payment processor systems include;
- Verified by Visa
- MasterCard SecureCode
- 3D Secure (American Express)
Online authentication systems require users to enter additional security information, such as address or postal code, CVV, security code (for American Express) and date of birth,. These additional measures proved to be effective in reducing the prevalence of online credit card fraud.
Mobile wallet systems
Mobile wallet systems operate using the RFID proximity readers included within payment terminals to enable contactless payments. Users are required to add their credit cards to their mobile device (which can be as easy as taking a photograph of them). When a user wishes to make a payment, they simply tap the payment terminal as they would when using a contactless card. Payments using mobile wallet systems are thought to be more secure than other authentication systems since either a fingerprint or pin code is required to use the app and no credit card details are publicly displayed at any time during the transaction.
In the case of contactless payments (which are intended to be quick), no authorisation is required whatsoever. Contactless card holders simply tap the proximity chip within their card on the reader and are able to make purchases of up to thirty pounds with no need for further authentication.
How are Credit Card Companies regulated?
In the In the UK, credit card companies are ultimately regulated by the FCA (Financial Conduct Authority) who superseded the governance of the Office of Fair Trading (OFT), but the act of supplying and advertising credit must also be undertaken in accordance with the broader legal framework which applies throughout the UK.
Specific legalisation which covers supplying credit to the general public includes;
Consumer Credit Act 1974 (CCA)
The Consumer Credit Act 1974 (CCA) was instrumental in establishing much of the consumer credit framework which now exists in the UK. Prior to the CCA, UK law governing the supply of credit in the UK was piecemeal. Laws had evolved organically to codify regulation for specific products, but never the entire credit industry.
The introduction of the CCA brought to bear a more holistic approach to UK credit regulation; informed by the findings of the Crowther Committee (which took six years to report), it harmonised the regulation of all credit products and established a Consumer Credit Division within the newly formed Office of Fair Trading to administer and enforce the provisions of the Act, including;
- Licencing of businesses undertaking credit related businesses
- Controls on methods for customer acquisition
- Credit agreement disclosures and prominence
- Controls on Ancillary credit businesses (including debt collecting & reference agencies)
The Act took around five years to go from assent to implementation and revolutionised the UK credit industry, heralding the focus on consumer protection (that remains the central focus of regulators today) with checks and balances to ensure consumers do not get 'over indebted', and protection against credit directly held against faulty goods with Section 75
Consumer Credit Act. 2006
The Consumer Credit Act. 2006 sought to build on the existing framework of the original 1974 Act. It increased certain sums contained within the original legislation, to reflect inflation and increased levels of borrowing, and increased the power of the OFT to impose and police conditions placed on businesses who receive licences. It also granted consumers of credit the option to seek redress from the Financial Ombudsman Service (FOS) if they were unhappy with their lenders resolution (or lack thereof).
Provisions in the CCA are due for Parliamentary review by 2019.
Consumer Credit Directive (CCD)
The Consumer Credit Directive was introduced to the UK market in February 2011, having been adopted by the European Council in May 2008. It was designed to be the first step in developing a pan-European market for credit products. As such, it sought to harmonise credit regulation across all member states, with common rules, terminology and approaches to advertising products (to help simplify credit comparison for consumer).
In some respects the CCD was a retrograde step in the UK, since we already had a well-regulated, established and competitive credit market. But since the directive applied across all EU markets it needed to be accessible and relevant to all. As such, the term "Typical", which referred to 66% of new applicants, was replaced with "Representative", which was only required to apply in 51% of applicants. This enabled UK credit suppliers to offer poorer credit card terms to a greater number of applicants than ever before. Conversely, it also meant they could be more generous with offers than ever before, safe in the knowledge that they could restrict who was accepted.
However, the CCD also bought much needed change to the way lenders could allocate customer payments; forcing credit card issuers to use payments to clear the most expensive debt first.
The CCD also sought to make product comparison easier with the introduction of the 'Representative Example', which (without marketing terminology) enables consumers to quickly compare interest rates on a like-for-like basis.
Consumer Credit Sourcebook (CONC)
As of 1st April 2014 the FCA gained full responsibility for regulating all UK consumer credit activities from the OFT, and from the outset made it clear it intended to refocus efforts on firms considered to be of higher risk to consumers (payday lenders, pawnbrokers and debt collectors). Radical changes were not required, but a change of emphasis and reiteration of previous Regulators guidance, and improved clarity regarding expectations of regulated firm was.
As such, on 28th February 2014 the FCA published the Consumer Credit sourcebook (CONC). With CONC the FCA sought to dispel confusion regarding UK consumer credit regulation; spelling out in different categories the FCA rules, together with guidance as to how firms were expected to apply them. CONC also changed the ways firms were expected to police each other, making firms responsible for ensuring their partners were fully compliant with its provisions.
CONC continues to be amended to meet ongoing needs, but remains the cornerstone of UK credit industry regulation.
Data Protection Act 1998
All businesses in the UK must comply with the eight data protection principles set out in the Data Protection Act 1998, but its provisions have particular resonance for the credit reference agencies used by credit card issuers and other lenders when accessing applications.
The Act restricts how credit reference agencies must process and secure data. It sets limits on the period of time that specific data elements can be kept in a credit file for (6 years in the case of most bankruptcy, IVA and CCJs) and gives access to credit reports for people who request it in writing from the reference agency.
The Act also gives individuals the right to complain to the Information Commissioners Office (ICO) if they feel credit reference agencies are not adhering to the principles of the Act, although it should be noted that there is no absolute right to data accuracy, only that reasonable steps have been taken to ensure it is correct.
Regulation on Interchange Fees for Card-based Payment Transactions 2015 (IFR)
In July 2013 the European Commission published proposals to restrict the interchange fees paid by merchants for processing payment card purchases to 0.2% for debit cards and 0.3% for credit cards.
The aim of the regulation was to harmonise interchange throughout the EU, remove barriers to free trade and help merchants reduce their costs (which would result in lower pricing for consumers). Indeed, the caps were set at levels it was believed merchants would be indifferent as to whether they were paid in cash or by payment card, the 'Merchant Indifference Test'.
In 2015 the proposals were passed by the European Parliament and came into force towards the end of that year.
Self-Regulation & Trade Bodies
Aside from the legal framework; credit card issuers are heavily influenced by various trade bodies and self-regulators. Although these groups do not regulate in their own right, they do help steer deployment of regulation, and lobby on behalf of the industry to shape its future direction, and set voluntary codes of practice which operators adhere to. These bodies include;
The Lending Standards Board
Established in 2009 and sponsored by the British Bankers' Association and UK Cards Association, the Lending Standards Board principally exists to monitor and enforce the Lending Code. The Lending Code is a voluntary code of practice for suppliers of unsecured credit in the UK, which seeks to ensure good lending practice to each and every touchpoint the consumer engages with during their credit life cycle.
UK Cards Association
Established in 2009 as a non-profit organisation, The UK Cards Association is a trade body that represents the payment card industry in the UK. It's members consist of UK card issuers and merchant acquirers (financial institutions that process card payments for merchants).
The UK Cards Association has a broad remit, which covers everything from promoting payments innovation (it was instrumental in pushing Chip & Pin technology) to defending the payments industry against fraud (sponsoring 'Financial Fraud Action UK' and the UK's 'Dedicated Cheque & Plastic Crime Unit' - a Metropolitan Police unit for fighting UK card and cheque fraud). Financial Fraud Action UK
Sponsored by the UK Cards Association, Financial Fraud Action UK seeks to equip UK consumers and businesses with the knowledge and tools to protect them from financial fraud.
The British Bankers' Association (BBA)
BBA Offices Founded in 1919, the British Banking Association is now the principle banking trade association in the UK. It represents around 230 members in the UK and internationally, helping to shape the industry to reflect its stated aims;
- Helping customers
- Promoting the growth of the UK banking industry
- Raising professional and ethical banking standards
In 2015 the BBA merged with Payments UK and the UK Cards Association, and absorbed their responsibilities, which it is due to start fulfilling exclusively towards the end of 2016.
Who offers credit cards in the UK?
The UK credit card market appears highly competitive and diverse, and in many respects it is. However, not all the brands who appearing to be offering credit cards in the UK offer them in their own right. A number of products are in fact 'white label' products; rebadged versions of other cards or products supplied in partnership with other issuers. Football and Charity products offer a good example of brands offering products in partnership with other issuers. Equally mergers and acquisitions have resulted in a number of banking brands joining forces. They may still issue under different brands, but much of the management and support functions are undertaken centrally. "White Labelling" isn't necessary an issue for customers day-to-day, but can be in certain instances.
Most credit card groups do not permit customers to transfer their balance between cards of the same issuer, or other brands within the group. This can cause difficulty if an individual does not appreciate the restrictions and applies for a product they cannot use to transfer an expensive balance - especially if an application recorded on their credit file impacts their ability to obtain further credit.
Shared Credit Scoring
Often products supplied by the same issuer group share the same scoring methodology, even where their pricing differs. This can prove particularly difficult for people with bad credit if they are declined for one product, then apply for another offered under a different brand with poorer pricing from the same group. In this instance the individual will see two applications appear on their file (hampering opportunities to apply with alternate lenders), the second of which they could not get, yet did not necessarily understand.
Despite the myriad of available brands there are fewer than thirty issuer groups in the UK. These include:
- Allied Irish Banks
- American Express
- Bank of China UK
- Bank of Ireland
- Capital One
- Clydesdale Bank
- Co-op Bank
- Coutts & Co
- Danske Bank
- John Lewis Financial Services
- Lloyds Banking Group
- M&S Bank
- Metro Bank
- Virgin Money
How do credit card issuers make money?
Credit card brands (and auxiliary credit businesses) are amongst the most well known in the UK. They sponsor sports events, football clubs and festivals, and can be extremely profitable. Yet 0% balance transfers, which are perhaps the cheapest way to borrow, grab the headlines and although people know that issuers have made money from PPI in the past, few understand how issuers make money day to day.
How much they make per booked account depends greatly on the terms of the product, but there are a number of different ways that issuers can make money.<;/p>
One of the most straightforward ways that credit card issuers can make money is by charging an annual fee for their products. There are costs associated with every account opened that issuers must bear, so in many respects it makes sense to past these costs on to the account holder.
Although a limited number of products do incur annual fees they are still uncommon in the UK. Fees tend to be charged on premium air mile card accounts or those with higher cash back rates, principally because higher 'earn rates' on these products leave little scope for issuers to make money elsewhere.
'Interchange Fees' are the fees that merchants pay to complete each and every payment card transaction they make. Historically they were used to cover the labour intensive processing of the carbon copy credit card slips that every transaction would have generated, but they now support the technical infrastructure required to enable electronic payments.
Because interchange fees are charged as a percentage of the purchase price, retailers of high value goods (especially where there is particular price sensitivity) have sought to pass the charges on directly to consumer ('low cost' airlines are a prime example of this). However, consumer frustration with perceived abuses of charges (many times higher than the actual interchange fee), coupled with an EU concern that prohibitively high fees might restrict free trade (especially for cross border transactions), has seen legislative action to restrict the levels of interchange chargeable to merchants.
EU regulation now caps interchange fees for Visa and MasterCard at 0.2% for debit cards and 0.3% for credit cards within the EU.
Interest charges on credit card balances are relatively straightforward to understand.
Every purchase made using a credit card entitles the card holder to a 'grace period&;#39; of up to 56 days to pay off the balance. However, if a balance is not cleared by the due date it attracts interest at agreed an rate (usually back dated to the date of the original purchase). When a balance is not cleared in full, credit card issuers use a 'payment hierarchy' to determine where to allocate the payments made. This is necessary because different uses of cards attract different interest rates. Cash withdrawals attract considerably higher rate than purchases, for instance.
Traditionally credit card issuers would use customer payments to clear the debt with the lowest interest rate, leaving balances which attract a higher rate to continue accruing interest. Changes brought about with the introduction of the Consumer Credit Directive in 2011 required all card issuers to change their payment hierarchies such that the most expensive debt is paid down first.
Fees & Charges
As well as having a wider impact on an individual's credit score; failure to meet the terms of credit agreements (like paying the minimum payment on time) can result in card holders incurring additional fees and charges such as late payment charges, and fees for notification letters.
How will credit cards of the future work?
Given the ubiquity of payment cards it can be hard to imagine a future without them, but it is almost a certainty that we eventually dispense with them. How long that takes, and what credit cards are replaced with is more uncertain. Current developments predominately seek to improve the functionality and security of existing cards, so investors clearly believe there is life in the existing card infrastructure. Likely short term developments include;
Although EMV (Chip & Pin payment) is secure, it still has vulnerabilities but uniqueness of fingerprints is practically impossible to fake. In collaboration with MasterCard, credit card issuers in Norway and Poland have now tested technology which requires fingerprint authentication for the card to become active to make payments with. This technology is expected in the UK over the next year and should revolutionise card security - especially were users are paying 'contactlessly'.
First developed in Australia, multi-function cards are becomingly increasing popular with banks and issuers, who are keen to ensure consumers can use their card where convenient. The technology works by enabling the users to access all their payment cards from a single plastic, in a similar way to a mobile wallet - meaning users can better access multiple reward programs, or use prepaid currency cards when abroad without changing their physical card.
Multi-function cards also have the benefit of users never having to carry their actual cards, so card numbers cannot be easily stolen and even terminal data is encrypted.
Dynamic CVV number
Likely to be deployed in 2017, dynamic CVV technology uses a small lithium battery and a computer chip, built into a standard card, to randomise the CVV number on the signature strip every few minutes. This effectively renders stolen credit card details useless within minutes and minimises the opportunity for online fraud.
Payment systems which use the unique 3D patterns made by veins in an individual's finger have already been tested in Poland and Japan (where the technology was developed) and as the unit cost of terminals declines, these passively secure payment technologies are likely to gain further traction.
Other developments to the physical cards are also likely, but given the rate of change in payment technology over the past 100 years, it could be that within a decade plastic cards are consigned to museum archives. Indeed, the future of payments is far more likely to be cybernetic or biometric - removing the need for cards, mobile phones or other devices altogether.
Of course in many respects the physical means of payment is unimportant. Cards are more convenient than cash, but the real benefit of credit cards is the way they simplify access to credit and the powerful consumer protection it affords people. Assuming these attributes are not consigned to the archives, credit cards will have left a powerful legacy to the world.
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