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Credit Card Industry Fact Sheet

DATA SHEET The Credit Card IndustryThe Credit Card Industry is a global, multi-lingual, multi-currency based financial services business. Thisbusiness is dominated by a few key players like Visa, MasterCard who provide the infrastructure for creditcard transactions and card issuers like MBNA, Citibank and American Express who provide the creditcard and credit to the customer. They may also play the role of an acquirer for enabling credit cardtransactions with merchants and banks. The Business Model has fixed ongoing infrastructure costs thatare a part of running the business. The Credit Card Vendors are looking for a better ROI on these fixedcosts as competition increases, brand loyalty decreases, margins decline and customers and merchantsare increasingly savvy about their credit card benefits. A new threat in the form of debit cards has alsoimpacted this mature Industry.

Participants

Merchant: A vendor of goods or services who accepts a credit card as a form of payment.

Acquirer: An acquiring financial institution (or "acquirer") contracts with the bank, card issuers andmerchants to enable credit card transactions. The acquirer deposits the daily credit card totals and debits

the end-of-month processing fees from the merchants accounts.

Customer: An individual or a business that uses a credit card to procure goods and services.

Network: A company that is authorized by the acquirer to capture, authorize and process merchanttransactions.

Card Issuer: An organization that issues cards to card holder and is responsible for billing the cardholder.

Association/Private Label: An organization like Visa, Master Card or American Express, Diners orDiscover which provides the brand names under which credit cards are issued. The associations markettheir brands along with the card issuers and share in the marketing costs. Visa and MasterCard areindustry standard and sponsored by a consortium of banks to ensure fairness in the credit card business.

The Transaction:

A merchant is a company accepting credit cards for retail, mail order, or Internet transactions. Themerchant has a deposit account with a merchant bank. The merchant has a contractual relationship withan acquirer who assigns them a merchant ID, purchases the merchant's credit card transactions at adiscount, and deposits funds into the merchant's bank. The merchant must choose an authorizationnetwork supported by, and paid by, the acquirer. The issuing bank makes the credit decision to issue thecard to the merchant's customer, sets their credit limit, and maintains all the details related to the cardtransactions. The cardholder applied for the card and is responsible for paying the bill from the issuingbank. Only an authorization network has direct access to issuing banks' computers to process credit cardauthorization requests.

To authorize a customer's card, the merchant creates an authorization request. This transaction containsthe card number, expiration date, amount, address verification service (AVS) data, the CVV2 numberfrom the signature area of the card, and other fields.

The merchant sends the transaction using a device or software certified by the authorization network. Thesystem dials the authorization network and sends the transaction to the authorization network hostcomputer. The network then inquires of the issuing bank, which authorizes or declines the transaction.For the merchant to be paid for the transaction, settlement must occur. The settlement is done the sameday on the Point of Sale or when fulfillment occurs.


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Credit Card Industry Status Quo:

This industry has matured in the US with a few big players like Citibank, MBNA, JPMC and Bank Onedominating the landscape. American Express and Discover Card are also major players with their ownprivate labels and not under the Visa and MasterCard Umbrella. Growth is limited in the US althoughglobal opportunities abound. Credit Card Usage has burgeoned in the US and stiff competition haslimited margins. The customer has benefited with lower interest rates and other perks. The credit cardbusiness is still subject to the vagaries of the economy.

In a competitive industry segment, the acquirers, issuers, associations and the networks play one or all ofthe roles. American Express for Instance plays all the above mentioned roles to maximize participation inthe credit card transaction process.

Key Credit Card Metrics (US 2001)

Top 10 Credit Card Vendors

Citibank

MBNA Bank One

Discover

Chase

Capital One

American Express

Bank of America

Providian

Fleet

Securitization:

Citigroup: $204 Billion. MBNA: $73 Billion.JPM/Chase: $75 Billion.

Fraud/Revenue Loss (Annual)

Stolen Cards $ 1 Billion

Bankruptcy $ 3 Billion Credit Card Fraud $ 10 Billion

Some Big Numbers

Total Available Credit $ 1.8 trillion

Total Credit Card Debt - $660 billion

Sales Volume ofo VISA $2.1 trilliono MC - $986 billiono AMEX - $298 billion

Credit Card Spending 1.3 trillion

Sub Prime Accounts 70 million

Credit Card Consumers 185 million

Credit Card Business Model Highlights

Securitization

Credit card receivables owed by customers to card issuers are treated as assets and securities areissued against those assets. The securities are traded as bonds and hence the term securitizing.Investors such as money market funds and pension plans buy these securities. That provides finance forlenders who recycle that into more credit card debt for customers by issuing more cards or higher credit

limits.

Sub Prime Cards

Individuals with less than stellar credit histories are targeted with credit card offerings. These credit cardofferings are accompanied by high interest rates and excessive fees. Providian pioneered this approachand did well until the economy slowed down which made it for difficult for these individuals to pay off theircredit card bills. The securitization of these credit card receivables and the securities issued against themare analogous to junk bonds in the credit market. Sub Prime Lending has come under the scrutiny of


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federal regulators because of the lenders predatory lending practices. Also, banks are required to keepsub-prime lending under limits by federal laws.

Affinity and Co-Branded Cards

MBNA pioneered this approach by marketing credit cards to professional and other communities which

are relatively affluent. The members of these communities have better credit histories which improves thequality of the credit card receivables and its securitization. These cards are called affinity cards becausethey affiliate with a group of people. Co-Branded cards are cards which are issued on behalf of anotherbrand to leverage the potential of both the card issuing vendor and the partner. Citibank for instance haspartnered with American Airlines to offer a credit card to its frequent flyers. Citibank lets users collect one

American Airline Mile for every dollar spent which influences the customer to spend on this co-brandedcard hence enhancing the profitability of the card.

Credit Card Industry Top 5 IT Initiatives

Fraud Detection

Visa and MasterCard have reduced credit card fraud to 6 cents for every 100 dollars of credit cardtransaction. Though this might seem small, the numbers are staggering as credit card usage soars to 5trillion dollars or more globally. Credit card companies and credit card infrastructure providers investsignificant ongoing resources in identifying credit card fraud. The internet has contributed to a rise incredit card fraud and investment in this area continues as a cost of running the business.

Call Center Productivity/Customer Experience

Credit card companies have significant call centers cists which operate 7/24/365. Automating thecustomer experience and reducing the talk time is a high priority for credit card companies. The internethas provided a framework for reducing call center costs as customers are lured to use the web for thecustomer experience. IT investment in this area has increased lately due to efficiencies in customerusing the web instead of the call center and opting for web statements instead of paper statements.

Up Selling and Cross Selling

Customers have different vendors for different financial services. Credit Card companies have become aplay as being acquirers or acquires for the customer bases to up sell other financial services likebrokerage, insurance, mortgage and investment advice. Citibank and American Express are setting thetrend by up-selling to their customer. Cross selling has become another profitable source of revenue forcredit card companies as they leverage their customer base information by selling products for othervendors and charging a portion of sales and charging a fee.

Mining the (un)Profitable Customer

A profitable customer for a credit card company is somebody who charges a lot to the credit card andfaithfully pays his credit card dues over a long period of time. Students, people who have just graduatedand people with several other profiles fit this description. An intelligent scan of the customer base willyield targeted lists which can be leveraged and incentives like lower interest rates can be given to thesecustomers as teasers and enticing them to spend and pay. Customers who have a potential for goingbankrupt should also be able to be identified so they can be incented with lower rates to pay off theircredit card balances or they can be denied further credit.


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Smart Cards A Wild Card

Smart Card which is popular in Europe has yet to catch up in the US due to several reasons, cultural andtechnological. Several Vendors, Financial Service Providers, Merchants, IT Providers, regulatoryauthorities have to come to terms with a common definition of a smart card and its capabilities. The battlefor a common definition of a smart card continues....This is a big opportunity for vendors to play a key role

in defining the capabilities of such a card as we have the infrastructure to do so across the enterprise.

Debit Card Threat

Debit cards have become increasingly popular with customers these days instead of paying with checks.This has posed a threat to the credit card industry from a revenue perspective. Since the debit carddirectly debits the customers bank account, the risk is reduced in the transaction and hence a debit cardtransaction is cheaper than a credit card transaction. Fortune magazine documented this in a recentarticle and the diagram below explains it all. Although one can have a Visa debit card which is Accepted

Anywhere Visa Is Accepted, a visa debit card is more expensive for the merchant than a regular debitcard. Battle Lines have been drawn between Visa and the merchants in this case.

As can be seen clearly, everybody benefits from a debit card transaction. The credit card has its place for

certain transaction types.

Source: Fortune MagazineTechnology as a Key Business Process Enabler in the Credit Card Industry

Citibank in India has pioneered the use of Wireless Technology to authenticate credit card transactions.The Indian Telephone and Communications Network is very cumbersome and expensive to use in bigcities because the lines may be busy or the merchant may not be able to procure a telephone or network

RetailerKeep$98.20

Ski LiftPackage$100.00

AcquirerKeeps$0.05

RetailersBank Keeps$0.23

IssuingBank Keeps$1.48

Visa/MCKeep$0.04

$1.80 $1.75 $1.50

$0.02$0.02

RetailerKeep$99.80

ProcessingAgentKeeps$0.05

IssuingBank Keeps$0.13

PIN NetworkKeeps$0.02

$0.20 $0.15 $1.50


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line because of the delays and the reliability of the government owned network. Hence using an EDCterminal is not a feasible option for a lot of merchants. These merchants had to use a manual processwhich increased the potential for fraud until now. Wireless technology is however private and readilyavailable and state of the art. The Merchant has a cell phone with a high capacity SIM Card. The phonehas special software which can accept card numbers and other card information. This information istransmitted to the Bank as an SMS message. The bank reads the message and check whether this cardcan be accepted or not and send another SMS message back to the merchant indicating acceptance ordenial of the charge. If the card is accepted, the merchant continues the transaction and the regulartransaction process of the credit card follows.

Technologically, the convergence of mobile phone and SMS technologies with card paymentsystems was a significant challenge. It meant developing the application on the SIM Card whileensuring data security and converting the SMS standard into the appropriate format recognizableby the Cards Switch for an authorization.

Executive Summary

The credit card industry is consolidating with a few major players dominating the landscape. Theseplayers are trying innovative financial instruments to leverage their portfolios. Securitization of credit cardreceivables is one such example. This has come under increasing scrutiny from federal regulatorsbecause of their accounting treatment. Technology could be used as a significant differentiator in thismature industry for the major participants to take market share from the other players. Citibank is apioneer in this area as shown in the section above.

The internet, wireless, messaging and smart cards could be a major factor in the next generation of creditcards.

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