Why banks lose money when you swipe your card

Even as you swipe your credit/debit card with carefree abandon at merchant outlets, banks are losing money to the tune of Rs 3,800 crore annually, says Soumya Kanti Ghosh.

Banks have installed more than 13 lakh PoS (point of sale) terminals from October 2016 to July 2017, resulting in debit and credit card transactions at PoS increasing to Rs 685 billion in July 2017, from Rs 519 billion in October 2016 (with a peak of Rs 892 billion in December 2016).

This exorbitant increase in the number of PoS terminals has incurred a huge amount of cost to banks in creating the payments infrastructure in the country.

Most of us may not have adequate knowledge that every transaction at PoS is routed through a system of channels, which requires a well-equipped payments infrastructure set-up.

This payments infrastructure works on a four-party model: (i) issuing bank, (ii) acquiring bank, (iii) merchant and (iv) customer.

The issuing bank issues cards (debit/credit/prepaid) to the customer.

The acquiring bank bears the costs to create the infrastructure for PoS terminals.

Clearing and settlement, merchant training, terminal maintenance, supply of consumables etc are all done by the acquiring bank, while the issuing bank is involved with the cost of issuing the cards and also manages other risks related to card-holders such as failed transactions, frauds etc.

In this process, the cost is partly shared by the acquiring bank and partly by merchants. Against this backdrop it is pertinent to analyse the costs and revenues of the cards industry in India.

To understand the cost and revenue of the PoS business, we can construct a hypothetical example.

Though costs are myriad, revenues come only in the form of MDR (Merchant Discount Rate) and monthly rental. Post-demonetisation, the Reserve Bank of India has lowered the MDR to 0.25 per cent till end-March 2017, for transactions up to Rs 1,000.

This incentivised the merchants to accept cards for the payment but this has significantly impacted the revenues of banks, as most of the transactions are in small amounts.

The monthly rental of PoS terminals varies from bank to bank.

To estimate the cost/revenue, we have simplified the example that only Rs 100 has been transacted by credit (debit) card over PoS terminals. Since there were 28.4 lakh PoS machines in the country as of July 2017, which handled credit card and debit card transactions of 390 million (the average from November 2016 to July 2017), it translates roughly into 150 transactions through each PoS machine per month.

We use this number as the starting point for calculating per transaction cost of consumables, monthly rental, etc.

Scenario 1: OFF-US transactions (approximately 70 per cent share)

When both the acquiring bank and the issuing bank are different entities (OFF-US transactions), we estimate that the acquiring bank has a net loss of Rs 1.09 per Rs 100 credit card transaction.

With transactions worth Rs 300 billion (monthly average) that happened on PoS terminals during November 2016-July 2017, this translates into an annual loss of Rs 2,700 crore.

In the case of debit cards, interchange cost and MDR vary with the transaction amount and we have estimated that there is a loss of Rs 0.64 per Rs 100 debit card transaction.

With transaction worth Rs 375 billion, the annual loss is at Rs 2,000 crore. The net revenue loss is thus around Rs 4,700 crore in Scenario 1.

Scenario 2: ON-US transactions; (approximately 30 per cent share)

If both the acquiring bank and the issuing bank are same (ON-US transactions), there is no interchange fee.

In this scenario, the net revenue gain per annum from ON-US transaction of credit and debit cards at PoS would be around Rs 900 crore. Hence the total net loss for ON-US plus OFF-US transactions to the banks is around Rs 3,800 crore.

The government has been pushing the banks to install more PoS machines, but at the current MDR charges and with the same level of transaction this raises the question of viability of the entire business.

Despite the rationalisation of MDR charges, most of the merchants are either not accepting cards or charging extra, up to two per cent over and above the cost of the product.

As per the agreement with bank, the merchant should be bearing the cost of MDR but they are transferring the entire cost to the customer.

Further, a better telecom infrastructure is needed to drive the digital payments agenda of the government successfully. This can be achieved by ensuring a dedicated spectrum for financial transactions alone, as there is insufficient quantum of spectrum for the infrastructure to take the additional load.

With the launch of Bharat QR code, the retail electronic payments will become more seamless to enable digital payments without using the physical card swiping machines and cards. Hence, it is a better alternative to PoS.

Making payment to the government in the way of taxes, bills etc should be done mandatorily through digital mode, thereby helping to drive digitalisation in the country.

Sumit Jain and Tapas Parida also contributed to the article. The views are personal.

Photograph: Mighty Travels/Creative Commons.