Housing finance in India

Housing – A Macro View 1

(in million) (Source: Census of India, 2001)

1981 1991 2001   Growth  Growth 

of 1991  of 2001 
over  over 
1981  1991 
(%) (%)
Population
Rural 523.87 628.70 742.00 20.01 18.02
Urban 159.46 217.60 285.00 36.46 30.97
1027.0
Total 683.33 846.30 0 23.85 21.35
Census Houses
Rural 113.96 142.98 177.50 25.47 24.14

of which pucca 
residential stock (in %) 22.53 30.58 35.36 --- ---
 Housing Finance - A Key Driver
for Economy
• It is a basic necessity, for an individual.

• supports economic activities, for a family / community.

• is a catalyst, for creating multiplier effect in other sectors.

• is a labour intensive activity, for increasing the per

capita income.

• is an engine of growth, for the national economy

Housing Finance - A Key Driver for
Economy
• Strengthens the Financial System.

• Leads to Investment Demand.

• Increases the Assets Formation.

• Leads to Formation of Household Physical Assets.

• Serves the Social Cause.

• Key to Development of Human Settlement.

 1995-96 to 
Item 1998-99 (Ave) 1999-00 2000-01 2001-02 2002-03 2003-04

Household 
Saving 17.9 20.8 21.9 22.6 23.3 24.3

a. Financial
Assets 9.8 10.5 10.7 11.2 10.3 11.4

b. Physical
Assets 8.1 10.3 11.2 11.4 13.0 13.0
 Reasons for growth of housing
finance in India
• Liquidity in the System
• Lower Inflation Rate
• Softer Interest Rate Regime
• Housing Loan has the Lowest Non Performing Assets
(NPAs)
• Fiscal Concessions
• Legal Reforms
• Wider Network - Banks/Housing Finance Companies
• Consumer Friendly Products/Approach
• Increasing number of Real Estate Developers
Housing Finance Interest Rates in
India
 Characteristics of housing finance

• Long term finance with repayments

spread over 15-20 years

• Most of the people prefer loan at fixed

interest rate.

• The concept of variable interest rate is

slowly picking up with the expectation
of further southward movement of
interest rate.
 Characteristics of housing finance

• Market is becoming very competitive after

the entry of banks in financial institutions
in retail lending.

• The spreads are declining the competition

and unless long term funds at reasonable
interest rates are made available, it would
be very difficult to maintain bottomline.
 Housing shortage and resource
requirement
A. Housing shortage

• India is a vast country with a population of over 1 billion

people. More than 50 million people are living in slums.

• India has a current housing shortage of 22 million units

(both in rural and urban areas). It will increase to 42
million by the end of 9th five-year plan.

• Rural areas are still neglected, both under

infrastructure and housing, resulting in shift towards
urban centres.
 Housing shortage and resource
requirement
• India is far behind Asian Countries such as
Singapore, Hongkong, Malaysia, Bangkok,
Korea and China in fulfilling this basic human
need.

• These Countries made home ownership their

prime objective in the early 60's, gave stimulus
to the construction industry, made massive
investment in physical infrastructure.
 Housing shortage and resource
requirement
B. Resources requirement

• It is difficult to make a correct assessment of

requirement of resources required to meet the huge
shortfall in India.

• But the estimated requirement of resources for meeting

the existing shortfall is Rs. 150000 crores.

• Bulk of these resources will come from the formal sector

such as HFCs, Banks and FIs.
 Housing loan market in India
• The size of mortgage loan market is relatively very small
compared to developed countries. Our estimated size of
mortgage loans with HFCs is about Rs. 32000 crores.

• In developed countries like UK and USA, the outstanding

mortgage loan to GDP is above 55%, Japan 33%, Korea
over 10%, in Malaysia over 20% and Hongkong over
30%.

• In India the ratio is just around 1.6%. After including

other indirect agencies like Govt. and institutions, the
percentage share will be less than 2%
 Problems of long term finance in
India
• The mortgage loans are long term loans
for 15-20 years.

• In some countries such as Japan these are

also available for 25-30 years

• There are very limited options for

availability of funds for such a long period
and at a fixed interest rate.
 Problems of long term finance in
India
• The long term Debt market has not so far
developed or stabilised in India.

• Most of the institutions are suffering from asset

liability mismatch and the consequences would
be felt when liabilities will mature for payment.

• The interest rate risk will be exposed once the

interest rates start moving northwards.
 What is primary and secondary
market
• The primary market constitutes housing loan
companies (HFC’ s) and the borrower.

• The (HFC’ s) hold the mortgages of a

borrower in their books.

• The participants in the secondary market are

specialised institution, to whom housing loan
mortgages are sold by (HFC’ s) at a market
determined interest rate.
 What is primary and secondary
market
• These loans are sold in the market to interested
buyers in the form of mortgage backed securities
(MBS).

• These interested buyers could be insurance

companies, pension funds, mutual funds and even
individuals.

• By this process, the avenues for funds are increased,

there is a greater participation of individuals and the
housing finance company is able to raise the long-
term funds from the secondary market.
 Mortgage loan insurance
• In developed economies, the risk of default under
mortgage loans is covered under an Insurance Policy for
a nominal premium.

• As a result the Mortgage loans become risk free and

only 50% risk weight is allotted on Housing Loans, which
vastly improves Capital adequacy ratio.

• In India, in the absence of such Insurance cover, the risk

of non-payment/ failure exists to a larger extent and
hence the risk weight is 100%.
• Thanks to NHB, who want to introduce this Scheme by
starting a separate Subsidiary.

• The success of this Scheme will depend on the premium

rate.

• Indians are traditionally and emotionally attached to their

own house therefore, the default ratio is low.

• the recovery percentage is as high as 98 to 99%. Taking

this factor into consideration, RBI has now reduced the
Risk weight to 75% taking into account the good asset
quality.
 The national housing bank
(amendment) Act, 2000
• The parliament passed the 'National
Housing Bank (Amendment) Act, 2000' 
which has come into force from 16th June
2000.
• The need for a summary procedure was
long felt for housing finance institutions for
giving impetus for creation of 'Secondary
Mortgage Market'.
 National Housing Bank
Profile
• The National Housing Bank (NHB) was established on
9th July 1988 under an Act of the Parliament viz. the
National Housing Bank Act, 1987 to function as a
principal agency to promote Housing Finance Institutions
and to provide financial and other support to such
institutions.

• The Act, inter alia, empowers NHB to:

• Issue directions to housing finance institutions to ensure

their growth on sound lines
 National Housing Bank
Profile
• Make loans and advances and render any other
form of financial assistance to scheduled banks
and housing finance institutions or to any
authority established by or under any Central,
State or Provincial Act and engaged in slum
improvement and

• Formulate schemes for the purpose of

mobilization of resources and extension of credit
for housing
 National Housing Bank
Objectives
• NHB has been established to achieve, inter alia, the following
objectives:

• a. To promote a sound, healthy, viable and cost effective housing

finance system to cater to all segments of the population and to
integrate the housing finance system with the overall financial
system.

• b. To promote a network of dedicated housing finance institutions to

adequately serve various regions and different income groups.

• c. To augment resources for the sector and canalize them for

housing.
 National Housing Bank
Objectives
• d. To make housing credit more affordable.

• e. To regulate the activities of housing finance companies based on

regulatory and supervisory authority derived under the Act.

• f. To encourage augmentation of supply of buildable land and also

building materials for housing and to upgrade the housing stock in
the country.

• g. To encourage public agencies to emerge as facilitators and

suppliers of serviced land, for housing.
 National Housing Bank
Business Activities
• NHB, as the Apex level financial institution for the housing sector in
the country, performs the following roles:
•
(a) Promotion and Development:

• NHB operates as a multifunctional Development Finance Institution

(DFI) for the housing sector.

• The Bank's policies are directed towards promotion and

development of housing finance institutions. NHB has framed
guidelines for HFC’s with a view to promoting their development on
sound and healthy lines.

• The guidelines are reviewed and modified from time to time in the
light of developments in the financial and housing sectors.
 National Housing Bank
Business Activities
• All HFC’ s registered with the National Housing Bank u/s 29A of the
National Housing Bank Act, 1987 and inter alia having minimum net
owned funds of Rs.10.0 crores are eligible for refinance support.

• It has also contributed to the equity capital of five HFC’ s.

• NHB has a dedicated Training Division which organizes regular

training programs in areas relating to housing and housing finance
for development of management capabilities of officials working in
the sector.

• NHB‘ s promotional endeavors are also directed towards capacity

building for the housing finance system besides enlarging the credit
absorption capacity.
 National Housing Bank
Business Activities
• (b) Regulation and Supervision:

• NHB exercises regulatory and supervisory authority over

the HFC’ s in the matter of acceptance of deposits by
them pursuant to the powers vested in it under the Act.

• As per the amendments to certain provisions of the Act,

which came into effect from June 12, 2000, NHB is

• vested with powers to grant Certificate of Registration to

companies for commencing/carrying on the business of a
housing finance institution.
 National Housing Bank
Business Activities
• Besides, NHB regulates the deposit acceptance activities
in accordance with the Housing Finance Companies
(NHB) Directions, 2001, amended from time to time, in
the matter of ceiling on borrowings (including public
deposits, rate of interest, period, liquid assets, etc).

• NHB has also issued Directions on prudential norms in

regard to capital adequacy, asset classification,
concentration of credit, income recognition, provisioning
for bad and doubtful debts etc. NHB supervises the
working of HFCs through on-site inspection and off-site
surveillance.
 National Housing Bank
Business Activities
• C. Finance

• NHB raises resources for the housing sector towards

increasing new housing stock and provides refinance to
a large set of retail lending institutions.

• These include scheduled commercial banks, scheduled

state cooperative banks, scheduled urban cooperative
banks, specialized housing finance institutions, apex co-
operative housing finance societies and agriculture and
rural development banks.
 National Housing Bank
Business Activities
• Refinance is provided by NHB under various schemes,
which are formulated taking into account, several
aspects of the National Housing Policy, the constraints
facing the sector etc.

• NHB has also a window for direct lending to Public

Agencies such as, State Level Housing Boards and Area
Development Authorities for large scale integrated
housing projects and slum redevelopment projects.

• NHB is also operating a special window for extending

financial assistance to the people affected by natural
calamities viz. earthquake, cyclone etc.
 National Housing Bank
Business Activities
• (d) Resources of NHB

• NHB raises resources from diversified sources,

both domestic and external by issuing Bonds/
debentures, borrowing from RBI and financial
institutions/organizations etc.

• Under the Act, NHB is authorized to issue and

sell Bonds with or without the guarantee of the
Central Government for the purpose of carrying
on its functions.
 National Housing Bank
Business Activities
• (e) Rural Housing:

• NHB launched the "Swarna Jayanti Rural

Housing Finance Scheme" to mark the golden
jubilee of India's Independence.

• The Scheme seeks to provide improved access

to housing loans to borrowers for
construction/acquisition/ up-gradation of a house
in rural areas of the country.
 National Housing Bank
Business Activities
• (f) Recent Initiatives

• Securitization of mortgage loans of the retail lending

institutions facilitates for canalizing household savings
into the housing sector is seen as a potentially viable
market oriented alternative.

• Support to Mortgage backed securitization is a major

policy initiative of the Government as manifested in its
National Housing and Habitat Policy announced in 1998.
 National Housing Bank
Business Activities
• This policy emphasizes NHB‘ s lead role in
mortgage-backed securitization and development
of a secondary mortgage market in the country.

• As the apex body in housing finance sector in

India, NHB has been playing a lead role in the
sector in matters relating to policy environment as
also operational mechanism for the development
of a secondary mortgage market in India.
 National Housing Bank
Business Activities
• In order to resolve the twin problems of
affordability and accessibility affecting the
growth of the housing finance business and the
prospect of home ownership.

• NHB has been entrusted with the responsibility

of launching a Mortgage Credit Guarantee
Scheme for protecting the lenders against
default.
Venture capital
 Venture capital
• In India, venture capital has been around for
some time now.

• The performance has been mixed.

• The fundamental principal underlying venture

capital fund is "No return without risk and 
greater the risk, greater the return".

• Venture capital is a booster for new

entrepreneurs.
 Venture capital
• A venture capital fund is a fund, which in
many ways is like mutual fund.

• It raises funds from several investors, who

generally have a large appetite for risk
and are looking out for greater returns.
 Venture capital
• These funds are then invested in several
fledging enterprises, which need funds,
but are unable to access them through the
conventional sources such as banks and
financial institutions.

• Typically, such enterprises are started by

first generation entrepreneurs.
 Venture capital
• Since most of the ventures financed through this route
are in new areas, the probability of their success is very
low.

• The venture capitalist is however not worried because

the deal, which succeeds, nets a very high return on his
investments.

• The return generally comes in the form of selling the

stocks when they get listed on the stock exchange.

• If the venture fails (more often then not), the entire

amount gets written off.
 Venture capital
• Venture capital funding may be by way of investment in
the equity of the new enterprise or by way of debt or a
combination of both, though equity is the most preferred
route.

• To conclude, a venture financier is one who funds a start

up company, in most cases promoted by a first
generation technocrat promoter with equity.

• Exit is preferably through listing on stock exchanges.

 Venture capital
• This method has been extremely successful in
USA, and venture funds have been credited with
the success of technology companies in Silicon
Valley.

• The entire computer industry thrives on it.

• One can ask why venture funding is so

successful in USA and has a not-so-impressive
track record in India.
 Venture capital
• For any venture idea to succeed, there should
be a product which has a growing market with a
scalable business model.

• The IT industry (which is most suited for venture

funding because of its "ideas" nature) in India till
recently had a service centric business model.

• Products developed for Indian markets lack

scale.
 Venture capital
• Also, till early 90s, under the license raj regime, only
commodity oriented businesses thrived in a deficit
situation.

• To fund a cement plant, venture capital is not needed.

What was needed was ability to get a license and then
get the project funded by the banks and DFI’s.

• In most cases, the promoters were well established

industrial houses, with no apparent need for funds.
Venture capital funding in
India
• Traditionally, the role of venture capital was an
extension of the developmental financial
institutions like IDBI, ICICI, SIDBI, State Finance
Corporations, etc.

• TDICI (now ICICI ventures) and Gujarat Venture

were one of the first venture capital
organizations in India.

• Both these organizations were promoted by the

financial institutions.
Venture capital funding in
India
• However, it was realized that the concept of venture
capital funding needed to be institutionalized and
regulated.

• Besides this funding requires different skills in assessing

the proposal.

• Thus dedicated funds providing only venture capital

funds have been formed.

• The sources of these funds are normally the financial

institutions or foreign institutional investors or pension
funds and high net-worth individuals etc.
Venture capital funding in
India
• Though an attempt was also made to raise funds from
the public and fund new ventures.

• Certain venture capital funds are industry specific (i.e.

they fund enterprises only in certain industries such as
pharmaceuticals, InfoTech or food processing, etc)
whereas others may have a much wider spectrum.

• Securities and Exchange Board of India (SEBI) has

come out with guidelines to which a venture capital fund
has to adhere in order to carry out its activities in India.
Venture capital funding in
India
• There are a number of funds which are currently
operational in India and involved in funding start-up
ventures.

• Most of them are not true venture funds as they do not

fund start ups.

• What they do is provide mezzanine or bridge funding

and are better known as private equity players.

• This article aims to give a bird-eye’s view of the various

guidelines a venture fund has to adhere to in India.
Venture capital funding in
India
• In 1973, a committee on the development
of small and medium-sized enterprises
highlighted the need to foster venture
capital as a source of funding for new
entrepreneurs and technology.
Venture capital funding in
India
• Later, a study was undertaken by the World
Bank to examine the possibility of developing
venture capital in the private sector, based on
which the Indian government took a policy
initiative and announced guidelines for venture
capital funds (VCFs) in 1988.

• However, these guidelines restricted the setting

up of VCFs to the banks or the financial
institutions only.
Venture capital funding in
India
• Thereafter, some public sector funds were
established but the activity of venture
capital did not gather momentum as the
thrust was on high-technology projects
funded on a purely financial rather than a
holistic basis.
Venture capital funding in
India
• Internationally, the trend favored venture
capital being supplied by smaller-scale,
entrepreneurial venture financiers willing
to take a high risk in the expectation of
high returns, a trend that has continued in
this decade
Venture capital funding in
India
• In September 1995 the Indian government issued guidelines for
overseas investments in venture capital in India.

• For tax exemption purposes, the Central Board of Direct Taxes

(CBDT) issued guidelines.

• The flow of investments and foreign currency in and out of India has
been governed by the Reserve Bank of India's (RBI) requirements.

• Furthermore, as part of its mandate to regulate and to develop the

Indian capital markets, the Securities and Exchange Board of India
(SEBI) framed the SEBI (Venture Capital Funds) Regulations, 1996.
 Objective and vision for venture
capital in India
• Venture capital is very different from traditional
sources of financing.

• Venture capitalists finance innovation and ideas,

which have a potential for high growth but with
inherent uncertainties.

• This makes it a high-risk, high-return investment.

Apart from finance, venture capitalists provide
networking, management and marketing support
as well.
Venture capital funding in
India
• In the broadest sense, therefore, venture
capital connotes human as well as
financial capital.

• In the global venture capital industry,

investors and investee firms work together
closely in an enabling environment that
allows entrepreneurs to focus on value
creating ideas
Venture capital funding in
India
• Venture capitalists, meanwhile, drive the industry
through ownership of the levers of control in
return for the provision of capital, skills,
information and complementary resources.

• This very blend of risk financing and

handholding of entrepreneurs by venture
capitalists creates an environment particularly
suitable for knowledge and technology-based
enterprises
Venture capital funding in
India
• Scientific, technological and knowledge-based ideas -
properly supported by venture capital - can be propelled
into a powerful engine of economic growth and wealth
creation in a sustainable manner.

• In various developed and developing economies, venture

capital has played a significant developmental role. India,
along with Israel, Taiwan and the US, is recognized for
its globally competitive high technology and human
capital.
Venture capital funding in
India
• India's recent success story in software and IT is
almost a fairy tale when considering obstacles
such as inadequate infrastructure, expensive
hardware, restricted access to foreign skills and
capital, and limited domestic demand.

• It also indicates the potential India has in terms

of knowledge and technology-based industry.
Venture capital funding in
India
• India has the second largest English speaking
scientific and technical manpower in the world.

• Some of its management (IIMs) and technology

institutes (IITs) are known globally as centres of
excellence.

• Every year, over 115,000 engineers graduate

from government-run and private engineering
colleges.
Venture capital funding in
India
• Many also graduate with diploma courses
in computers and other technical areas.
Management institutes produce 40,000
management graduates annually.

• All of these candidates are potential

entrepreneurs.
• It is also important to recognise that while
India is doing very well in IT and software,
it is still behind in terms of product and
packaged development.

• Many experts believe that just as the US

did in the semiconductor industry in the
eighties, it is time for India to move to a
higher level in the value chain.
• This is not expected to happen automatically.

• The sequence of steps in the high technology

value chain is information, knowledge, ideas,
innovation, product development and marketing.

• Basically, India is still at the level of ‘knowledge'.

• Given the limited infrastructure, low foreign
investment and other transitional problems, it
certainly needs policy support to move to the
third stage - ie, ideas - and beyond, towards
innovation and product development.

• This is crucial for sustainable growth and for

maintaining India's competitive edge.

• This will take capital and other support, which

can be provided by venture capitalists.
Venture capital funding in
India
• India also has a vast pool of existing and on-
going scientific and technical research carried
out by a large number of research laboratories,
including defense laboratories as well as
universities and technical institutes.

• A suitable venture capital environment - which

includes incubation facilities - can help a great
deal in identifying and actualizing some of this
research into commercial production.
Venture capital funding in
India
• The development of a proper venture capital
industry, particularly in the Indian context, is
needed if high quality public offerings (IPO's) are
to be achieved.

• In the present situation, an individual investor

becomes a venture capitalist of a sort by
financing new enterprises and undertaking
unknown risks.
•
Venture capital funding in
India
• Investors also get enticed into public
offerings of unproven and at times dubious
quality.
• This situation can be corrected by
venture-backed successful enterprises
accessing the capital market.

• This will also protect smaller investors.

 Income tax benefits
• In order to encourage the development of venture capital
funds, the Income Tax Act, 1961 exempts the income of
a venture capital fund from income tax.

• Income of a Venture Capital fund [section 10(23FB)] (on

and from Financial Year 1999-2000.

• Any income of a Venture Capital Fund ( VCF ) or a

Venture Capital Company ( VCC ) set up to raise funds
for investment in a Venture Capital Undertaking ( VCU )
is exempt.
 Income tax benefits
• VCC means a company which has been granted
a certificate of registration by SEBI and which
fulfils the conditions laid down by SEBI with the
approval of the Central Government.

• VCF means a fund operating under a trust deed

registered under the Registration Act, 1908,
which has been granted a certificate of
registration by SEBI and which fulfils the
conditions laid down by SEBI with the approval of
the Central Government.
MERCHANT BANKING
 Definition
Merchant banking may be defined as, ‘an 
institution  which  covers  a  wide  range 
of  activities  such  as  management  of 
customer  services,  portfolio 
management,  credit  syndication, 
acceptance  credit,  counselling, 
insurance etc.
The  Notification  of  the  Ministry  of  Finance 
defines  a  merchant  banker  as,  “  any  person 
who is engaged in the business of issue
management  either  by  making  arrangements 
regarding  selling,  buying  or  subscribing  to 
the  securities  as  manager,  consultant, 
advisor  or  rendering  corporate  advisory 
service  in  relation  to  such  issue 
management.
• A merchant banker is a financial intermediary who 
helps to transfer capital from those who possess it 
to those who need it. 
• Merchant banking includes a wide range of 
activities such as management of customers 
securities, portfolio management, project 
counseling and appraisal, underwriting of shares 
and debentures, loan syndication, acting as 
banker for the refund orders, handling interest and 
dividend warrants etc. 
• Thus, a merchant banker renders a host of 
services to corporate and merchant banker 
promotes industrial development in the country.
 Services of merchant banks:
• A merchant banker helps in the process of issue
management and his services are broadly
categorized as pre-issue management and post
issue management.
• The pre-issue management involves the following:
• Ø Printing prospectus
• Ø Pricing of issues
• Ø Marketing the issue
• Ø Underwriting
• Ø Listing of securities in stock exchange
• Post issue management includes the
following:
• Ø Collection of application forms
• Ø Screening the applications
• Ø Deciding allotment procedure
• Ø Mailing of letter of allotment
• Ø Issue of share certificates
• Ø Refund of application money to non-
allotters
• A merchant banker acts as a liasoning officer at
the event of mergers and acquisitions. He helps
the company in managing its portfolio. A
merchant banker help their clients in off shore
financing such as long term foreign currency
loans, joint ventures abroad, licensing and
franchising, financing exports and imports,
foreign collaboration arrangements etc
• The services of Merchant bankers also include
investment advisory to Non-Resident Indians in
terms of identification of investment
opportunities, selection of securities, investment
management etc. They also take care of the
operational details like purchase and sale of
securities, securing necessary clearance from
RBI.
CREDIT CARDS
• A credit card is a thin plastic card, with a
magnetic strip usually 3-1/8 inches by 2-1/8
inches in size that contains identification
information such as a signature or picture, and
authorizes the person named on it to charge
purchases or services to his account -- charges
for which he will be billed periodically.

• Today, the information on the card is read by:

automated teller machines (ATMs), store
readers, and bank and Internet computers.
 Who invented credit cards?
• A credit card is an automatic way of offering 
credit to a consumer.
• Credit is a method of selling goods or services
without the buyer having cash in hand.
• A credit card is only an automatic way of
offering credit to a consumer.
• Today, every credit card carries an identifying
number that speeds shopping transactions.
• Imagine what a credit purchase would be like
without it, the sales person would have to record
your identity, billing address, and terms of
repayment.

• According to Encyclopedia Britannica, "the use

of credit cards originated in the United States
during the 1920s, when individual firms, such as
oil companies and hotel chains, began issuing
them to customers."
• However, references to credit cards have
been made as far back as 1890 in Europe.

• Early credit cards involved sales directly

between the merchant offering the credit
and credit card, and that merchant's
customer.
• Around 1938, companies started to accept
each other's cards.

• Today, credit cards allow you to make

purchases with countless third parties.
 The shape of credit cards
• Credit cards were not always been made
of plastic.

• There have been credit tokens made from

metal coins, metal plates, and celluloid,
metal, fiber, paper, and now mostly plastic
cards.
 First bank credit card
• The inventor of the first bank issued credit card
was John Biggins of the Flatbush National Bank
of Brooklyn in New York.

• In 1946, Biggins invented the "Charge-It"

program between bank customers and local
merchants.

• Merchants could deposit sales slips into the

bank and the bank billed the customer who used
the card.
 Diners club credit card
• In 1950, the Diners Club issued their credit card in the
United States.

• The Diners Club credit card was invented by Diners' Club

founder Frank McNamara and it was intended to pay
restaurant bills.

• A customer could eat without cash at any restaurant that

would accept Diners' Club credit cards.

• Diners' Club would pay the restaurant and the credit card
holder would repay Diners' Club.
• The Diners Club card was at first technically a
charge card rather than a credit card since the
customer had to repay the entire amount when
billed by Diners Club.

• American Express issued their first credit card in

1958.

• Bank of America issued the BankAmericard

(now Visa) bank credit card later in 1958.
 Popularity of credit cards
• Credit cards were first promoted to traveling
salesmen (more common in that era) for use on
the road.

• By the early 1960s, more companies offered

credit cards, advertising them as a time-saving
device rather than a form of credit.

• American Express and MasterCard became

huge successes overnight.
• By the mid-'70s, the U.S. Congress begin
regulating the credit card industry by
banning such practices as the mass
mailing of active credit cards to those who
had not requested them.

• However, not all regulations have been as

consumer friendly.
• In 1996, the U.S. Supreme Court in Smiley
vs. Citibank lifted restrictions on the
amount of late penalty fees a credit card
company could charge.

• Deregulation has also allowed very high

interest rates to be charged.
 Understanding credit cards
• Credit Card – A credit card is a financial
instrument, which can be used more than once
to borrow money or buy products and services
on credit. Banks, retail stores and other
businesses generally issue these.

• Credit limit – The maximum amount of charges

a cardholder may apply to the account.
• Annual fee – A bank charge for use of a credit card
levied each year, which ranges depending upon the type
of card one possesses. Banks usually take an initial fixed
amount in the first year and then a lower amount as
yearly renewal fees.

• Revolving Line Of Credit - An agreement to lend a

specific amount to a borrower and to allow that amount
to be borrowed again once it has been repaid. Most
credit cards offer revolving credit.
• Personal Identification Number (PIN) - As a
security measure, some cards require a number
to be punched into a keypad before a
transaction can be completed. The number can
usually be changed by the cardholder.

• Teaser Rate - Often called the introductory rate,

it is the below-market interest rate offered to new
customers to switch credit cards.
• Joint Credit - Issued to a couple based
on both of their assets, incomes and credit
reports. It generally results in a higher
credit limit, but makes both parties
responsible for repaying the debt.
 Types of cards
• MasterCard – Master Card is a product of MasterCard
International and along with VISA are distributed by
financial institutions around the world.

• Cardholders borrow money against a line of credit and

pay it back with interest if the balance is carried over
from month to month.

• Its products are issued by 23,000 financial institutions in

220 countries and territories.

• cards in circulation, whose users spent $650 billion in

more than 16.2 million locations.
• VISA Card – VISA cards is a product of VISA USA and
along with MasterCard is distributed by financial
institutions around the world.

• A VISA cardholder borrows money against a credit line

and repays the money with interest if the balance is
carried over from month to month in a revolving line of
credit.

• Nearly 600 million cards carry one of the VISA brands

and more than 14 million locations accept VISA cards.
• Affinity Cards - A card offered by two
organizations, one a lending institution, the other
a non-financial group.

• Schools, non-profit groups, pro wrestlers,

popular singers and airlines are among those
featured on affinity cards.

• Usually, use of the card entitles holders to

special discounts or deals from the non-financial
group.
• Classic Card – Brand name for the
standard card issued by VISA.

• Gold Card/Executive Card – A credit
card that offers a higher line of credit than
a standard card. Income eligibility is also
higher.
• In addition, issuers provide extra perks or
incentives to cardholders.
• Standard Card – It is the most basic card
offered by issuers.

• Platinum Card – A credit card with a

higher limit and additional perks than a
gold card.
• Titanium Card – A card with an even higher limit
than a platinum card.

• Secured Card – A credit card that a cardholder

secures with a savings deposit to ensure
payment of the outstanding balance if the
cardholder defaults on payments.

• It is used by people new to credit, or people

trying to rebuild their poor credit ratings.
• Smart Card – Smart cards, sometimes called chip cards,
contain a computer chip embedded in the plastic.

• Where a typical credit card's magnetic stripe can hold

only a few dozen characters, smart cards are now
available with 16K of memory.

• When read by a special terminals, the cards can perform

a number of functions or access data stored in the chip.

• These cards can be used as cash cards or as credit

cards with a preset credit limit, or used as ID cards with
stored-in passwords.
• Charge Card – Falls between a debit and credit
card. Works like the latter and you don't have to
be an accountholder.

• Just pay up in full when the bill arrives with the

mail.

• No outstanding are allowed, in other words, no

revolving credit facility either.

• American Express and Diners are providers.

• Rebate Card – This is a card that allows
the customer to accumulate cash,
merchandise or services based on card
usage.
• Cash Card – Cash cards, similar to pre-paid
phone cards, contain a set amount of value,
which can be read by a special cash card
reader.

• Participating retailers will use the reader to debit

the card in increments until the value is gone.

• The cards are like cash -- they have no built-in

security, so if lost or stolen, they can be used by
anyone.
• Travel Card – These work mostly as debit
cards for the limited purpose of travel.

• Citibank Dollar Card, American Express,

Bobcard Global and Hongbank Bank
Thomas Cook International Card are
among the players in this section.
• Debit Card – It is the accountholder's mobile ATM.

• Open an account with a bank that offers a debit card, and

payments for purchases are deducted from your bank
account.

• The retailer swipes the card over an electronic terminal at

his outlet, you enter the personal identification number
on a PIN pad and the money is immediately debited at
the bank.

• Citibank and a few domestic banks like Times Bank offer

this.
 Cost implications for the banks
• Credit card issuers (banks) have several types of costs:
• Interest Expenses.

• Banks generally borrow the money that they then lend to their
customers.

• As they receive very low-interest loans from other firms, they may
borrow as much as their customers require, while lending their
capital to other borrowers at higher rates.

• If the card issuer charges 15% on money lent to users, and pays 5%
on that same amount, they are essentially making 10% on the loan.

• This 5% difference is the "interest expense."

• Operating Costs. 

• This is the cost of running the credit card portfolio,

including everything from paying the executives who run
the company and their secretaries to printing the plastics
to mailing the statements to running the computers that
keep track of every cardholder's balance to taking the
many phone calls which cardholders place to their issuer
to tracking down fraud rings to protect the customers.

• The expenses involved in taking phone calls from

customers are usually the greatest of these categories.
• Charge Offs.

• Some customers never pay their credit card bill.

• In any given year, anywhere from 4% to 9% of the money that a

bank lends to its credit card customers will never be repaid.

• Some credit card issuers have had various troubles and seen this
number rise to over 20%.

• As this number climbs or becomes erratic, officials from the Federal

Reserve take a close look at the finances of the bank and may
impose various operating strictures on the bank, and in the most
extreme cases, may close the bank entirely.
• Rewards Costs.

• Many credit card customers receive rewards, such as

airline miles or cash back, as an incentive to use the
card.

• Rewards are generally tied to spending money on the

card, which may or may not include balance transfers,
cash advances, or other special uses.

• These rewards rarely cost credit card issuers less than

0.25% or more than 2%, and in fact will usually run in the
0.5% to 1% range, as a percentage of purchases.
• Fraud costs.

• Where a card is stolen, or an unauthorized duplicate made, a most

card issuers will refund some or all of the charges that the customer
would have otherwise received, for things they didn't buy.

• These refunds will in some cases be at the expense of the

merchant, especially in mail order cases where the merchant cannot
claim sight of the card, but in other cases, these costs must be
borne by the card issuer.

• The cost of fraud is high; in the UK in 2004 it was over £500 million.
• Offsetting those costs are the following revenues:

• Interchange fees. 

• Interchange fees are charged by the merchant's acquirer to a card-

accepting merchant as component of the so-called merchant discount fee.

• The merchant pays a merchant discount fee that is typically 2 to 3 percent

(this is negotiated, but will vary not only from merchant to merchant, but also
from card to card, with business cards and rewards cards generally costing
the merchants more to process), which is why some merchants prefer cash,
debit cards, or even checks.

• The majority of this fee, called the interchange fee, goes to the issuing
bank, but parts of it go to the processing network, the card brand (American
Express, Visa, MasterCard, etc.), and the merchant's acquirer.
• The interchange fee that applies to a particular merchant is a
function of many variables including the type of merchant, the
merchant's average ticket dollar amount, whether the cards are
physically present, if the card's magnetic stripe is read or if the
transaction is hand-keyed, the specific type of card, when the
transaction is settled, the authorized and settled transaction
amounts, etc.

• For a typical credit card issuer, interchange fee revenues may

represent about fifteen percent of total revenues, but this will vary
greatly with the type of customers represented in their portfolio.

• Customers who carry high balances will have low interchange

revenues, while customers who use their cards for business and
spend hundreds of thousands of dollars a year on their cards will
have very healthy interchange revenues.
• Charging interest on outstanding balances. 

• Customers who do not pay in full the amount owed on their monthly
statement (the "balance") by the due date (that is, at the end of the
"grace period") owe interest ("finance charges").

• These customers are known in the industry as "revolvers". Those

who pay in full (pay the entire balance) do not.

• These customers are known in the industry as "transactors" or

"convenience users".

• Interest charges vary widely from card issuer to card issuer.

• Fees charged to customers.

• The major fees are for:

• (1) late payments;

• (2) charges that result in exceeding the credit limit on the card (whether
done deliberately or by mistake);

• (3) Returned check fees or payment processing fees (eg phone payment
fee);

• (4) cash advances and convenience checks (often 3 percent of the amount);

•
• (5) transactions in a foreign currency (as much as 3
percent of the amount; a few financial institutions
charge no fee for this -- it is worth noting as an aside
that the credit card issuer charges a fee on top of
the international bank rate when converting
currency, which in most circumstances is a better
rate than is available elsewhere, even with the fee
added on); and

(6) membership fees (annual or monthly), sometimes

a percentage of the credit limit.