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How your credit card works

IT'S said that Forewarned is often Forearmed. This aphorism has given birth to a generation of knowledge seekers. Everyone wants to know every detail about everything before they do anything.

August 19, 2011 / 03:30 PM IST

IT'S said that Forewarned is often Forearmed. This aphorism has given birth to a generation of knowledge seekers. Everyone wants to know every detail about everything before they do anything. No wonder websites like have been born and are doing rather well.

While it may not serve any purpose to know how snow leopards mate or how galangal is grown in Thailand, there are a few things that we would do well to learn about. Credit cards is definitely one of them.

Let's learn some fast facts:

The Basics

  • When you apply for a credit card, the bank you apply to carefully screens your application. You cant blame them given that there is always a crook around the corner.

  • A credit limit is worked out for you, based on your financial capability and other parameters like income levels, educational qualifications, age etc. The bank that issues you the card is called the 'issuing bank'.

The Business

From the bank's point of view, credit cards are good business for two reasons.

  • Banks make money through fees from merchant establishment.

  • The higher than normal interest rate paid by cardholders for the balance in their card.

  • So what are these merchant establishments? These form the heart of the business. Merchant establishments can be hotels, shops, travel agencies or any place where money transactions are made. The banks that enroll merchant establishments are called 'acquiring banks'.

  • The relationship between the bank and the merchant establishments is run via international networks such as Visa and Master card.

  • Your credit card is valid in any merchant establishment that accepts your network (ie Master Card or Visa), irrespective of the issuing bank. Most Indian card issuing banks are part of either Master Card network or Visa network, or both. There are others credit card networks like American Express and Diners Club too.

  • The merchant establishment finds the credit card a safer and efficient payment mode, and brings more business. The merchant establishment pays a fee to the bank that enrolled it for the service.


The Transaction


  • When you use a card at an establishment to purchase a product or service, your card is swiped on a swipe-machine. The swipe machine is connected to a central computer belonging to the network, which in turn is connected to all issuing banks.

  • The system verifies with your issuing bank whether you have sufficient credit to cover the purchase in a few seconds, and approves or rejects the transaction. As soon as approval comes through, you are asked to sign the charge slip. The merchant then verifies your signature with the one at the back of the card.

  • The charge slip is then forwarded to the acquiring bank, which in turn settles the transaction with the merchant. The issuing bank also proceeds to bill you for payment as per the cardholder agreement. The acquiring bank will settle the transaction with your issuing bank through the network.

Sounds pretty straightforward? Then you're wondering why credit cards are such accursed instruments? That happens when you delay payments and get caught in an interest cycle. When you use a credit card you have the option to pay only a part of the total amount spent and carry forward the balance. But in such a case you will have to pay interest on all your purchases without any free credit period.

You can save yourself only if you are prompt in paying the balance by the due date. Credit card users get a free period of credit before they reimburse the credit card issuing bank. This may vary from 15 days to 40 days depending on the issuing banks.

So that concludes our session on How Credit Cards Work. If you're now looking for information on How Snow Leopards Mate then you're on the wrong site my friend!

Disclaimer: While we have made efforts to ensure the accuracy of our content (consisting of articles and information), neither this website nor the author shall be held responsible for any losses/ incidents suffered by people accessing, using or is supplied with the content.

first published: Aug 4, 2011 07:00 pm

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