Disclaimer: This is a broad industry article and not a commentary on any individual security. The intent here is to simplify and explain the working of a particular industry. This post is not a recommendation to buy/hold/sell any security. It is for informational purposes only. Investors should seek the advice of their independent financial advisor prior to making any investment decision based on this article or for any necessary explanation of its contents. The data used in this article is from publically available sources and I am not responsible for any discrepancy in the same.
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With the SBI IPO set to launch sometime in January, we thought this would be a good time to look at credit cards in India, understand their revenue model, and try to understand the drivers of growth in the space.
It would help to start by understanding how credit cards make money.
Interchange fee: There are five major players involved in any credit card ecosystem: The card user(average consumer), the issuer (HDFC, SBI, etc.), the network provider (Visa, Mastercard, Rupay, etc), the merchant (shopkeeper), and the merchant acquirer(link between merchant and network provider, also provides merchant with ancillary support services). Every time you use your credit card to pay ₹ 100, the merchant pays an interchange rate, roughly 2% to the merchant acquirer. Why would the shopkeeper agree to pay this fee? Because it effectively gives them access to a vast amount of customers who like to pay using credit cards. Of the ~2.0%, around ~1.5% goes to the issuer for taking the credit risk (i.e. possibility that the customer doesn't pay back, ~0.3% goes to the network for providing access to the network, and the rest stays with the merchant acquirer for onboarding the merchants into the network).
A small graphical representation of the same. Please pardon the shoddy design while I grow the business enough to afford a design person on the team! If you're a designer willing to do short pieces for us for a shout out and link back to your Website/Insta please do reach out at firstname.lastname@example.org
Membership & other Fees: Cardholders often pay annual membership fees to use the card. The membership fee makes sense given the host of benefits including access to credit, access to airport lounges, and reward points that most cards offer. In addition to this credit card companies also earn instance-based fees including late fees & reward redemption fees.
Interest Income: Clients of credit cards have an option to repay their credit card obligations over a period of time, paying a minimum amount every month. When they choose this option they pay an interest amount in addition to the principal amount (their credit card spend) based on rates set by the credit card issuer. This forms by far the largest chunk of revenue for credit card businesses.
Non-conventional sources: Card providers also have various other smaller sources of income including brand association fees from partners (Petrol pumps, restaurants among others) and business development incentive fees from network providers. These are generally extremely small contributors to overall revenue.
Having this basic backdrop, we can now move to understand the drivers of growth for the broader market, while keeping in mind the implications of each of those drivers for these line items.
What would drive overall growth in the credit card space
Based on the drivers listed above we can arrive at the following key drivers for credit card revenue growth
1. More cards
Increased credit card penetration: The low penetration of a particular item in India has probably been beaten to death as a rationale to justify growth. That being said, it helps to get it out of the way before we look at other factors.
3% credit card penetration: Credit card penetration in India stands at just around 3%, putting us not only significantly behind the leader here: US ( although at 320% penetration they have problems of their own) but also behind emerging markets players like Brazil at 73%, China at 42%, and Indonesia at 7%. A part of this can be attributed to Indian credit card firms becoming extremely conservative post the 2009 crisis, drastically slashing the cards in circulation. Most of it, however, is driven by consumer preference (Indians still aren't comfortable with credit) and access (lack of sufficient financial resources/history for an issuer to give credit).
While the consensus across the board is that this number will definitely shoot up, who will get it there is a question that is still under question. For example, the booming e-commerce market has been a big driver for credit card growth globally. And while it will drive growth for credit cards as well, NBFCs offering "zero cost EMI" financing for consumer durables could eat into some share from the credit card players.
Lower down the economic spectrum, for the historically underreached-underserved market, access to multiple digital data points on customers and cheap internet will draw a number of fin-tech lenders to fill the void. Players with a large install base, more data points, and greater capital to burn for customer acquisition (think Jio, Xiaomi, Airtel, Paytm) will in all likelihood be the winners of this game.
That being said, the drivers for credit card growth in the short-medium term are tremendously powerful Greater urbanization, greater organized retail spending, larger disposable income, deeper penetration of e-commerce players with Flipkart and Amazon making inroads into tier 2 and tier 3 towns, and the growth of contactless which will spur growth in credit card ownership.
Along with all the pull factors that will lead to an increased demand for credit cards, it is important to take into account the push factors as well. Banks across the country have begun to recognize the potential with India's retail base, and have been actively finding ways to push credit cards to the right customers. HDFC has recently begun giving its coveted Diners card to freshly minted b-school graduates by waiving off all fees for life (with the rationale possibly being locking in the loyalty of a high-value base very early, while also driving faster adoption amongst retailers who want these people to be able to shop at their stores.) Numerous cobranded cards with travel, oil, and other operators are also helping growth.
Based on RBI data, credit cards have grown at a 20% CAGR over the last 5 years, from around 2.1cr to now 4.7cr. A recent report had this number grow by 25% over the next year. All in all a very strong driver of growth for the industry.
2. More spend per card
More spend per card can basically come from two sources, one the customer spending more overall and second the customer using their credit card for more of their spending needs. Let us look at both of those factors in detail.
Increased spend per customer: India, despite its current position remains one of the fastest-growing large economies over the medium term. After a dismal performance in FY20, the IMF expects India to grow at 7%+ in real terms through 2024. In the same period, China and Indonesia are expected to grow at around 5.5% with Brazil expected to grow around 2.5% making India a clear outlier. The latest report expects consumer spending to grow at 7.5% through 2024. This combined with the approximately 5% inflation will imply a 12% growth in nominal consumption overall. Lets now look at the second aspect of the puzzle, credit cards capturing increased weight of average customer spend.
Increased weight of customer spend via credit card: The central factor here is increased discretionary spend by the Indian consumer. As more people move into the middle class every year the incremental income they get is diverted more towards non-discretionary items (consumer durables, dining, vacations etc.) From FY14 to FY18 discretionary spend has increased from ~47% to ~53%, a trend which will only increase from here. Given that credit cards are more likely to be used on discretionary spend this leads to a natural tilt in credit card weight. Other systemic factors like the growth of organized retail and online e-commerce, where again the use of credit cards is significantly higher, along with the attractive reward schemes that credit card companies are pushing and the partnerships they are striking with most players where you are likely to spend, all drive customers towards spending more of their monthly expense using credit cards. Which brings us to the last factor, and something which I'm personally not a huge fan of, Indians starting to have credit card debt.
3. More debt (hopefully within limit)
Unsecured loans (loans that are not supported by collateral) have shown tremendous growth in India, growing at ~28% over the last 5 years. As discussed above it is likely that a good share of this will be captured by NBFCs and new-age fin-tech firms, but credit card firms will undoubtedly benefit. The flipside of this, however, and something that we must be increasingly cautious about, especially as banks go overboard in trusting the retail segment in the aftermath of the corporate debt blowups, is that in a downturn this could get extremely tricky if we are over-levered, as the ability (due to lower pay) and willingness (because a lot higher importance of expenses for staples and debt repayments for assets like a house) of people to pay back credit card debt goes down significantly. The ability to dial back the number of cards in circulation for a bit, and take a hit on growth to preserve quality are tradeoffs that these card companies might have to make if we head into a serious downturn.
In summary, it looks like an extremely interesting space, with multiple levers of long term growth and a very interesting growth story in India. We will try coming out another detailed post on the competitive dynamic and potential disruptors in the space sometime soon. Do let us know if there is anything else you would like us to cover in the comments below.
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