In the 1990s, India witnessed the introduction of credit cards to the general public, a financial instrument initially designed to cater to traders and businesspeople facing working capital crunches. However, these corporate products were rebranded and sold to the common public without fully understanding the complexities involved. This shift in usage and target audience led to significant misconceptions and financial struggles for many individuals who failed to grasp the true nature of credit cards. In this blog article, we will explore the history, implications, and underlying issues surrounding the curious case of credit cards in India.
The Curious Case of Credit Cards
Table of Contents:
- The Origin of Credit Cards
- How cash credit facility (or say credit cards) are used typically
- Rebranding for the Masses
- Ideal Use of Credit Card - Travel Reimbursement Scenario
- Misuse of Credit Card - Treating it as Extra Income
- The Pitfalls of Mis-Selling
- The Impact on Personal Finance
- Examples of How Credit Cards Can Be Used Wisely
- Scenarios where credit cards can be used wisely
The Origin of Credit Cards
Originally, credit cards were intended to serve as a cash credit facility for traders and businesses dealing with working capital shortages. The concept allowed traders to rely on pre-sanctioned bank loans to fulfill their immediate financial needs. Once they received their profits in the subsequent business cycle, they would repay the borrowed amount, along with a small interest fee. This credit facility served as a viable tool for businesses to manage their bill receivables effectively.
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How cash credit facility (or say credit cards) are used typically
Imagine you run a small retail shop in India, and you need to stock up on inventory to meet the demands of your customers during the festive season. However, at the moment, you don't have enough cash on hand to purchase the goods from your suppliers. This is where a cash credit facility comes to your rescue.
•You approach your bank, which knows your shop's business history, and apply for a cash credit facility. The bank, based on your shop's financial credibility, approves a cash credit limit of ₹50,000 for you.
•With this cash credit facility, you can now confidently go to your suppliers and purchase the inventory you need for your shop, even though you don't have the money in your account right now. Let's say you buy the inventory worth ₹40,000.
•Now, your cash credit balance stands at ₹50,000 (the limit) - ₹40,000 (amount spent on inventory) = ₹10,000.
•As your shop operates during the festive season, you sell the goods to your customers and collect payments from them. Let's say you make a total of ₹30,000 in sales during this period.
•At the end of the festive season, you have a choice: you can either repay the borrowed amount or continue using the remaining cash credit balance to meet any further financial requirements for your shop.
•If you decide to repay the borrowed amount, you would return ₹10,000 (the remaining cash credit balance) along with a small interest fee to the bank. This fee is usually charged on the amount you borrowed and the time you used the money.
•Now, your cash credit balance is back to zero. But since your shop had a successful festive season with ₹30,000 in sales, you're in a better financial position, and you can apply for a cash credit facility again in the future if needed.
Rebranding for the Masses
However, in the 1990s, financial institutions saw an opportunity to expand their customer base and boost revenues by rebranding credit cards as consumer products. The idea was to offer individuals the convenience of making purchases on credit, and if managed responsibly, they could enjoy interest-free loans for a certain period, typically around 40 to 50 days. This concept was marketed to the public as a hassle-free way to manage personal expenses and bridge temporary financial gaps.
Let's create an example to illustrate the ideal way of using your credit card and the potential consequences of misusing it:
Ideal Use of Credit Card - Travel Reimbursement Scenario
Meet Ramesh, a salaried professional who works in a multinational company. His employer has offered him a business travel opportunity to attend a conference in another city. The company policy states that all travel expenses will be reimbursed after the trip, but Ramesh needs to cover the upfront costs himself.
Scenario 1 - Using the Credit Card Wisely:Ramesh decides to use his credit card smartly to fund his travel expenses. He has a clear understanding of the credit card's purpose and the importance of managing his finances responsibly.
Travel Booking: Ramesh books his flight tickets, hotel accommodation, and conference registration fees using his credit card, amounting to ₹50,000.
During the Travel: Throughout the trip, Ramesh keeps track of his expenses and ensures that he only spends on necessary business-related items, maintaining fiscal discipline.
Post-Travel: After returning from the conference, Ramesh gathers all his travel-related receipts and prepares an expense report for reimbursement. The total amount to be reimbursed is ₹50,000.
Reimbursement: Ramesh submits the expense report to his employer, and they process the reimbursement in a timely manner. Ramesh receives the full amount of ₹50,000.
Credit Card Repayment: With the reimbursed amount, Ramesh immediately pays off his credit card bill, avoiding any interest charges. His financial position remains stable, and he continues with his regular budget and disposable income as planned.
Misuse of Credit Card - Treating it as Extra Income
Meet Ramesh, a salaried professional working in a multinational company. His employer offers him a business travel opportunity to attend a conference in another city. The company policy states that all travel expenses will be reimbursed after the trip, but Ramesh needs to cover the upfront costs himself.
Travel Booking: Ramesh uses his credit card to book his travel expenses for the conference, totaling ₹50,000.
TDuring the Travel: Ramesh follows his initial plan during most of the trip but ends up making some unintended non-essential purchases, which amount to ₹10,000.
Post-Travel: After returning from the conference, Ramesh gathers all his travel-related receipts, including the unintended purchases, and prepares an expense report for reimbursement. The total amount to be reimbursed for the actual travel expenses is ₹50,000.
Reimbursement: Ramesh submits the expense report to his employer, and they process the reimbursement for the actual travel expenses, which is ₹50,000.
Credit Card Bill Arrives: Ramesh receives his credit card bill, which includes the ₹10,000 unintended purchases. Since he was expecting a reimbursement of ₹50,000, he decides to pay the ₹10,000 from his next month's salary, thinking it won't affect his budget.
Next Month's Budget: In the following month, Ramesh's salary is short by ₹10,000 due to paying off the unintended purchases. His disposable income has reduced by this amount, causing a strain on his usual budget.
Financial Struggle: With his disposable income reduced, Ramesh struggles to manage his regular expenses and finds it difficult to maintain his usual standard of living. He may have to cut back on other expenses or borrow money to make ends meet.
In this scenario, Ramesh misused his credit card by making unintended non-essential purchases, thinking he could easily repay them once he received the reimbursement. However, when the credit card bill arrived and he had to pay from his next month's salary, it led to a reduction in his disposable income and disrupted his budget. Ramesh now faces financial strain and must find ways to manage his expenses with less income or consider borrowing money to cover the shortfall.
The Pitfalls of Mis-Selling
The mis-selling of credit cards to the general public brought several inherent issues to the forefront. Many individuals were unfamiliar with the complexities of this financial instrument, and credit card sellers often failed to educate customers properly about its proper usage and implications. As a result, a significant number of credit card holders did not comprehend the billing cycle, interest rates, and the potential impact on their disposable income.
Unlike in a business context, where credit facilities are used to manage bill receivables, credit cardholders don't have outstanding bills to offset their spending. The credit card bill is essentially a reflection of the income that has already been received, and using the credit card means the next month's income will be reduced due to the repayment obligation.
The Impact on Personal Finance
This lack of understanding and financial literacy among credit cardholders has led to various adverse consequences. Many individuals struggle to maintain proper credit card management, resulting in accumulating credit card debt. The interest rates on credit cards can be substantial, and failing to clear outstanding dues on time can lead to a debt trap, where borrowers may find it challenging to escape the cycle of debt.
Additionally, the easy availability of credit cards has contributed to the increasing demand for personal loans. People resort to personal loans to manage their mounting credit card debts, leading to a shrinkage of disposable income and a potential burden on their overall financial well-being.
Here are a few examples of how credit cards can be used wisely by consumers:
•To build your credit history. When you use your credit card responsibly and pay your bills on time, you are building a good credit history. This can help you qualify for loans in the future, such as a mortgage or car loan.
•To earn rewards. Many credit cards offer rewards programs that can earn you cash back, travel points, or other benefits. If you use your credit card for everyday purchases, you can earn a significant amount of rewards over time.
•To protect your purchases. Many credit cards offer purchase protection, which can help you if your purchase is lost, stolen, or damaged. This can give you peace of mind knowing that you are protected in case something goes wrong.
•To get access to exclusive benefits. Some credit cards offer exclusive benefits, such as airport lounge access, travel insurance, or discounts on hotels and other travel expenses. If you travel frequently, these benefits can save you a lot of money.
Here are some specific examples of how credit cards can be used wisely in these situations:
•If you are expecting a large refund or tax return. You can use your credit card to pay for expenses in the meantime, and then pay off the balance when you receive your refund or tax return. This will give you the benefit of using your credit card for purchases and earning rewards, without having to worry about paying interest.
•If you are buying a large item that you will need to finance. You can use your credit card to finance the purchase of a large item, such as a new car or furniture. This will give you the benefit of spreading out the payments over time, and you may be able to get a lower interest rate than you would with a personal loan.
•If you are traveling and need to rent a car or book a hotel room. Many credit cards offer travel benefits, such as rental car insurance or free upgrades on hotel stays. You can use these benefits to save money on your travel expenses.
In conclusion, The curious case of credit cards in India serves as a cautionary tale about the mis-selling of financial products. While credit cards can be valuable tools when used responsibly, their transition from a corporate product to a consumer product was not without pitfalls. The lack of proper education and understanding among credit cardholders has resulted in financial struggles for many, with rising personal loan debts and diminishing disposable incomes. Financial institutions must prioritize customer education and transparency to ensure that individuals fully grasp the implications of the financial products they are offered. Moreover, consumers should take the initiative to educate themselves about credit cards and their responsible usage to avoid falling into the trap of mismanaged debt. By promoting financial literacy and responsible borrowing, we can create a more financially secure future for ourselves and our society.
