Credit Cards

From Open Risk Manual

Definition

Credit Cards denotes a type of credit product that combines a line of credit with a payment card to offer flexible availability of (relatively) small unsecured funds for both consumer and corporate use

Credit Card Product Details

Besides the credit institution underwriting the credit risk, a credit card involves also a credit card company operating the payments system.

  • Using the card for payments incurs charges for the buyer and/or the seller
  • Interest rate calculation: it is usual that there are no credit charges when balances are paid in full within a predetermined period. Unpaid balances are charged a variable rate.
  • There is typically a minimum payment requirement for each period
  • There is typically a credit limit

Credit Risk

The primary risk with credit cards is credit risk. It is a type of retail credit risk, namely the legal entity that may default on the credit card contract is a physical person. Correspondingly the obligations and legal framework that is applicable in such a case is determined by the laws governing the responsibilities of physical persons for honoring their financial contracts. These laws vary considerably from country to country. Psychologically, consumers are more likely to default first on their credit card obligations.

In common with other credit risk types, credit card credit risk can be decomposed into Default Risk and Recovery Risk. Since credit card contracts typically do not use any form of credit collateral (unsecured credit), recovery risk can be significant. Given that the actual utilized amount on the card is not predefined, there is also Exposure Risk.

Issues and Challenges

  • Consumers may become heavily indebted and finance essential needs using relatively more expensive credit card debt

See Also


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