Everyone tells you to build your credit score. We want to tell you why you should be on the investor side too.
Though a feature of the urban population and not so well received in rural India yet, nearly 58 million people in India use credit cards. The credit card industry is estimated to grow at a CAGR of 25% till 2025, and opportunities like a huge untapped market lie before it. The credit card Base (Base I was first developed in 1973 as an electronic real-time authorization system for credit card transactions.) has grown by 8% YoY from 5.72 Cr. in February last year to 6.16 Cr. in February 2021:
The credit card industry is dominated by a few major players namely HDFC Bank (maintaining its position despite the 8 month ban by RBI), SBI Cards, ICICI Bank and Axis Bank with market shares of 24%, 19%, 17% and 12% respectively. In the next runk of players come RBL Bank with a roughly 5% share and Kotak Mahindra Bank with a 4% market share. All other banks make up for the rest. There is very limited market share held by foreign banks. Here is a visual depiction of the same, from Finshots:
A key metric here is the per card spends, that measures how much business one customer is giving its bank and though HDFC Bank and SBI seem to dominate the space, the per card spends tell a different story.
How does a credit card company make money?
Credit card companies are built around the concept of revolving credit. As opposed to offering a loan, these companies let you borrow money repeatedly (upto a limit) and let you pay back over time. You can either pay off the credit you use every month or pay a minimum amount for the time being and carry over the rest to the next month. Companies collect interest on this outstanding (unpaid) amount and make the major chunk of revenues here. They also collect interest when the cardholder withdraws cash from ATMs. Most Indian companies charge roughly 3.5% monthly interest and 40% of annual percentage rate.
The second source of revenue is through merchant payments. When a retailer accepts payments through a credit card, a commission (at the interchange rate) of that sale goes to the credit card company. Hence, you may often notice retailers accepting cards from certain providers, offering discounts and incentives to do so, because they tie up with these providers, in a quest to grow business for each other. This tactic of offering special incentives to credit card users is a famous tactic of companies to induce people to opt for their credit cards. Hence, a company must have a reputed name and good network to make the best of this. This explains why one notices well established banks doing well in this business, because they already have a base to sell this to.
It's interesting to note that after the internet boom and ever increasing urbanization, 7% of credit card purchases are those at e-commerce / online stores.
There also exist card network companies like Visa and American Express who are responsible to process these transactions and earn an assessment fee of roughly under 0.2% per transaction. Since such an electronic network infrastructure is tough and expensive to build and operate, this specified sector is an oligopoly with not more than 2-3 companies sharing market share.
In the business of lending, money unreturned are an inescapable evil. Bad debts are roughly 5% for most credit card issuers, and though they may not look like much of a problem, there is another situation that the "good customers and timely payers" pose. If borrowers pay the entire outstanding amount on time, carrying practically no debt every month, they receive incentives, gift vouchers and various discounts. Here is where these companies have a potential risk. If the number of "good borrowers" go up, it would mean that they are making less as opposed to if users carried their debt to the next month. and not to mention, the new generation are getting increasingly aware and do make use of this thing.
In India, only 3 out of every 100 people own a credit card, compared with USA's 320! The reason for this credit averse attitude is rooted in the conservative mentality of Indians of spending only within one's means and saving every penny. Loans are preferred by us, mostly for a house or vehicle, to achieve social validation. Compared to the USA's 127.11% of national debt to GDP ratio, India stands at just 89.56%.
Another temporary, yet major issue for credit card issuers is the pandemic situation. With the world economy crashing, and so many businesses shut down, consumer spending touched rock bottom. This posed a threat to most financial institutions and credit cards significantly. Many accounts were shut and bad debt ratios surged too. The uncertain nature of lockdowns taking place in various states did certainly slow down the recovery momentum.
Also, the RBI had banned HDFC Bank from issuing credit cards and imposed a halt of its digital business generating activities due to inefficiencies in its internet, mobile banking and payment systems over the last 2 years. Though the ban was lifted after satisfactory compliance, the 8 month halt was a big blow to the business of one of India's leading credit card issuers.
Positives > Negatives
Given the different hurdles presented, there are still enough reasons for the industry to pick up in India.
The unexposed rural India presents a huge untapped market, where companies can benefit by just being present and making people aware. SBI Cards is doing a great job here, given the SBI bank is the most widely recognized and trusted bank in the country and its presence is felt all over the country.
Most of the forecasted success is on the basis of the changing demographic, owing to their lifestyle changes and increased awareness. A greater piece of the population is in the earning age, with their disposable income rising and a higher working women ratio too. A booming economy is a boon to a cyclical industry like the credit card industry, since increased consumer spending is obvious.
With Government initiatives of making India a cashless nation, more plastic money is being made and people are shifting to digital ways to make payments since it offers convenience. Gen Z is also more financially aware, and recognizes the benefits of building a credit score as early as possible. The situation is conducive to the growth of the credit card industry in India.
With India's limping recovery from the pandemic, a new momentum in spending is finally visible. Much of this spending is attributable to pent up demand, since now consumers have regained the confidence to repay their debts. The upcoming festive season (and the various discounts offered by e-commerce sites during this time) is also expected to play a key role.
A healthy economy is a prerequisite for credit card issuers to do well. Given it’s a cyclical industry, it now presents a good chance to make profits with a short as well as long term perspective.
Here's something for DIY investors: Since it's important for businesses to be able to recover money for it to post consistent earnings, look for companies that have a strong KYC and card approval process, appropriate delinquency levels. A strong merchant network is very important too, since it's a crucial way of acquiring new business.
It was already mentioned that the segment is dominated by the top 2-5 banks since they possess advantages of low customer acquisition due to an inherent customer base, a stronger merchant network that helps retain customers through reward points and cash backs; and an efficient processing & analytics team.
Analyst recommendations for the same are:
Note: Since SBI Cards is the only listed player in this segment, it will always be a popular choice among investors, and a high degree of premium valuation will exist until other niche-specific players enter.
In a nutshell,
The credit card industry is ruled by a few strong banks, and a booming economy plus a suitable demographic profile is conducive to its growth.